What is insurance?

For many of us, insurance is a routine part of economic life. We insure our homes, our health, our phones, our cars, our lives. We pay premiums to an insurer, on a regular schedule, to secure the right to compensation if harm or loss befalls us. This allows us to replace what is lost, stolen, or destroyed; to get back on our feet after an accident or disaster; to provide financial security for our family members; and to navigate the fundamental uncertainties of life with a bit more confidence. 

 

For the insurer, our premiums are capital that can be reinvested in assets that generate income, which is what allows the insurer to pay our claims and make a profit. The insurer manages its portfolio in large part by being choosy about which risks to insure, subject to regulation. The ideal customer is someone who is less likely to make a claim, so insurers put a lot of resources and energy into figuring out who and what is low or high risk, selling policies and setting insurance rates accordingly. 

 

Framed this way, insurance reads like a tool for managing our individual risks through a two-way contract with an insurance company or public insurer. It is that. 

 

But when we sign those individual insurance contracts, we join what insurers call a “risk pool.” We agree to share our risk: to contribute something so that if calamity strikes any one of us, there are enough resources to make us whole. Insurance forges a community of fate. The legal scholar Tom Baker has written that insurance arrangements reveal our social compact. Through its very routine, mundane operations, insurance “define[s] the contours of individual and social responsibility.” When an insurer establishes what or whose perils to insure, at what prices, and according to what conditions, it creates relationships of obligation, including some and excluding others. 

 

The consequences of being excluded are serious. Not having insurance means you don’t get access to the compensation that can help smooth out the economic disruption of getting sick, getting flooded, or losing your job. 

 

The effects of exclusion ripple out further when we consider property insurance, the kind of insurance policy you take out on a home. Not having access to this kind of insurance—whether because it is prohibitively expensive, or because insurers refuse to underwrite in a particular neighborhood or city block—can also make it extremely difficult to build wealth through homeownership. This is because having insurance is a condition of getting and holding a mortgage. For most of us, getting a mortgage is necessary for purchasing property. And purchasing property, in the United States, is one of the principal paths to economic prosperity. Insurance is an unavoidable passage-point on the journey to realizing the American dream. 

 

Communities of color, and particularly Black communities, know this all too well. They have for decades encountered more difficulty getting access to insurance (as well as credit and mortgages), which has in turn made it harder to acquire property and build wealth. Beginning in the 1930s, federal officials “redlined” Black neighborhoods, marking them as “too risky” for investment–designations that were then incorporated into the decision-making of banks and insurers for decades to come. The legacy of redlining practices, which were formally outlawed in the 1970s,  is still felt today, and racist assumptions and practices continue to shape housing markets. A 2023 Harvard University study found that in nearly every state, people of color are less likely to own homes compared to white households; Black households have the lowest homeownership rate nationally. Racial wealth gaps persist and appear to be growing. An analysis of the latest federal data shows a total difference of $240,120 in wealth between the median white household and the median Black household–much of that bound up in the wealth that accrues from home ownership. 

 

Through inclusion and exclusion, and the creation of ‘communities of fate’, Insurance is a profoundly social institution, as well as an individual economic tool. And because of the ways insurance is implicated in setting relations and boundaries of responsibility and obligation, questions about how to design, adjust, or interpret insurance arrangements are unavoidably moral and political ones. 

 

At stake is not only a determination of who is in and who is out—who gets access to networks of risk sharing and who must go it alone—but also whether or how individual insureds can be made responsible. Insurers manage risk in part by trying to influence behavior. The price of insurance ought, in their view, to act as an incentive—lower your risk and lower the price you pay. This is not only economically efficient and rational, it also satisfies what insurers call “actuarial fairness”: everyone pays their “fair share.” 

 

This presumes that risk is in fact “yours,” something you have the power to ratchet up or down by the force of your choices alone. But the “choice” to live in a fire-prone area, for instance, is the result of many factors, some of which transcend and predate the homeowner trying to find affordable insurance. It has to do with long histories of zoning, real estate development, economic inequality, and government investment (or the lack thereof). And what that homeowner can conceivably do to reduce “their” fire risk is seriously constrained. Many of the steps that FEMA recommends, such as creating 30 feet of defensible space around your home, free of combustibles, or enclosing your foundations, or installing new windows and shutters, are expensive and complex jobs–and may have limited impact if none of your neighbors have made these upgrades. Even if someone can fireproof in these ways, this won’t alter the course of a wildfire. 

 

What’s more, risks are intensifying rapidly as  the impacts of climate change grow more severe. Even that ideal insurance customer—the most prudent and well-informed home buyer—may have moved into an area that was once considered safe from flooding or fire or storms, only to find that with each passing year their exposure to disaster seems to increase. Insurance leaves that problem on the homeowner’s doorstep, making it the homeowners’ responsibility to manage the economic effects. Where homeowners are also landlords, they may then pass those higher costs onto tenants. But responsibility for climate change, which is profoundly shaping the underlying risks, lies principally with fossil fuel companies, their investors and financial facilitators – including insurers and reinsurers, who help fossil fuel companies manage their own risks – and governments.

 

Talk of “actuarial fairness” notwithstanding, insurers often frame their decision-making as purely technical. The routine operations of insurance are undertaken by actuaries, underwriters, accountants, claims adjusters, and other experts who marshal an array of data and models to produce assessments of risk. They quantify; they assign probabilities; they price risk; they estimate the value of assets. In short, they produce information that rationalizes the world, imposing a kind of simplified order on a messy and complex reality in order to do business.   

 

But that messy and complex reality never disappears, no matter how elegantly it is modeled. Underlying all that modeling, and built into the structure of any insurance institution, are fundamental questions about how to distribute the benefits and burdens of social interdependence. Those questions can’t and won’t be answered with more math or financial innovation. They require us to talk openly and democratically about how best to provide protection—the social good that insurance represents—fairly and equitably, especially as the threat of climate losses mounts.