In addition to policy arguments such as those against putting costs and responsibilities on the public or burdens on gun owners, the insurance industry has offered two major substantive arguments against mandating gun insurance. The first, which is the claim that insurance does not and cannot cover, intentional or criminal arguments is simply false. This has been extensively explored by this blog at the post entitled “Gun Insurance for Willful, Intentional & Criminal Acts.” The second argument is basically a “Chicken and Egg” objection. They claim that insurers have no experience to price such insurance and that without ratings experience such insurance cannot be sold. This post is to show the reasons that this objection is of greatly diminished importance in the case of mandatory gun insurance.
Why can’t insurers simply add up the losses that are occurring as they are reported by emergency rooms, as part of claims for various other kinds of insurance, media reports and government statistics and assign them different weights in an estimate? The basic reason is that, with voluntary insurance, the people who will actually buy the insurance are not a representative sample of the risk exposed public. Sometimes that works for the insurers advantage because people can buy insurance because they are more than typically responsible in many ways and produce fewer than average claims. But those who know that they have an elevated risk can buy insurance for that reason as well.
The possibility that insurance will be disproportionately purchased by those with higher risks is usually referred to as adverse selection. This is something that is very scary from the viewpoint of insurers. It is covered in every introductory insurance textbook. The danger is that if insurers raise their premiums in order to compensate for this additional risk level among their policy holders, then even more of the lower risk portion will drop out. Every time the insurer tries to adjust premiums to cover the level of claims, the loss rises and there may be no premium price level which will prove profitable. Adverse selection comes when the potential insurance purchasers have better knowledge of their own risks than the insurer. It can also occur when constraints, regulatory or otherwise, prevent the insurers from taking risk factors into account.
Adverse Selection Not a Problem with Mandatory Insurance
When insurance is compulsory, persons who wish to do the activity in question must purchase insurance. They cannot drop out of the pool because they perceive low risks for themselves. The body of insured persons is a representative sample of the entire population of persons doing the insured activity because it is required to be all of them. Insurers will identify risky situations and charge higher premiums or resist insuring these situations. Those are the situations where an incentive to reduce the risks will serve the public.
Without Adverse Selection Insurance Pricing is a Marketplace Activity
Because pricing in a atmosphere of adverse selection is governed by the rules of game theory with the insurers and the insured as players, it is inherently unstable. But without selection being a factor, it functions as a marketplace where both known factors and uncertain information are priced into the transactions. Some insurers will want to cover the uncertainty in calculating the projected costs by offering higher premiums but they will be bidding against other insurers who will want to establish themselves in a new market with a potential for future profits. This happens every day and usually passes without comment, not only when new kinds of insurance arise but when there are significant changes in the situations that affect insurance losses. For example, major changes in liability law from legislation or judicial decision do not collapse the market for liability insurance for the affected industry; but they may change the premium rates substantially.
Pricing for Mandatory Gun Insurance
In the case of firearms, insurers will have a lot of information about future insured losses but not nearly as much as they should have. For the reasons explained above, this will not make the insurance market impossible or unstable; but it will increase the level of premiums. Collection of detailed data by local and national government entities has been restrained by legislation designed to obscure the risks of gun ownership. Removal of these restrictions for insurers and researchers will provide benefits in many ways including insurance costs. Other posts on this blog have shown that the average costs attributable to insured losses are quite reasonable. Better data will enable insurers to apply these averages to most gun owners resulting in inexpensive insurance.