The Conflict Between Pricing
for Risk and Social Good

Edward J. Dodson

[29 April, 2012]

In our everyday lives we are exposed to all manner of risks. Long ago people decided to provide a degree of protection against some forms of risk by introducing insurance plans. Every member of the community was required to make regular payments into a fund from which an allocation would be made in the event a member experienced a covered loss. This idea of shared risk is ancient. Pricing for risk eventually emerged as statistics were collected on the frequency of events and the characteristics of those most likely to experience various types of injury, disease, property loss and exposure to one of many forms of natural disaster.

When modern for-profit insurance companies price for the risk associated with providing protection to individuals based on like characteristics and behaviors, this should be a signal that if we want insurance coverage we must either pay the appropriate premium or make changes in what we do. Those who voluntarily engage in high risk behaviors should not be permitted to be "free riders" on the risk of the population. Smoking cigarettes, regularly consuming excessive quantities of alcoholic beverages, using other addictive drugs, becoming grossly overweight, engaging in extreme sports, building in harm's way (e.g., at sea level, on or near an earthquake fault, below a periodically-active volcano, etc. etc.).

Societies face hard decisions regarding which risks ought to be subsidized. A good example is the rate of interest charged to home buyers in need of mortgage financing. Pricing for the actual risk of default would tend to adversely affect lower income households and others whose income and employment are at a known greater risk of interruption. Pricing for risk would preclude some portion of this population from becoming homeowners -- a long-standing societal objective promoted by public policy.

And, then, there is the matter of health care. The law requires hospitals to treat all persons who come through their doors regardless of whether the person is covered by insurance or has the financial resources to pay for the services rendered. When neither an insurance company nor personal assets are available, the costs are passed on to the general population. Almost no one believes this is an equitable or efficient system of health care. What changes ought to be made is the subject of endless debate and almost no agreement.