Thursday, November 19, 2009

Riskless Society

What Does Riskless Society Mean?

According to Investopedia, a riskless society can be defined as A fictional society in which the world markets become complete and sophisticated enough that every imaginable risk can be mitigated by insurance. The notion of the riskless society was developed by Dr. Kenneth Arrow and Gerard Debreu, which has led the way to further progress in the risk management sciences.

Granted, the premise of the fictional society is that market equilibrium is possible, which is an assumption that opposes much of the practical evidence we see.

However, why someone would create a model with such obvious flaws is rather baffling, unless there are some issues that are above my pay-grade, which is quite probable. Dr. Debreu won the Nobel Memorial Prize for this in 1983, which also says something about it, I suppose.

One aspect that I found particularly flawed is the notion that a market would be complete and sophisticated when every imaginable risk has been mitigated by insurance. Those are irreconcilable forces. Insurance, by its very nature, spawns risky behavior because the consequences of the behavior have been sold to an underwriter liberating the risk-taker to engage in even riskier behavior. Unfortunately, as insurance mitigates more risks, risks become greater at an accelerated scale, rapidly overtaking the ability to insure them.

A couple of years ago, there was an issue with our auto insurance, which only came to my attention after receiving a cell-phone call while I was driving 70 mph on one of the busiest freeways in the country. With gazillions of cars going in all different directions whizzing past me sometimes with only inches to spare, I suddenly realized I might not have insurance.

I immediately slowed down, made sure there was more than ample room between my car and the guy in front of me, scanned the instruments, rear-view mirror, side mirrors, traffic on the other side of the concrete median, everything, like a pilot on Instrument Flying Rules scanning his old steam gauges. If someone a mile away from me acted suspiciously, I knew about it and already planned a counter action to avoid any collision or incident. If someone cut in front of me, I gladly made room and let him in as long as he didn’t think that my intent was malicious and engage in road rage.

Damn! I just need to get to the office unscathed to sort this mess out.

It dawned on me that that is the way everyone should be driving with or without insurance. But that’s not reality, that’s like seeking a riskless society. It’s a fallacy and like trying to prove that a cat cannot sustain level flight under its own power. You know that already.

There was no problem with our insurance after all. I got onto the freeway to go home and as I sped up to 70 mph again, gave what just happened a brief thought.

That was all.

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Seeking the truth until I find it.