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Source link: http://archive.mises.org/16438/the-social-function-of-insurance/

The Social Function of Insurance

April 11, 2011 by

With insurance the client pays a small amount of money (the premium) in exchange for a more certain future, in which his wealth will not fluctuate as wildly in different possible scenarios. FULL ARTICLE by Robert P. Murphy


Nate April 11, 2011 at 8:46 am

Since insurers are also looking to reduce their own risk exposure, it is practical for them to issue rules, guidelines, and/or incentives to policyholders that increase safety, reliability, and performance. One of the more prominent in the shipbuilding realm is Lloyd’s Register. A little blurb from their website:

“Our classification services are designed to ensure that your vessel is maintained in accordance with our Rules. Developed as a result of extensive research and experience in the maritime industry, our Rules and Regulations set standards for the design, construction and ongoing maintenance of ships.

Our periodic class surveys enable you to manage your ship to its full potential, maintaining operational effectiveness while minimising risks to life, property and the environment.”

Walt D. April 11, 2011 at 11:45 am

Good article. You might want to add some material on the following.
1) The role of the State Insurance Commissioner’s Office – while purporting to “protect the consumer”, how it brings corruption and inefficiency into the process.
2) The use of life insurance as a means of avoiding probate and death taxes.

Tony Fernandez April 11, 2011 at 12:17 pm

Anything that these progressives hate, such as anything that people can make a fortune on, will be denegrated as gambling. Forget the useful function that investing serves. It’s nothing more than a casino. They forget that even a casino serves a useful function at it is entertainment for so many.

Living in ivory castles would make anyone else look contemptible. I guess the air is pretty think up there too.

Inquisitor April 11, 2011 at 12:24 pm

Let’s call them by their proper name – regressives.

El Tonno April 12, 2011 at 3:31 am

That’s discrimination!!1!! Because “Progressive Brains have more Grey Matter”!

“A new study shows liberals have more gray matter in a part of the brain related to understanding complexity, while the conservative brain is bigger in the section linked to fear.”


Anakin Skywalker was a conservative!

Shay April 11, 2011 at 1:19 pm

On the subject of demonizing insurance companies, this sentence from the article is open to it:

In practice, insurers quote different premiums based on the risk of the applicant, and may deny coverage altogether for particularly risky cases.

I can just see the “deny coverage, how evil” comment. Here’s my rewording that makes clear what is really going on, and why it’s not out of malice: “… and because coverage for particularly risky cases would be so costly that nobody would buy it, it is not offered”

BoB April 11, 2011 at 12:25 pm

Mr. Murphy,

Good Article….

Ironically I was having a discussion with my friend the other day, and he has quite a few automobiles, and it burnt him up that the State Requires him to keep minimum liability on his payed-for vehicles that he doesn’t drive maybe once a year. Of course his solution was to put a bond up at the county office for the State to hold on to, and if you have 0 claims you get your money back. He also believes the liability should be on the driver. Keep in mind this was for Minimum liability that the State requires to drive on State Funded roads. Hopefully I understood him right on his solution, but like I said to him, the State never has a “Dedicated Fund”, and obviously what govt. does is never efficient nor good for the customers. Plus how can a company valuate tangible property, just qualifying the driver? He agrees for insurance on a vehicle thats has a lien, for obvious reasons, but his gripe was with the State telling him he must have it, and of course he blames the insurance companies profiting off him, in that regard.

I guess overall what I’m trying to say, is how does the State factor into the insurance business, since many States require a minimum liability amount to drive. Is this the result of lawyers and insurance companies lobbying, etc. aka a primer for more business for the monopolized court system?

BTW, I disagree with his solution.

Patrick Barron April 11, 2011 at 1:29 pm

The state’s usual argument for mandatory insurance is that it protects us from irresponsible people who will harm us and not have the resources to compensate us. But how can the state force anyone to do this? It can’t. Empirical studies have shown that there are just as many uninsured drivers on the road as ever. And there will be more, because mandatory insurance, enforced by the state insurance commissions, makes it difficult for low cost insurers to enter a market. So prices go up, quality goes down, and more do without insurance. To counter higher costs, insurance commissions deny price increases to insurance companies, so some actually leave the state, as happened in New Jersey. Just more of the blessings of socialims.

Patrick Barron April 11, 2011 at 1:22 pm

Dear Bob,
Excellent, as usual. You simplify something that most of us see as complex, but it takes a great deal of understanding to make the complex appear as simple.

greg April 11, 2011 at 1:57 pm

The problem most people have is that they are over insured. For example, there are many people that still carry $100 deductible on their auto insurance and paying a high premium. If they make over $50,000 a year, their deductible should be $1000 or more. Furthermore, if you damage your car and place a claim for a dollar more than your deductible, your insurance cost will rise and you will pay many times the cost of the claim over 3 years. This is why when my daughter wrecked her car, I was better off to not to submit the claim and pay cash for the damage to all parties.

i agree that insurance is not gambling, the odds are so high against you, a better statement would be you are giving the insurance company money. It is simply a service which anyone can pay for or not. For me, the less I pay, the better off I am. I have never carried a life insurance policy because I could not justify paying for something that i could never benefit from. Instead, I invested in education and training for my wife and kids so that they could earn a good living without me whether I am dead or alive.

For me, not carrying some insurances and maintaining high deductibles worked the best. Over 20 years, I saved over $250,000 in premiums which more than covered all the education cost for my kids and wife. But that is my choice.

Ned Netterville April 11, 2011 at 2:37 pm

There may be less to insurance than meets the eye, as described in this article and in Nate’s comment. The desire for security such as insurance purports to provide has led to some undesirable consequences that may or may not fully compensate for the supposed advantages mentioned by Professor Murphy and Nate. While I recognize that they both are endorsing completely voluntary measures to make the future more secure, where the beast the State exists, involuntary measures are bound to be imposed to achieve that unachievable end, for security is the primary reasons why so many people accept the State as desirable, necessary or inevitable.

Although, for example, Lloyd’s classification services mentioned by Nate will undoubtedly encourage good maintenance and safety practices among their clients, and because of the company’s concentrated interest in maritime safety, Lloyd’s research will undoubtedly discover practices and procedures that make shipping safer, which might not otherwise have been understood nor broadly shared with many others. That is what is seen. What is not seen are possible foolhardy acts by ship captains or owners undertaken because they are insured against suffering the full consequences of their behavior. A captain or owner insured against loss may well be made less responsible for being able to slough off some of the negative consequences of one’s own foolish behavior on others. Lloyd’s best efforts cannot ensure sound judgment under stress by its clients. I happen to believe that insurance tends to diminish the utmost responsible behavior.

The desire for security through insurance and belief that it can be thus attained has led democratic majorities to limit the freedom of minorities by requiring them under penalty of law to buy insurance. Thus we have mandatory-vehicle-insurance laws in many states, and we have Obama Care’s IRS-enforced mandate that everyone must buy medical insurance. Such egregious violations of the rights of minorities and the principles of liberty are the result of efforts to secure the future through government.

Of course neither Murphy nor Nate would endorse State-mandated or State-subsidized insurance, the latter of which really isn’t insurance in the true sense of that word’s meaning. But in passing it is worth pointing out that such “insurance” programs may be among man’s dumbest inventions, yet are sold and viewed by many as good forms of insurance. State-subsidized insurance unquestionably promotes irresponsible behavior. Thus government-subsidized flood-insurance induces housing developers and home owners to build and rebuild and rebuild again housing where no housing should or would exist because the threat of loss would be prohibitive, such as on barrier islands or flood plains. Social Security and Medicare are other egregious perversions of man’s desire to insure against the future’s uncertainty. The approval of so many people of the State itself, with all of its taxes and wars and other debilitating costs, is based on the same desire for security against the unknowable future that motivates purchasing insurance.

For myself, I rely on the wisdom of Jesus to keep me safe from the potential hazards the unknown future holds. In his Sermon on the Mount he advised: Take no thought, saying, What shall we eat? Or what shall we drink? Or with what shall we be clothed?…Your heavenly Father knows that ye have need of all these things. But seek ye first the kingdom of God, and his righteousness, and all these things shall be ministered unto you.” This advice, as I interpret it, has saved me a lot of unnecessary worry and a ton of insurance premiums.

Dagnytg April 12, 2011 at 1:24 am


What you’re describing is called moral hazard.

Aaron April 11, 2011 at 5:11 pm

Can anyone tell me why fractional reserve banking is flawed but insurance is okay? I’m a libertarian who accepts fractional reserve banking as valid as all parties understand the trade and risk.

Insurance is a promise to pay. If a massive event caused an increase in policy holder claims, would this not put pressure on the reserves set aside by the insurance company and maybe even cause a failure?

In the same manner, bank runs occur when demand deposit holders want their cash now rather than later and bank reserves run out. So I’m confused as to why insurance is okay morally and ethically.

Daniel April 11, 2011 at 10:30 pm

Depends on what “type” of libertarian you are:

> Some interpret FRB as fraud, plain and simple, so it should be outlawed on its face.

> Others, interpret FRB not as inherently fraudulent as long as it is clarified in contract, that is, CDs just hold cash and pay a [storage] fee, liabilities are immediate fulfilled; savings pay interest because the bank is contractually allowed to invest a portion of your savings, earning a return, but liabilities can only be fulfilled in the future.

As a practical libertarian, I take Rothbard’s position that in a free market for banking services, FRB would be nearly impractical and reserve margins would near 100%

Daniel April 11, 2011 at 11:11 pm

I just noticed I didn’t address your concerns regarding insurance. Sorry. I have to turn in now, but I’ll try later

Aaron April 12, 2011 at 10:44 am

I think I agree with you that FRB would be nearly impractical. I however believe that deposit holders would demand a higher risk premium for their deposits in a truely free banking sytem w/o the Federal Reserve, FDIC insurance, etc. with the understanding that their deposits do not have 100% reseves.

nate-m April 12, 2011 at 2:49 am

Can anyone tell me why fractional reserve banking is flawed but insurance is okay? I’m a libertarian who accepts fractional reserve banking as valid as all parties understand the trade and risk.

I, for one, do think that while fractional banks should allow to exist they are not trustworthy and it would be foolish to trust your money with them.

The problem with the fractional banking system is the fiat money schemes and government manipulation of the banking system required to keep it afloat.

If you want to put your money into a organization that will reinvest it and loan it out your far better off lending it to somebody that will be honest about it. That way while your assuming the same risk as a savings account in a fractional bank your more likely going to get a honest return on your investment rather then some pitiful savings account interest rate.

Aaron April 12, 2011 at 10:45 am


Higher risk premiums would be needed to induce participants in FRB.

Shay April 12, 2011 at 12:02 pm

My take is that insurance doesn’t create any new money or money-like things, therefore it’s not a source of inflation and thus OK. If there were unexpected large claims, the insurance company simply wouldn’t be able to pay. This would cause hardship, but this would be due to the unexpected large damage causing the hardship, not artificial money creation.

Dave M April 11, 2011 at 10:27 pm

Insurance policies are fine until they are mandated by the state. Once insurance becomes compulsory by law the rates go up. I have a hanger at the local airport and until recently you were not required to have liability insurance on your hanger. The municipality dreamed up this new requirement about three years ago. The liability insurance on the hanger costs more than the insurance on my plane!

The hanger owners had a meeting with the county about their new insurance requirements and their representative said it was simply due dilagence on our part to be insured. I pointed out there was no law requiring a homeowner to obtain insurance on his property in the same county so why the difference with an airport?

Up until the 1980′s you were not required to have any insurance what ever on private aircraft in Canada. Of course someone felt that there was a pressing need to make it mandatory to have aircraft insurance. Prior to being compulsory insurance rates were quite reasonable. Once it became mandatory of course the rates almost doubled.

This same county has no insurance on any of its own vehicles. There is a loophole allowing municipalities to be exempt. This is an example of the state being in collusion with industry at the expense of the taxpayer.

Dagnytg April 12, 2011 at 3:15 am

Reading this article, though in its economic purity I understand the insurance business model, I can’t help but feel like a minarchist is trying to convince me how virtuous a limited government would be when all I can see around me is a vast, intrusive gov’t so large and complex that it is impossible to believe otherwise.

That’s how I view the insurance industry.

It has great power and influence in government. It has dictated not only mandatory insurance laws but has its hands in public policy ranging from building codes to seat belt laws and that’s just scratching the surface.

I’m making an educated guess, but I bet we can track the growth of the industry with the growth of government.

And excluding the moral hazard issue for the moment…can someone explain to me how insurance is any different than a ponzi or pyramid scheme?

Inquisitor April 12, 2011 at 8:26 am

How is it even remotely similar to either scheme?

Dagnytg April 14, 2011 at 3:19 am


Sorry for the delayed reply…work bs.

In simple terms, ponzi/pyramid schemes and their variations (i.e. social security) have one theme in common. They all require a continued addition of people to support future delivery of a promise.

If there becomes a shortage of new recruits, potentially there is a problem in delivering that promise. If all (or an inordinate amount) require delivery at the same time, the same problem arises. Of course, if both occur then it is assured that what was promised will be shown to be a lie (i.e. Madoff).

Insurance follows the same model as stated above. It constantly requires new people to pay into a system with the hope that very few will actually collect or collect at the same time. If the variables collide, as they do when disasters strike, then you have an example of a future promise not being fulfilled.

In many ways, Aaron raises a good point in paralleling fractional reserve banking with insurance. With FRB you have more than one party claiming title to the same property. It seems to me insurance runs into the same problem though, I admit, indirectly. Needless to say, the outcome of bank runs and runs on insurance are very similar.

I might point out that insurance, in many ways, is a response to an inflationary society. In other words, in a sound money society prices generally remain stable. Thus replacement costs stay equal (or fall) overtime. Henceforth, insurance doesn’t become such a necessity. (It would be interesting to see how insurance fared in the 18th and 19th centuries.)

Obviously, it is intent that differentiates between insurance or social security and your typical ponzi/pyramid scheme.

But the longer I continue to contemplate life, through the lens of libertarianism, it has occurred to me, like gov’t itself, that certain business models (regardless of their intentions) become inherently an antithesis to the libertarian ideal. And like FRB and IP, I question whether insurance should not be put on that list.

Ned Netterville April 13, 2011 at 8:28 am

>Dagnytg, IMHO your remarks regarding the insurance industry’s ties to and influence upon the growth of big government are spot on, although I think the same condemnation by libertarians could as well be applied to many other big, government-franchised–aren’t they all?–corporations and their industries, such as those in the auto and banking industries.

Regarding an insurance company becoming insolvent and unable to meet its obligations due to too many claims at once, it seems to me that if the company is truly a “mutual” company it could and would meet its obligations by assessing all of its policy holders with sufficient additional premiums to cover all insured losses. Yes, No?

Dagnytg April 14, 2011 at 3:57 am


In regards to your last paragraph, you’re right-they could and probably would increase their premiums but there is a time delay in collection and people may not re-up due to the increase. Furthermore, many may bail because they fear their insurance company (due to rate hikes by way of disasters) may not be able to deliver on its future obligations.

These outcomes are what lead to the collapse of most ponzi/pyramid schemes. Too many drop out and too many want to collect… all at the same time.

If I had to chisel it down-the insurance business model is flawed because it does not have enough to cover all its obligations. And isn’t that the essence of the worlds problems these days?

Len @ seguros medicos April 20, 2011 at 11:13 am

Your content is fantastic for the general public and insurance professionals alike.

Matt Taylor April 23, 2011 at 1:50 am

Insurance companies have a bad image. But I think it is right to mention the important social function of insurance as a whole for the society. Without insurance each person would have to bear the risk alone and that is way more negative than the disadvantages some insurance policies surely have.

David - Expert In Term Life Insurance June 29, 2011 at 4:16 am

Who wouldn’t want to reduce the risk of exposure? Having your properties insured will protect not only the things you own but also you. With insurance at our side, you wouldn’t have to be burden with the risk alone. This is nothing compared to some insurance policies that are a little disadvantageous.

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