Consumer behaviour and the GFC

So why are such risk-sharing policies unavailable?

The short answer is that they don't fit the industry's adopted business model. Such policies may be actuarially attractive, but they don't provide the cash flow of the "small stuff". Those who control firms don't simply seek profit; they also seek growth. It's more fun and more financially rewarding being the CEO of a big company with modest profit than being the CEO of a small company with high profits.

More importantly, the "small stuff" provides a buffer against risk, for insurance firms are intrinsically risk-averse. Insuring cars, for example, is low-risk predictable business, for car accidents don't vary much year to year. Houses are a different matter, for natural catastrophes do not behave in a neat statistical distribution, and there is no means of predicting the effects of climate change.

Thanks to a combination of consumer biases, and the industry's risk aversion, we have an insurance market that operates in exactly the opposite way in which it should. While it makes sense to take responsibility for minor contingencies from our own resources, rather than paying a high-cost financial intermediary, it would make sense if we could find insurance for those things we cannot afford to replace, while we accept the benefit of a large gap or co-payment. (This is the way corporate insurance works.)

Instead, that model is turned on its head. Insurers, by various means including exclusionary clauses and payment limits, cap their own liability while leaving consumers exposed to the open-ended risk. They are willing to cover things we can cover ourselves, but not to cover risks that can leave us devastated.

Catastrophes over the last two years have brought those problems to our attention. Many will complain about what they see as unconscionable behavior by insurance firms, but that is to ignore the incentives in a competitive industry and the biases in consumer behaviour. There is a fundamental market failure, requiring policy intervention, by way of regulation of government provision. Failure in insurance markets may not have the world-wide consequences of the GFC, but for those who have lost their houses or livelihoods the consequences are many times more severe.