LLOYDS of LIFE
What is the hell is an “over abundance of caution?” And more importantly is that a good thing? COVID has taught us to be careful. But what are the appropriate limits of caution? From my perspective many of the policies we so easily accepted to “keep us safe” were nuts. Later in this post I will offer some examples - but first let me explain how I got interested in understanding risk.
Near the completion of my doctoral work I began a strange tangent into insurance. That came about as a result of several things. First, the insurance markets, especially for liability coverage and more specifically for Directors and Officers policies, began to constrict. Fashion played a part in that debacle because a group young financial analysts in several companies speculated that the high interest rates in the late 1970s and early 1980s would last forever. So they convinced their bosses to ignore normal standards of underwriting and to simply pursue a strategy that any unprofitable business could be made up by returns on the bond portfolio. That was foolish. When the inevitable losses appeared several of the companies that followed that advice began to restrict coverages and raise rates to compensate for all those losses that happened after interest rates went into more normal territory.
By the time the folly of cash flow underwriting had become a crisis many of the colleges and universities in the Association were having problems in finding reasonably priced insurance. I brought together a group in the Association and we spoke with four or five major insurance experts to see if we could form a risk pool. The Association I worked for had done a remarkable job in pooling risk for workers compensation coverage; in that case a pool limited to California worked; in liability coverage it did not. I became involved in a group of institutions nationwide and we soon formed a company called United Educators RRG, which to this day is recognized as a leader in providing a range of coverages for non-profits. I became the founding chair of the board.
A few years later I was asked to join the board of a reciprocal company (which is like a mutual insurance company) that offered casualty insurance for educators, nurses and cops. I served on that board for fifteen years. In 2018 and 2019 that company faced some huge losses as a result of the California fires.
A second precipitating event for my interest in insurance was created after following some advice from one of my professors at USC. He urged doctoral students to send copies of their papers (at least the good ones) to living scholars that they wrote about. I wrote the two founders of the field of Public Choice Economics after I had written a paper about one line of their theories. And damned if they didn’t write back and we kept up a sporadic correspondence for a couple of years. They were both very generous with their time. Lo and behold about two years after I finished my dissertation one of those two was awarded the equivalent of the Nobel in Economics. (Technically the Sveriges Riksbank Prize in Economic Sciences).
I also sent paper to UC Professor Aaron Wildavsky. I had read one of his books as an undergraduate (The Politics of the Budgetary Process) and had come across an article on an issue that I was thinking about and wrote him some of my thoughts. Wildavsky sent me back some handwritten comments but then within about a year he began sending me manuscripts of book drafts (he was a prolific author). The first was on tax and expenditure theory (a book with audacious title of A History of Taxation and Expenditure in the Western World). A couple of years after my dissertation a manuscript arrived, which I continue to treasure, called Searching for Safety in the same early form. In both cases I was so flattered by the attention of such an academic notable that I actually spent a fair amount of time researching and commenting on the manuscript. One of my SC professors told me that was how Aaron wrote. He would throw together a manuscript in an area - send it out widely, then cull all those comments do a bit more research and write the definitive book in the field. Searching for Safety evolved into a second book on risk theory. This time he coauthored with a colleague named Mary Douglas in which they explored the cultural theory of risk. Both books argued that our approaches to risk were in part cultural and political.
Insurance is a strange topic. In its simplest form we are trying to predict the future. Its founding is often credited to Lloyds of London which was created in the 17th century in a coffee house in London. The members of the syndicate would be given the chance to underwrite potential losses from maritime activities. So if ship were bound to India, the owners might go to Lloyds and see if they could get a group from the syndicate to, for a fee based on risk, indemnify the losses if the ship were lost at sea. Each of the members of the syndicate would bid on the cost of providing coverage and often the market functioned from a series of bids from individual members who ultimately agreed to take down all or part of the risk. In a very pure sense that is how much of insurance still functions, especially the reinsurance market - where companies seek to hedge their risks for extraordinary losses.
Two concepts are important here frequency and severity. Betting on the future requires two judgments. First, how often do losses happen? Some insurance is relatively predictable - for example car accidents. Based on lots of data, it is relatively simple to predict how often someone will have an accident. Second, how much will it cost to cover the loss? So for example, car accidents, as things go, are mostly inexpensive to fix. But some big events don’t happen very often. So if you are trying to indemnify losses for something like a flood the costs when the losses are paid out episodically but when the losses occur they can be huge. For the years that I owned stock in Berkshire Hathaway Warren Buffett’s annual reports gave a superb tutorial in the economics of insurance (BH owns Geico as well as a series of companies that offer reinsurance and high cap coverages).
In San Miguel last Spring the municipal government deployed a series of measures, including one which made me giggle. One morning while I was out (properly masked and socially distanced) I encountered a city employee with a hazmat suit on. He had a reservoir on his back attached to a hand pump sprayer and he and his colleagues, which looked to me like a group of Pillsbury Doughboys, would go out a couple of days a week and spray down the cement with some mysterious fluid. Was that an example of an overabundance of caution?
In the US, from my view, we have allowed the teacher’s unions to get away with keeping the schools closed too long. Our governor in a sign of “health theater” has commented several times that he sympathizes with all the parents who are concerned that their kids are losing educational time. Needless to say he has not mentioned that his darlings attend a private school which has remained open. Kids sporting events have been cancelled, in my mind, without rationale or reason. I can see limitations on some contact sports and on some crowd events but it made no sense to cancel events like kids soccer. Our son has been a leader in the “let them play” movement - which seems finally to be making progress in reopening things, under reasonable standards. In both schools and sports - the chances for “super-spreader” events are remote. (Who invented the term “super-spreader” is still a mystery to me.)
But it seems to me that Wildavsky and Douglas were right about cultural and political approaches to risk. In the 2012 Democratic convention there was a short video, called “the story of Julia” about a woman who got cradle to grave services from the government. The vision of what government could do successfully and more importantly what government should do was robust. As I watched that message, I kept wondering whether it made a good argument for shielding Julia and her counterparts from the visisitudes of life. Obviously there is a balance here. Even such conservative icons of conservatism like Frederick Hayek and Adam Smith recognized an appropriate role for government in providing a “safety net.” But the question of whether there are inappropriate trade offs from making all those decisions for society is never addressed by the left.
There is in my mind a second set of issues here. Once something is authorized for government to assume more risk there are always what economists call “moral hazards.” The formal definition of that term suggests that when risk is protected by some form of insurance that people are less likely to be vigilant in assessing their own risks. The classic example in the literature is seat belt usage. Many writers suggest that mandatory laws may encourage drivers to be a bit more risky in their driving habits. But would anyone really like to go back to the era when seatbelts were not used?
A good example of the absurdity of nanny statism is contained in Proposition 65 warnings. We recently switched internet providers and as a consequence had a new router installed. The provider, as required by Proposition 65, informed us that the router, I assume if we decided to consume it, had the potential for causing cancer. Just how does that help protect me from getting cancer?
About a decade ago Cass Sunstien and Richard Thaler produced a book in 2008 called Nudge. The novel argument suggested what some reviewers called “Nanny State Paternalism.” It proposed that by setting decision structures in the right way you can get individuals to make the “right” set of decisions. An example might be by simply resetting a default choice. So for example, in retirement programs a company might reset a decision so that employees need to opt out of investing in their retirement program rather than making an affirmative choice to pay into the program. I can see the rationale for making that change. But I simply disagree with it. An even more pernicious example is called age based investing which some financial advisors sear by. In its simplest form as you age your portfolio commitment to stocks diminishes as you age (for example at 25 your commitment to stocks should be 75%/ at age 50 it should drop to 50%). Look at any long term investing strategy and the age based approach is a good example of an over abundance of caution. I am all for educating employees about the benefits of saving for retirement and for providing information about the consequences of various options; but I think even this small choice has larger effects on society. That is the crux of my quibble with the sign.
What the writers of the sign don’t seem to realize is that the over abundance of caution can produce the same kinds of distortions as reckless behavior. But then you wouldn’t be surprised that a baseline for most of my philosophy is to encourage individuals to take responsibility for their actions.
The state of the book - Of Course It’s True, Except for a Couple of Lies, is with an editor. And I am fast learning about the dizzying range of options in the DIY world. Here are some of the issues I am trying to think about. First, I want an Ebook format as well as a soft bound. It will be published on Apple Books and one other site for the ebook. I am looking at options. Second, a good part of my research for this book is a series of photos, especially in the first section of the book. Two examples are a photo of the original passage receipt for my namesake to come to California and a photo of my great grandfather in front of his telegraph office. But putting images in a book creates some other issues. I’ve thought of creating a website which would be referenced in the manuscript and logged by chapter. A niece did that for her book on computer security and it allowed her to add updates. If I chose to do that it would require some rewrites.
