High risk? Sorry pal, count me out

Yvette Cooper argues that the private insurance market is not yet equipped to handle welfare provision fairly

PETER LILLEY has been lopping. Little bits and bobs from the welfare state keep vanishing and popping up again - thanks to the Social Security Secretary - in the private insurance market. Cover for monthly mortgage payments, should a homeowner get sick or lose a job, is one burgeoning addition. So too are permanent health insurance (designed to provide sickness benefit) and cover for long-term care.

But as the insurance companies manoeuvre to assess the new risks and absorb this new business, it isn't at all clear that private insurance markets - at least as they stand - are able to handle welfare provision in the most efficient and fair way.

In principle, to pool the risk of troubles ahead makes sense. If we all had to save to cover ourselves for every eventuality and every rainy day, savings would be far too high; rainy days won't drench all of us all at once. By insuring ourselves - whether against burglary, car crash, the death of a family breadwinner, unemployment, or disease - we share the cost with everyone else of the terrible things that happen to just a few of us.

The trouble is that private insurance markets don't quite work the way they are supposed to - as a new report from the Rowntree Foundation into private welfare provision makes clear. Authors John Hills and Tania Burchardt discovered, for a start, that the cost of private cover is currently extremely high. The middle-aged man on average earnings who wanted cover for his pounds 250 monthly mortgage repayments, pounds 200 weekly sickness benefit and pounds 1,250 monthly long-term care cover would find himself forking out pounds 992 a year - about a half of his current National Insurance contributions.

The Rowntree authors suggest that part of the reason for these high costs is the inefficiencies of current private sector provision. Were mortgage protection insurance to be made compulsory, for example, and differential premiums strictly regulated, considerable savings could be made. For permanent health insurance (private sickness benefit), they argue that the private insurance market is even less efficient because insurers are desperate to avoid getting stuck with costly, sickly customers. There they believe that regulation or public provision is a far more cost-effective - as well as more equitable - alternative to current arrangements.

But these weaknesses aren't new. Economists have long pointed to the imperfections of insurance markets and the problems of fairly and efficiently pooling the risks we face.

The first imperfection in the market is that of "moral hazard". Once you've dosed yourself with insurance against every eventuality, you have far less incentive to try to stop bad things happening - to drive carefully, for example, or to get proper locks on the doors.

The second problem is "adverse selection". People with high risks will take out lots of insurance, leaving the companies covering only the costliest customers. Fearing this, the insurance company pushes premiums up for everyone.

One way round adverse selection is to regulate the markets and make insurance compulsory - as the Rowntree authors suggest for mortgage cover. That way the insurer can be content that low-risk customers, and not the insurer itself, will be sharing the burden of the payouts, so the overall costs to customers will fall. In other words, low-risk customers - in this case low-risk mortgage holders - end up subsidising high-risk customers.

Which leads us to the third, and stickiest question: equity. In a world where individual risks are broadly unknown, insurance and redistribution (from the lucky to the unlucky) blur conveniently together. People share the costs of terrible things that happen to very few of us because there, but for the grace of God, we each of us go.

But once God's grace emerges from the shadows and becomes a known genetic blueprint, we have to decide how much of what we know to be other people's burdens we are willing to bear. If insurance companies think you are in a high-risk group - because of a congenital defect or your occupation or lifestyle - they will push the premiums up. You might not even get cover at all.

The state can always intervene - either to act as a giant insurance company itself, as it does with healthcare costs and National Insurance at the moment, or to regulate the private market - to make cover compulsory and spread the risks across everyone.

But it isn't always fair that people with low risks should subsidise people with high risks - especially when the customers involved have a choice about quite how much risk they take. If someone in a highly-paid but insecure job decides to take out a whopping great mortgage, it hardly seems fair that the low paid and sensible among homeowners should have to pay more to support them.

Academics David Halpern and Stuart White have suggested one way to resolve the fairness problem. In a paper for the on-line think-tank Nexus, they argue that responsibility should be partitioned. Society as a whole should share the risk of things that are brute luck (like genetics), while individuals should pay higher premiums for the risks they take as a matter of lifestyle choice (like smoking).

This kind of principle seems worthy enough. But it is hard to apply in practice, especially to welfare insurance. Who can tell, for example, how far someone's high risk of unemployment is to do with brute luck (stupidity, age, or poor education through no fault of their own) or lifestyle choice (choosing to be an actor rather than an architect or being fussy about jobs).

More important, public opinion on how many of these unlucky burdens should be shared among everyone remains mixed and confused. Although the public may feel squeamish right now at the thought of paying higher insurance premiums on mortgages on the basis of genetic tests, they are not complaining that women have to pay higher premiums for long- term care insurance because as women (by accident of birth) they are likely to live longer.

Regulation of private welfare insurance or direct public provision of social insurance may be the best ways to ensure that we provide welfare cover in the most efficient and cost- effective way. But whatever the system, in the end, the crunch questions are about how much people really wish to share the terrible risk faced by others - something public debate has not yet resolved.