Science of Insurance Gauges Risk

Dr. John Bartlit
New Mexico Citizens
for Clean Air & Water

Column of October 5, 2014, Los Alamos Monitor

A tidal flat is an ultra productive ecosystem by virtue of its being part sea and part land. As it were, new vigor breeds also where the sea of government regulation blends with the firm footing of commercial insurance.

Consider a regulatory model of mixed origins.  

We hear endless debate over whether this or that industrial project will cause how much ecological damage. An example is a major break in a long and winding oil pipeline. One side says all is safe. The other side says woe to our world.

Rather than feeding on hopes and fears, rules could simply require the industry to buy insurance against such a break and its consequences. The economy and ecology would find their own balance in short order.

If the insurance industry agrees the risk is as small as some claim, the cost of insurance will amount to nothing. If insurers judge the real risk is higher, the insurance will cost more. And so on.

Over time, insurance rates will be based on actual data, the way the price of life insurance depends on death rates. Risk will track with data, not word wars and competing ads.
     
Better still, insurance rates will drive improvements in pipeline safety. Insurance has a long history of boosting safety. In 1954, Liberty Mutual Insurance founded the Liberty Mutual Research Institute for Safety outside of Boston to study ways to reduce the most serious risks to workers. Manuals created by insurance companies help guide and standardize industrial safety practices.

Insuring and regulating have more in common than we hear in passing. Applying many good features of insuring does not require using all features. Hybrids have their strengths.

Means of reducing risk are major products of the insurance industry’s inbred focus on statistics of risks and their costs.

Insurance companies can and do increase their profits by taking steps to reduce costly accidents. A common action of insurance companies is sending their trained safety teams to inspect customers’ facilities and report on weak points. Insurers reward good safety findings.
  
The lessons grow. Legislators are fond of pushing regulators to treat every company the same. Yet insurance writers typically charge lower rates to customers with better safety records. This sensible tool boosts profits and steers safety.

Some will say the insurance model cannot stop all accidents. Always true. At the same time, insurance science would speed up improvements in the safety of pipelines and tank cars.

The key, of course, is working with commercial insurance, not self-insuring as is done now.

Buying insurance from an outside interest creates competition between buyers and sellers that rewards safety with the best price. Without this feature, society loses the historic benefits of competing for profits—a system that constantly breeds better ideas and better products.

The nation’s insurance industry is older than the nation itself. Benjamin Franklin, that relentless founder of new systems, had a hand in starting fire insurance in Philadelphia.

In the two-and-a-half centuries since, the industry has created methods that assess risk, reduce risk and build statistics for pricing insurance based on cumulative costs.

More specific terms describe the basics of actuarial science, which is taught at many colleges. Texts on the subject explain elements such as “statistical framework,” “economic and behavioral framework” and “principles underlying risk management and actuarial modeling.”

Insurance and society thrive on knowledge of pooled risks and shared costs. If more pipelines were insured against public damages, risks and costs would soon stand on more solid data. The ways of business can work for all.

Actual data chart a better course than counting votes for “all is safe” or “woe to our world.” Science spawned in the insurance industry has a natural place in the future of regulation.