In this episode, Alex and Tyler dive deep into the fascinating and often misunderstood world of insurance, exploring how this trillion-dollar industry underpins modern economies while shaping human behavior in surprising ways. From its ancient roots in maritime adventures to the revolutionary development of life insurance, they unravel the economic logic and social norms that made this market possible. Along the way, they grapple with enduring puzzles: Why do people insure against some risks but not others? Why did life insurance once seem repugnant, only to become a moral imperative? How has the industry's ability to manage moral hazard and agency problems evolved—or not? From mutual aid in Indian villages to the legacy of 17th-century tontines, the conversation illuminates the ways in which insurance reflects both the limits of human foresight and our relentless attempts to navigate an uncertain world.

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ALEX TABARROK: Hello, everyone. I’m Alex Tabarrok.

TYLER COWEN: Tyler Cowen. Hello.

TABARROK: The topic of today is insurance. It’s a huge industry, Tyler. I was shocked. It is $1.4 trillion in the US. About half of that is auto, homeowners, and commercial insurance. Half of that is life and accident insurance, and that’s 6% of GDP. Now, here’s what’s really remarkable, Tyler. It is almost a free lunch. How can that be? Think about it. Really what insurance is doing is transferring money. It’s not spending money, it’s transferring money. It’s taking money—lots of small contributions from the many to cover the big losses of the few. Offering peace of mind and certainty to everyone. Now, of course, it’s not literally true that it’s a free lunch. In the US, the insurance industry employs nearly 3 million people, and these people, they got to be paid with real resources, but the major reason why the insurance industry can be so large is that over a long period, on average, the payouts are about the same as the contributions.

COWEN: I’ve been trying to figure out two questions, not with an amazing degree of success. The first is what’s the real resource cost of all this insurance? The premia, of course, they’re transfers. What is the opportunity cost of insuring our economy to the extent that we do? As a side issue, there becomes a moral hazard issue. Also, there’s signaling costs. When people buy insurance, to what extent is that a rational decision that actually improves their resource allocation over time?

Or to what extent is it people feeling a sense of anxiety and they do the thing to alleviate the anxiety, and in fact, there would be cheaper ways of alleviating the anxiety? I tend to think this is often the case with life insurance. You feel you’re supposed to buy it, but an alternative strategy is just to spend less money and have more wealth. It’s not clear to me why you think the intermediary can manage your portfolio better than you can.

TABARROK: Let’s hold off on life insurance for a little bit. I definitely agree with you that there’s some pressure sometimes to buy insurance. When you’re standing in line at the Best Buy and you buy some electronics and they say, “Would you like some insurance with that?” you should always say, “No.” 

COWEN: That’s right. I never win this argument, but yes, you should say, “No.”

Insurance as a transaction-enabler 

TABARROK: Yes, you should say “No.” You don’t want to insure small amounts, but on the big questions, I think insurance is incredibly important, because there are big risks in life. The ability to cover those risks and create some peace of mind is extremely valuable. 

We can see this because the insurance industry goes back a long, long time. You go to villages in India, for example—and Robert Townsend has got this fascinating paper. What he shows is very interesting. He shows that if you want to predict the consumption of a member of the village, the best thing to know is not how much that member produces, but how much the village produces. In good years, everyone consumes a lot. In bad years, everyone consumes a little.

Because you can’t insure that, but if your field is not doing particularly well, or you have an injury or something like that, that you can insure, and the villages in India, they insure mutually. They mutually insure one another so that your consumption is predicted by the village production, not by your production. You’re insured if you have a bad year.

COWEN: Now you’re making me all the more worried about insurance, but let me first state, I think an underrated benefit of insurance is not that it insures against risk aversion, but simply it enables a lot of transactions. If you buy insurance on your home, you may or may not need that insurance from your marginal utility overall portfolio point of view, but it enables you in a simple way to buy and sell the home, to take out mortgages against the home. Maritime issues when you buy insurance for shipping and cargo.

Again, you might have fully diversified shareholders who in risk aversion terms, don’t really care if that single shipment goes bad somehow. But again, it eases the cost of transacting, and just by giving you larger, more liquid markets, it seems to me that’s a benefit of insurance. People don’t quite talk about it enough, though you see it a lot in practice. But let me tell you my worry with these villages.

TABARROK: Sure.

COWEN: That insurance, it is a benefit, it’s a high benefit when you’re not having economic growth, but it’s also a high marginal tax rate. It means the people in the village who earn more have to turn over money to the people who are earning less, and the implied marginal tax rate, at least in the village where I did fieldwork in rural Mexico, it seemed really high to me. I informally estimated it once at 80%. You’re expected to help out your friends, compatriots, relatives who are not doing well, and when the village should be growing, that’s a huge tax. That’s another reason to be suspicious of insurance.

TABARROK: I do think that’s a problem in informal insurance. How can you separate out what is insurance and what is your relatives who are just sponging off you? The same informal norms which motivate people to protect one another when there’s an injury in the family can also be used to make people protect one another when someone’s being lazy.

That is a cost. That’s one reason why formal insurance is better than informal insurance. With formal insurance, you have a contract. If we look how insurance evolved from this mutual protection in the village and in the family, we begin to see the creation of formal insurance, actually, as you had mentioned, with maritime insurance. You have a ship and it’s going to go out on an extremely risky adventure, going to travel from England to India or something like that.

Most of the ships didn’t make it back. Lots and lots of risk there. You say, “Well, there’s two things you can do. You can get a rich guy to help you out, take some of that risk. Or even more importantly, you can subdivide the risk.” Subdivision is really the key. You can take a million dollars and subdivide that among the thousand people with $1,000 each, and then each of them can handle that amount of risk.

COWEN: You also are, again, at least trying to create this homogeneous class of assets that then can be evaluated, traded, standardized, and that’s getting back to some of these other gains from insurance, but you have to compare insurance against selling equity. If you’re doing a voyage, it was very common back then, and indeed now, to sell equity in the voyage, equity in the ship, equity from the take of the voyage, and the advantage of equity is it puts the trust problem somewhere else.

If you’re buying insurance, you’re always worried about the solvency of the insurer, and that is the problem. I think it still has not gone away even after centuries of insurance. When it’s equity, the agency problem in a sense is on you. You might just keep the money, not do the voyage, not do the voyage well, not be motivated enough to do the voyage properly.

The general question of, whom is trusted least I think determines often when you have insurance. But equity just intuitively to me, makes more economic sense than insuring these voyages. How do you tell when there should be an insurance payoff? Say it’s the 16th century and you’re sailing to the New World, and you have a contract for insurance. Who’s verifying what?

TABARROK: I don’t think it’s that hard. The way these insurance contracts on maritime insurance would work is that you would get a loan to build the ship and you would only have to pay the loan back if the ship arrived back in port. Now that’s pretty verifiable. Did the ship come back? If it didn’t come back, you don’t have to pay back the loan. You can actually see that same structure being used today in catastrophe bonds. 

COWEN: These are loans though. Insurance is different, right?

TABARROK: No, I don’t think so. The structure of the loan has an insurance contract built into it. So with the catastrophe bond, a company borrows the money, and it only has to pay the money back if the catastrophe doesn’t happen. You have a firm which is building a skyscraper in California, and they borrow some of the money with a catastrophe bond. They can then put that in a safe place. If there’s a catastrophe, they could use that money because it’s theirs.

COWEN: That’s insurance-like, but insurance proper in the narrower sense of the term, say you write a contract, “Well if my ship doesn’t come back to port, the insurance company pays me off.” There’s a lot of different ports. At the risk of sounding like Theseus, also, what is the ship, the damaged ship? “I brought back a plank. Oh, I don’t have a plank from the ship. Oh, I sold the gold and we didn’t need the ship anymore. We caught a ride with someone else.” I’m not saying these things happened, but in equilibrium, you need a structure that stops them from happening.

TABARROK: It’s definitely true that insurance creates an opportunity for insurance fraud. Sounds like you’d be pretty good at that. 

That’s, again, one reason why insurance, I think, has grown as a part of the economy, because we’re better able to handle insurance fraud. Let’s talk about something which you’ve written a little bit on, which was the Great Fire of 1666 in London and Nicholas Barbon and his role in the creation of fire insurance.

Nicholas Barbon, Robin Hanson, and insurance bundling 

COWEN: I wrote this paper as an undergraduate, actually. It was a study of Nicholas Barbon. I think they just pronounced it “barb-in” then since the family had become English. He was one of the first economists who understood the invisible hand. He has a very clear notion of increasing returns. He understands how cities tie into increasing returns. Parts of it sound quite a bit like Paul Romer. He was a strong advocate for YIMBY. He’s the father of YIMBY.

Actually, California YIMBY, the group, a while back, had plans to reprint Barbon’s pamphlet. I think it’s from the 1660s, called Defense of the Builder. It’s a defense of the builder. He was the builder. He was very important rebuilding London after the Great Fire and very important in developing fire insurance. He was intellectually and practically a major figure of his day.

TABARROK: Yes, in 1680, he creates the first fire office in London, so the first joint stock company which provides a fire insurance. You see here exactly what you had said, that it’s a joint stock company, so the risk of the company is held in equity and is divided. That kind of risk is actually handled by the insurance company through equity, so there’s a combination there. 

He also does something else, which is very interesting. He starts a private fire brigade to protect the insured properties. Now, this makes a lot of sense because he’s got the incentive to stop fires because he’s the one who’s going to have to pay out on the insured property if there is a fire, and he knows a lot about where the fires are likely to occur. It’s a lot cheaper than paying the insurance. He’s got the expertise and the economies of scale to invest in the right equipment.

In addition, he understands moral hazard. He understands that the people buying the fire insurance, once they’re insured, you don’t have quite the same incentive to invest in preventing the fire as Barbon does. It’s a very interesting combination of the fire insurance with private fire brigades.

COWEN: It is a general puzzle in the history of insurance: Why you don’t have more combinations of insurance with other things. Insurance so often is hands-off. Yes, there are workplace plans where the health insurer will induce employers to give benefits for employees to go to the gym or to lose weight, but it’s not that prominent, as our colleague Robin Hanson has pointed out. You don’t see health insurance and life insurance bundled together. You might think in a naive economic model that would make sense.

We can get back to why it doesn’t happen, but I’ve never heard of such a thing. As you know, there’s often positive selection into insurance. It’s not the people who maybe really need the insurance who buy it, say auto insurance. It’s the people who are the good drivers who buy auto insurance. Refusing to buy auto insurance, even when there’s a legal mandate, is extremely common. Those who refuse are typically the bad drivers, and they have low solvency.

They’re the ones you would most want to be insured. If they run over a kid and someone sues them, you can pay the parents a million dollars or whatever, but they’re not. Moral hazard theory becomes funny once you recognize positive rather than adverse selection into the purchase of insurance.

TABARROK: I actually think the Hanson idea has got more promise. I think, admittedly, we don’t see it, but it would be a great idea. The idea, just restated a little bit, is that you would buy your health insurance and your life insurance basically from the same company. Now, as a life insurance company, they want you to live a long time. 

The life insurance company has got a great incentive to give you healthcare which actually works. I think my doctor wants me to live a long time, sort of, but my doctor also makes a lot of money when I have an operation or something like that. It would be nice if my doctor actually made more if I lived longer. I would like to see these things combined.

COWEN: I don’t see those incentives as very strong, and maybe I’m puzzled as to why they’re not. It seems to me a lot of insurance is just about generating scale, limiting extreme risk in the aggregate, and then having good ways to invest in higher-yielding assets that are not too risky. Above and beyond that, people will die when they will, and you just let that roll.

I know it’s a little odd in an economic model that these margins are ignored, but my sense is that’s how it’s running. They’re not even out there lobbying in a major way for policies that might help people live longer; they just mostly seem to ignore it. 

TABARROK: Yes, the insurance industry of America does put some work into rating the safety of automobiles, but admittedly, they could do more. They could do more. It would be nice to see these things joined. 

COWEN: It may just be hard to scale those incentives, though. If the successful companies are about scaling everything they do, and they’re built to be scalable along all dimensions, and your company cannot be good in every way. If you build a company to be scalable, you’re maybe not going to be very good at the super nonscalable things. And getting Alex Tabarrok to live longer by prodding him, maybe they just let it go. That’s what the equilibrium looks like to me. I’m not sure there’s a big profit opportunity from the Robin Hanson scheme.

TABARROK: Marriage is a lot like insurance, too. Is what you’re saying.

COWEN: That’s nonscalable.

TABARROK: Right, exactly, it’s nonscalable.

COWEN: It’s not good at the scalable things. Your partner can’t tell that many other people how they ought to live, but your partner can tell you.

TABARROK: Exactly. That’s my point. [laughter]

We did see some combination of insurance and other economic incentives in, actually, the early history of policing. Great Britain, they didn’t even have public police officers until the 1850s. Before that time, the avoidance, detection, and prosecution of crime was the responsibility of the victim. Now, of course, most victims, they wouldn’t have the wherewithal or the money to go and investigate the crime which had been committed against them.

What they would do is they would buy insurance in advance, and when you had a crime, the insurance company would recoup your loss, and they would go after the criminal, including with detectives and including with prosecuting them.

COWEN: Like bounty hunters. Your paper on bounty hunters.

TABARROK: Exactly, like bounty hunters, yes.

COWEN: This Coasean reassignment of the monitoring or the retrieval, it may relate to life insurance also. If you simply give a discount, say, to married men—and I believe that’s quite general; married men do live longer, they’re healthier—in a sense, you’re encouraging people to take on the monitor of a partner and maybe having the partner monitor and just paying for partnering through this discount is the best the life insurance company can do. They’re recruiting some nonscalable expert. Paying you at the margin to do that a bit.

TABARROK:  I don’t think my wife feels like she’s being paid by the insurance company to make me live longer, but maybe.

The effect of advances in mathematics on life insurance

TABARROK:  Let’s talk a little bit about life insurance because this is, again, a huge market. It was actually quite late in the history of insurance that we began to get life insurance. Part of it relied on the development of mathematics and the law of large numbers. The law of large numbers says that the expected value is a better predictor of the average, the larger the sample size. You flip a coin once, you know on average, it’s going to come up tails half the time, and heads half the time. In actuality, of course, it either comes up tails or it comes up heads. If you flip it a million times, then you know that the proportion of heads to tails is very, very likely to be near 0.5.

What this means for insurance is that if you have a lot of independent random events, then you can be reasonably certain about what will happen on average, even when you know very little about the individual events. Death is a case in point. Predicting death for any one individual is pretty difficult. The United States, we know every week, there’ll be about 60,000 deaths. The number varies a little bit according to the season.

It changes slowly as people are born and age. In normal times, it doesn’t change very much or very rapidly. When we started to see people dying, 87,000 deaths per week during the height of the pandemic, in January of 2021, we could be pretty confident that those 27,000 excess deaths were caused by COVID, which was the only unusual event at the time. Now, if you can predict the number of deaths in a large sample of people, then it becomes possible to issue life insurance. But figuring all that out requires quite a bit of background.

Let me just give you one interesting example. In the 17th century, the British government raised a lot of money issuing annuities. An annuity was similar to a bond, in that the buyer gave the government a lump sum payment, and in return, the government would agree to pay the buyer a stream of payments over time. What made these annuities different from a bond was that the government would agree to pay not for 10 or 20 years, but for the lifetime of the buyer.

Now, here’s what’s amazing: the British government didn’t pay any attention at all to the age of the person giving them the money. They just didn’t have any clue about, well, how could we possibly estimate?

COWEN: Yes, they thought 30- and 40-year-olds were equally likely to die.

TABARROK: Exactly.                       

COWEN: That was not true then, it’s not true now.

TABARROK: Exactly. There were obviously schemes where very young people would be fronted the money to buy these bonds, but the government just really didn’t have any idea, until Pascal and Fermat came along.

COWEN: I worry about all these accounts for a few reasons. First, there seems to be a mention of life insurance or something like it in the Code of Hammurabi. Maybe we don’t understand the context, I wouldn’t overinterpret that, but speaking of risk and uncertainty, I’d be willing to bet you five to one, that during the Roman Empire, or Song China, probably both, there was something like life insurance. I’m not aware that we have any documentation of that, but it would just be very surprising if we didn’t.

I see time and again, people in business figuring out how to make businesses work before they know the underlying probability structure of whatever they’re doing. So many books on the history of insurance: there’s John Graunt with the Bills of Mortality in the 17th century. The other people who get credit is Edmond Halley of Halley’s Comet and Leibniz. Like, “Oh, they gathered this data”, and then the story is insurance becomes possible. I just don’t believe that. I know it’s in most of the history books.

My best guess is it’s the partial overcoming of agency problems that makes insurance possible. I just see too many cases where people can make businesses work. The grain harvest, who knew the probability distribution of bad weather back in year whenever, but you had markets in grain. There’s a trial and error and the people who don’t get it close enough to right go out of business. I would challenge the standard account. I’m not convinced by it.

TABARROK: You think there’s a lot of backcasting where the science is assumed to come before the technology.

COWEN: They really develop together, is my guess.

TABARROK: Yes. Certainly, there are lots of other examples of that, where that’s the case. The Wright brothers and flying being a classic case.

COWEN: Exactly, what was their estimate of the probability distribution?

TABARROK: Yes. Still, the insurance companies today spend quite a bit of money on actuarial science.

COWEN: Of course. Sure.

TABARROK: I think you’re right, people had the idea of how to do this, and only later do they begin to adopt more scientific means of doing that.

Tradable insurance as an early prediction market

COWEN: One thing I get a big kick out of—I have two favorite anecdotes in the history of insurance. I’ll give you one of them, we’ll get to the other later. I always like talking about Robin Hanson. For a while, at least in England, you could buy life insurance, and then sell that to other people, and they did not have to have an insurable interest in you. That changed. That requirement was put on later, but for that time, it seems like there were, in essence, betting markets on when a person would die, because these claims were traded and anyone could buy or sell.

I would think in this system, you get a lot of people, they buy life insurance, they have an unexpected liquidity shock. They need the money, they sell their life insurance. It gets back to the question of how efficient this ever was, to begin with, by the way, maybe they should have just saved the money because now they’re paying bid-ask spread in liquid markets. But then the market is deciding, “Well, what’s your life worth?” It was a back-route way of getting prediction markets, and we don’t have prediction markets on those events today.

TABARROK: Yes. Let’s take a step back for the audience here. Robin Hanson is famous for being the father or the grandfather, if you like, of prediction markets. These markets, which have become more common in recent years, are ones where you can bet on things like who will win the next election. It turns out that these bets you can go and look right now, I think Trump is ahead actually at like 55% or something like that. They are saying, someone will be paid $1 if Trump wins the election, and to get that asset, you only have to pay 55 cents, so people believe that there’s a 55% chance that Trump will win the election.

Hanson has been a proponent of using prediction markets, not just to predict elections, but to improve the forecasting ability of firms. Will this product be successful or not? Often in a firm, there’s a lot of people telling, “Of course, it’s going to be successful.” People don’t want to tell the boss the truth, but a prediction market where people have to put their money where their mouth is, can reveal a lot of interesting information.

Now, these markets when Hanson started talking about them, they didn’t exist, but historically they did exist. Historically, there were markets, as you said, in whether someone would die, like Prince Charlie or something like that. You can take a lot of bets on whether Prince Charlie is going to die, but I don’t think people had this sense back then that they were doing anything other than gambling. 

COWEN: It’s fine because sports today, there are betting markets. It feels like gambling, but there are prediction markets on who wins the Super Bowl.

TABARROK: Absolutely, but people were not using the prices in order to forecast anything of interest.

COWEN: Right. Sure, that’s true.

TABARROK: I think with Hayek and with Hanson, we get a much better understanding of the information quality of prices.

COWEN: Today, there are these gray market celebrity death pools. It’s not a huge thing, but it’s a pretty big thing. People amongst themselves—I don’t know if it’s illegal or gray market—but they bet, “Well, who’s the famous celebrity who’s going to die next?” You pick names. I don’t do this, to be quite clear, but someone I know quite well does it. I used to get these periodic queries since I just know a lot of different things. “Well, who’s going to be next?” He would figure I would know, and I tossed some name back, that would be incredibly obscure, like some economist who is 98 years old. He says, “No, that one’s no good. Give me someone famous.”

TABARROK: Surprisingly so, they’re pretty gruesome and I think it actually helps to explain something which is pretty surprising, is that, although you had argued, probably correctly, that there were some forms of life insurance going back to Code of Hammurabi and things like that, it’s also the case that life insurance in many places was banned, was like illegal. 

COWEN: Yes.

TABARROK:  Life insurance was illegal in France, until 1850. The French revolutionary government in 1793, they said that “insurance replaces the services of humanity by the services of money, and undermines the sense of compassion, which should form the basis of society.” That’s a quote from Viviana Zelizer’s excellent book on Morals and Markets. 

The same was true in the United States; there was a real dislike of life insurance. The fundamentalists, they would point to Jeremiah 49:11, which says, “Leave your fatherless children, I will keep them alive. Your widows too, can depend upon me,” that being God. In other words, God would take care of orphans and widows, and it was presumptive of the husband, typically the husband at that time, to think that he could usurp God’s rule by buying insurance for his loved ones. No, no, no, that’s God’s role. That’s not your job. Insurance really had this negative connotation.

COWEN: It’s striking to me how rapidly, I think it’s the 1860s, life insurance in America becomes more important. One metric I saw—again, it may be imperfect numbers—but it’s going up by three times in a decade, so maybe the social norm becomes weaker, and then everyone a bit stampedes toward this new thing you can do. But the history of insurance to me, in general, is just strange.

What happened to tontines, praytell?

COWEN: Another question I had, which I could not figure out the answer to, is what happened to tontines. They were this funny packaged version of life insurance, plus something like an annuity. This is typically in Britain. The way some of them would work is you would do it with a small club of people, and if you lived the longest as they died, you would get their shares to payments. So you are insuring against you living too long when it would be hard to support yourself and you had life insurance. And as people dropped out, if you’re the one who makes it to 84 way back when, you get annuity payments. I just think of that in the abstract, it makes sense. One thing I find, trying to use economic intuition to think about insurance markets can very rapidly lead you astray.

TABARROK: It’s pretty weird to think about tontines. On the other hand, I’ve got a tontine with my wife.

COWEN: It’s super nonscale. It’s not really a market.

TABARROK: Yes, that’s true. The idea doesn’t sound so weird when I say that when I die my wife will inherit the house. That doesn’t sound so strange. But you’re right. You and I don’t have a tontine.

COWEN: Are you sure?

TABARROK: One of us will get Marginal Revolution. It’ll continue if you get it. I’m not sure what will happen if I get it.

COWEN: At the very least you could sell the site name for something.

TABARROK: Yes, that’s true.

COWEN: Any co-done project is a tontine of a sort, if it carries some value.

TABARROK: If we had a group, what would be the virtue or the point of having a large-scale tontine?

COWEN: One issue is what scale it should be at. The other issue is why aren’t there more and better annuity markets and why don’t more people want to buy annuities? If I just approach this using my economic intuition, I would think annuity is massively popular, it’s successful. Life insurance: a bit for the losers. But that’s the opposite of what we observe. 

That makes me wonder, well, is some of that regulation? I don’t know. Is some of that you can’t trust intuition in this area? That’s my main hypothesis. Is some of it just the world hasn’t come to where it ought to be? That would be the Robin Hanson or even the Alex Tabarrok approach. That one I usually don’t like. Why are annuities so tough to pull off at fair value?

TABARROK: Reverse mortgages make a lot of sense to me and to most economists.

COWEN: Same issue. Exactly. We don’t see that many of them.

TABARROK: Yes, we don’t see many.

COWEN: Though they’re there, right?

TABARROK: Yes.

COWEN: You can’t say it hasn’t been tried?

TABARROK: Yes, but people, they think of them as being shady. Again, for the audience, a reverse mortgage is where you get a payment from an annuity company and the payment lasts as long as you live. You can live and you get this money which is coming into you, $1,000 a year or a month or whatever it happens to be. The only condition is that when you die, your house becomes the property of the insurance company.

Now, this seems great because you’re taking care of a potential risk, the risk that you might live too long and so you’ve got a guaranteed source of income and you have an asset there. It seems to make a lot of sense and yet people regard these as very shady deals that someone is going to be ripping you off. “Well, what if I die early?” Yes, but what if you die late? 

Risks we don't insure against 

COWEN: If I think of my own personal situation, I have insurance on a bunch of things. I don’t really want most of it. There can be mandates, whatever, health insurance I do want. The other thing I really want, and indeed I bought some at what I think is an unfair price, is disability insurance. That I just figure as long as I’m up and kicking, I can earn money some way to take care of other risks. If I’m disabled and can’t really work, well there, I want the insurance.

Again, disability insurance, while it’s quite common, it’s not dominating the sector. You would think maybe it should be at least using my economic intuition, at least for people with high human capital. Admittedly, it’s not everyone, but it’s a lot of people and they have a lot of purchasing power by definition.

TABARROK: I think disability and long-term care insurance is becoming more popular.

COWEN: It’s bad prices, everyone says, and you look at the price you pay and you wince. Again, I don’t understand that.

TABARROK: Still, it is worrying for people. Perhaps like you and I, we could live a long time with Alzheimer’s or something of that nature. It’s like we’re in a funny point in life extension history. It’s where people are living longer and longer, but the quality of the life could be quite low. We haven’t really gotten people to live longer at a younger age, if I could put it that way.

COWEN: Somewhat we have, but the risk of Alzheimer’s is only rising for now.

TABARROK: Exactly. For now, the risk of Alzheimer’s is only rising. I think that’s true.

COWEN: You’ve written on this in other contexts. It’s a more general puzzle. There are a lot of big events we don’t insure against much. There’s not a futures market in GDP or unemployment. There is unemployment insurance of a kind. Could you buy insurance against medical science not making any more advances? Of course not. Is that so hard? Couldn’t you have a panel of oracles who are trusted, like put Vitalik on it, put you on it and they have some measure? I would trust those people. Still, it doesn’t happen.

TABARROK: It doesn’t happen, yes. You’re absolutely right. There are some very big risks which most of us take on, which we can’t really diversify away from very easily. Particularly the risk that your country is going to go down the drain. That GDP is going to fall, there’s going to be a massive recession. We know that there are growth disasters. Argentina has not grown in 30 years. Great Britain even has not grown in 10 years. Italy has not grown in 20 years.

I’m amazed, like, why Italians are not screaming from the rooftops that our country isn’t growing. It hasn’t grown in 20 years. You have all of these people living with their parents and so forth, but no one is buying insurance against that. Yet you could trade. Some Italian GDP could be traded for US GDP. This is Bob Shiller’s idea of macro markets. Yet the demand for that insurance doesn’t seem that high.

COWEN: There’s a recent paper by Miles Kimball and coauthors in the NBER working paper series. Maybe it should cause us to rethink a lot of intuitions about insurance. It’s not a paper on insurance. It’s just about measuring the diminishing marginal utility of money, and how rapidly it diminishes what that curvature is. The main point of the paper—this has already been known, but they systematize it—is how much the estimates of the curvature depend on the context of the decision or question people are faced with.

If you’re choosing a riskier job against higher pay, a small risk, a risk to your children rather than yourself, a risk framed as someone doing something to you as opposed to a natural disaster, and so on, that your risk aversion is not just, oh, 20% or 30% different, it can be many times off, depending on the context. That implies, I think, that insurance decisions also are highly context-dependent in a way that just doesn’t fall out of price theory. But which are the contexts people want insurance for and why, still doesn’t make sense to me, but I think that’s one reason why economic intuitions don’t always work well for insurance.

Charles Ives and changing social attitudes around life insurance

TABARROK: We did see that in the evolution of life insurance. As I had mentioned, it was banned in many places and was considered repugnant for a long time. Then very quickly in the United States in the 1860s, suddenly life insurance became not something which was repugnant, but something which was required. Christianity really, a lot of Christian preachers changed their mind on this.

Again, from Viviana Zelizer’s book, she quotes one remarkable sermon from the 1880s, where the preacher says, “It is meanly selfish for you to be so absorbed in heaven that you forget what is to become of your wife and children after you are dead. It is a mean thing for you to go to heaven while they go to the poor house.” We had this remarkable switch from, “No, God is going to take care of the widows and the orphans,” to, “No, it is your Christian duty to take care of the widows and the orphans.”

Indeed, in the advertising of life insurance, life insurance—I like this—was described as “the unseen hand of the provident father reaching forth from the grave and still nourishing his offspring.” Here, of course, the provident father is not God the Father, but the actual father reaching from the grave. An invisible hand, but a peculiar and a little bit of a strange one, providing insurance. One thing which is funny about life insurance, which I think does play into what you’re saying, is that you don’t really buy it for yourself.

COWEN: When you buy something for someone else, problems are going to arise.

TABARROK: Exactly. That’s why marketing was so important. Because whether you thought of this as a good was totally dependent upon preferences upon marketing, it wasn’t something which may have been all of that natural. Life insurance then exploded in popularity and became something which every good father must do.

COWEN: This brings us to my other favorite insurance anecdote. This one is super obscure, but I got such a big kick out of it. The composer Charles Ives, one of my favorite American composers—and by the way, his best pieces are “Central Park in the Dark,” “The Unanswered Question,” and the microtonal short pieces for piano. But that aside, he was an insurance executive in Connecticut. He started an insurance company in 1907, it was highly successful, he was well to do. But he wrote pamphlets about insurance and one pamphlet in particular, it was a kind of moral defense of life insurance, that it was a noble thing to do. It was pro-family. It was strengthening the fiber of the nation. He was combating those arguments, although we think of him as a composer. And he also focused on the issue of how life insurance and the inheritance tax would interact. He was a very good economist.

His fear—I don’t know the numbers of his time. You hear this from Republican politicians today, and it’s mocked by people like Paul Krugman. Charles Ives said, “Well, the real problem is you have all these middle-class families and then they die and they have to pay the inheritance tax,” which was more broadly applied back then. “Then they have to sell the family farm. There’s a great loss of value and there’s a kind of negative insurance from having to sell the farm at a discount.” This was a big problem, and one of the noble things about life insurance was that it helped you adjust for the costs that you would bear from the inheritance tax.

He had the analysis completely correct, very articulate, well-reasoned. He was not only a wonderful composer, he was a good writer, a good preacher, you could say, of a sort, and on this issue, a first-rate economist.

TABARROK: Excellent. Now we know the musical accompaniment for our podcast.

COWEN: Then no one will listen if it’s Charles Ives. Symphony No. 4 is good, and the Concord piano sonata [Piano Sonata No. 2] I would recommend as well.

TABARROK: Good.

COWEN: To stay in character, in case anyone’s wondering if this is me.

Will repugnance fade for paid organ donations as it did for life insurance?

TABARROK: The fact that the moral view of life insurance could change so quickly—I don’t think you’re going to like this—but it actually gives me hope that there are many—

COWEN: No, I do like it. I knew you’d be getting at this. I was going to bring you there, but go on. 

TABARROK: —that there, in fact, are many other institutions which could have a great flowering. The repugnance which people felt for life insurance, that this was gambling on death, that this was taking God’s role and so forth. You see these same kinds of arguments which are put forward today for why we shouldn’t compensate organ donors, for example, like kidneys, and livers, and things like that. As you know for a long time, I’ve been a proponent of various different types of incentive and compensation schemes to compensate the organ donors in order to increase the supply of organs. We have the same thing with blood and it’s been very controversial about paying people for blood. I gave blood yesterday, by the way.

COWEN: What did you get?

TABARROK: I got a cookie. Yet, those feelings of repugnance, on the one hand, they seem very deep, but on the other hand, maybe with the right kind of marketing, in the next generation, it might think about these feelings of repugnance the way that we find it very puzzling to think, “Well, why would people be against life insurance to even go so far as to banning life insurance?” That seems very strange to us. It was also the case that many professions, which today seem to us quite noble and virtuous, were in the past considered ignoble, including things like opera singers. To make money by using your body.

COWEN: It was like being a prostitute, right?

TABARROK: It was like being a prostitute. That again, gives me hope in one sense, is that these repugnant feelings can go away and we can get more efficient institutions to compensate organ donors and blood donors and to create international markets and GDP and things like that. These feelings of repugnance will fade away.

COWEN: I don’t disagree with any of that. I more or less figured you would go there, but I have a corresponding fear, which is that we’ll find more things repugnant and you see some signs of this. You look at the recent EU directives on artificial intelligence. I don’t think they would have come out that way 20 years ago. People have all these worries, possibly stemming from experience with social media. You may or may not think that tie is justified. But one thing that is true with social media is you see a lot of things more up close, or you read about people’s opinions on them. Maybe we just become objecting more.

The Martin Gurri thesis: well, we don’t trust the elites as much, that’s part of the problem, but then we sort of see how a market actually works and maybe the negative side of that is always more salient for us than the positive side. It could be over time we object to more and more markets and gum up the works. Does that worry you?

TABARROK: Well, I sometimes worry that there’s a fixed amount of repugnance and we just have to spread it out.

COWEN: That could be, but then, I’m not sure we should spend it like on GDP futures markets.

TABARROK: Maybe.

COWEN: I’d rather we tolerated other things.

TABARROK: Yes, people do like to feel repugnant, right? It gives them—

COWEN: Absolutely. Feel outrage. 

TABARROK: —some feeling of moral superiority to denounce other people. Maybe we’re never going to get rid of that entirely.

Have the agency problems behind insurance been fully solved?

COWEN: I want to get to the big, big question about insurance and see what you think. This is my worry. My worry is the agency problems behind insurance never have been solved. Now, we’re not talking about health insurance, quite a separate topic. Take, for instance, life insurance, the panic of 1873, there’s a crash, major systemic problems with life insurance in that year. You think, “Well, that hasn’t happened in a while.” Was AIG an exception? You could debate that.

Maybe all that mattered is simply they were trading in derivatives, not that they were an insurance company. Keep in mind, the world today, or America today, we’ve seen unbelievable run-ups in asset prices since 1980, just astonishing, unprecedented. That’s great, I’m all for it. I don’t, in general, think it’s a bubble, but I think it means our data from the last, more or less, 45 years, they’re not that reliable for what works and what doesn’t.

This is true for a broad variety of institutions. The core thing that goes on with life insurance is they take your money and they hold it for decades and it’s not insured the way the FDIC is. It is insured at the state level. It’s backed in different ways, it’s regulated. We can talk more about that. Why think that’s going to work well? What’s the economic intuition that gives you great faith in that? Because historically, it’s gone bust many times.

TABARROK: It is a peculiar market in the sense that all of your revenues come early.

COWEN: That’s right.

TABARROK: You’re selling all of this insurance, and everything is great because all of the money is coming in and your costs don’t come until much, much later. Your customers need to be convinced that you’re going to be around for a long time and are going to fulfill these implicit debts. Which is one reason insurance companies like to have big buildings with giant columns, like banks, to make them look solid. How do we guarantee that? I absolutely agree that’s a huge problem. I hate to say, but, there is a lot of insurance regulation which is precisely meant to deal with this problem.

COWEN: At the state level, you can choose the state. There’s reinsurance through Bermuda or other locales. The actual effective level of regulation—to be clear, I’m not unhappy with the status quo necessarily, I don’t yet see the problem—but it may not be that high. It’s not like how major banks are regulated at the national level. The problem is not just the company, it’s the person buying the insurance. You could have an insurance company. They advertise, we hold only T-bills and you know they’re safe. People don’t want that. It’s not what I would want. I want the riskier life insurance to get a higher return on the package.

The fact that it’s not for me, makes it really easy to spend for something that promises higher return. They don’t pay it all off, or oh, whatever, but I’ll be dead then, and you don’t think that explicitly. But your ability to monitor the true safety is maybe fairly weak. Maybe it’s efficient to have a bunch of these not pay off, and you get the higher yields on average. You don’t want full safety in most spheres of human existence. The real risk is that you die, right?

TABARROK: If anything, the insurance markets have becoming safer over time because as they get larger, law of large numbers does mean that the risk falls.

COWEN: Assets are more and more correlated over time, I would say.

TABARROK: Well, so we haven’t reinsured. 

COWEN: It’s not that everyone’s going to die at once. The problem is the assets all go crazy at the same time. The world’s more globalized, the gains in the S&P 500 have been concentrated in seven or eight stocks lately. There’s a lot of worrying signs on the asset side, this higher correlation and the law of large numbers is working against you. Fewer publicly traded companies. A place like China is not really somewhere you’re going to be investing in. Maybe you would have thought that 15 years ago. It seems to me going in the wrong direction.

TABARROK: This raises the interesting issue of different types of insurance. The ordinary type which we typically think about is where the insurance company invests the money and maybe the investments go well, maybe they don’t go well, and so forth. The other type of insurance is where it’s a mutual insurance where you agree, in essence, to be taxed if the disaster happens. Then the money is redistributed. That actually, of course, is most famously in Social Security and government insurance. The government is not investing your Social Security payments into the stock market in order to pay you back when you get older.

They’re just creating these promises, and the promises are going to be fulfilled hopefully by the taxpayers of the future. Now, again, that is only a very partial solution because you’re no longer dependent upon asset prices so much, but you are dependent upon the wealth of the economy and the taxpaying system and the laws. The government doesn’t suddenly say, “I’m sorry, you old people, there’s too many of you, and we’re going to help the young now.” There’s risks everywhere.

COWEN: I also wonder if the relative growth and success of insurance is not in part a response to overregulating banking or banking not going so well. The returns to holding money in a checking account, as you know, they’re very poor. They’re especially poor now as compared to some earlier times. People don’t want to do it as much. Banks have been shrinking as a share of lending. It’s now down to about 20%. It used to be much higher. You just want to put the money somewhere where you can get higher yield.

If insurance is less regulated, some Modigliani-Miller-like logic might kick in where you cut back on your banking participation, you increase your insurance participation. You might make offsetting portfolio adjustments to try to undo some of that, but you’re just in the less regulated sector. You have on average higher yield. If, say, you’re buying life insurance, well, you treat your spouse better, you get some other favors in return. That’s how you claw back some of that change in the investment. Maybe it’s permanent and it’s more about banking and the failures of banking than insurance per se.

TABARROK: There is a connection between banking and insurance. There are some people who like to use a whole life insurance policy as their own bank, the so-called infinite banking. Bob Murphy has talked a lot about this. The idea basically is like with a whole life insurance, it’s a savings product at the same time as it’s an insurance product. As you contribute to your whole life insurance, there is an amount of collateral which was being built up in the insurance contract.

The insurance company actually lets you borrow from that very easily because it’s your money. The collateral is all there. They’re not worried that you might not pay your debt because they’ll just say, “Okay, we’re not going to pay your insurance.” That’s fine to them. You can actually use a whole life insurance policy as a form of banking. You can borrow from it.

COWEN: Absolutely. The real lesson here is that maybe the growth of shadow banking just can’t be stopped.

TABARROK: Yes.

COWEN: Thus crises will recur, whether or not it’s in insurance as a narrow field. You’ll find some way of recreating a bank-like set of relationships in a way that’s less regulated. And the Modigliani-Miller theorem, again, which says you can rearrange financial matters to have things more to your liking would be a very general statement of the theorem. It’s just hard to beat.

TABARROK: We started out talking about maritime insurance and villages. Now, we’re talking about Modigliani-Miller and finance. I do think the lesson here is quite true, is that there are close connections between insurance, between stock markets, equity markets, banking. All of these different types of financial institutions are really ways of rearranging our consumption across different states of nature, different states of the world, different states of time. We have a large number of options, literally options in some cases, to rearrange our productivity across these different states of nature. And insurance is just one means of doing this.

The bottom line

COWEN: Two general observations I’d like to make. I’d like to hear your perspective on them. First, doing prep for this session, it really struck me how little high-quality economics research there is on most insurance. Health insurance, again, is different, but life insurance, in particular, insurance more generally, most of it bored me. It wasn’t that conceptual. The historians didn’t think in economic terms. I found it a surprisingly disappointing literature. That’s my first point. Your reaction to that.

TABARROK: I agree. I was looking for the standard book that people would read on the economics of insurance. It really doesn’t exist.

COWEN: I gave you that one theory book in your box by Karl Borch. It’s called Economics of Insurance. You think, oh, this is the book. It’s not worth anything. It’s an object lesson about pure theory and how the value of it, most of it, has plummeted to near zero. There’s no insight in that book whatsoever. He’s a smart guy. He’s a well-published economist. I’m sorry, Karl, if you’re listening.

TABARROK: I wouldn’t have gone that far. Yes, I agree. The theory was remarkably slim. The integration of theory with history and practice was almost nonexistent. The best book was by the sociologist, Viviana Zelizer, I’ve mentioned already, Morals and Markets: The Development of Life Insurance in the United States. She is mostly documenting this shift away from hating life insurance, not liking life insurance, toward thinking of it as a duty. It’s a sociology book, very little on the economics, however. I agree with you.

COWEN: I liked that book, but it wasn’t my favorite because I felt she overemphasized the moral side. My intuition, again, I could be wrong, is that greater ability to solve agency problems drove a lot more of the growth of insurance than she let on. 

My favorite book, by far, was by a historian, Geoffrey Clark. He’s at one of the SUNYs. The book is called Betting on Lives, and a lot of it’s the earlier British and European histories and how that evolved. It was quite conceptual. It was short. Very nicely written. That, I thought, was excellent. There weren’t that many other things on insurance proper where I really thought, ah, that was the kind of thing I wanted to read.

TABARROK: All right. Let’s do the takeaway. I just say a lot of financial contracts, which we take for granted, require a deep set of institutions and ideas behind them. Insurance required counting, statistics, birth and death records, probability theory. This reliance on birth and death records is interesting. It shows you how state power and market power can actually grow sometimes together.

There were also moral foundations, surprising moral foundations in how people thought about life insurance. Different kinds of mindsets. Are we going to control the world? Insurance is like taking charge. We are going to be in charge of these different states of nature. It also made me think about that these things, repugnance against kidney markets and things like that, puts a different spin on it. Maybe we can change this. Maybe we can improve it. Maybe there is a free lunch out there.

COWEN: I have two takeaways. They’re different from yours. Not a surprise. The first is you look at microeconomic theory. You feel all insurance should be a simple thing. There is risk aversion. You buy the contract. You look at the actual history. It’s very hard to make sense of it. The more I learned, I found the more questions I had. I didn’t fall into some, oh, now I understand what was happening kind of pattern. And the second is simply, I had been underrating Charles Ives. He was more than a great composer. Those are my takeaways.

TABARROK: Thanks, Tyler.

COWEN: Thanks, Alex.