‘Insurance inequality’: Why people who need more insurance buy less

Rich households have more savings to weather financial risks, but they tend to have better insurance coverage.

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Myles Ma, CPFCSenior ReporterMyles Ma, CPFC, is a certified personal finance counselor and former senior reporter at Policygenius, where he covered insurance and personal finance. His expertise has been featured in The Washington Post, PBS, CNBC, CBS News, USA Today, HuffPost, Salon, Inc. Magazine, MarketWatch, and elsewhere.

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People buy insurance to protect themselves and their families from financial risk, especially risks that are too big to cover with savings, like car accidents, house fires, or death. When times are tough, you’d expect people to become more dependent on insurance because they’re less able to handle financial risks on their own. But economists say the opposite seems to be true — rich households tend to be better insured than poor households, and one reason is because you have to pay for insurance upfront.

There’s a lot of conflicting evidence about when the next recession is coming, but it’s worth looking at what people do with their insurance coverage during downturns, and how to handle yours.

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Do people buy less insurance during downturns?

Adriano Rampini, a finance professor at Duke University’s Fuqua School of Business, co-authored a working paper with fellow Duke professor Vish Viswanathan that says households prioritize their immediate finances over future risks when deciding to buy insurance.

“The broad pattern it suggests is when households are less well off, then they will, at the margin, reduce the extent of insurance and at times completely forgo it,” Rampini says.

The authors created a mathematical model that suggests the reason for this is because of how you pay for insurance. To stay covered and remain eligible for making claims, you first have to pay your premiums regularly. You can adjust your level of coverage, but there isn’t always flexibility to pay more when you’re flush or less when you’re pinched. 

“When you’re particularly constrained, you have to make ends meet, and you’re thinking about your limited resources and how to use them,” Rampini says. 

This tradeoff results in “insurance inequality,” where rich households, who have less of a need for insurance, are better insured than poor households. The poorer households aren’t making a mistake, Rampini says — it’s just that they have tougher decisions to make with their finances.

Insurance ends up working like a luxury good, which means you buy more of it when your income is higher, when it should probably work the other way around.

The data bears this out: Households are more likely to go without health and car insurance during recessions. The result is the people who are the least well off, and the least able to weather financial risks without insurance, are the most likely to be under- or uninsured.

In a working paper published in the National Bureau of Economic Research in 2021, Camelia Kuhnen and Michael Gropper examined administrative data from a financial services firm for 63,000 people from September 2015 through 2019, and found “a very strong positive relationship between a person’s wealth and the extent of coverage secured through life insurance and homeowners and other property-related insurance, controlling for the value of the insured asset.”

In other words, “as a person’s wealth or income changes, so does their coverage,” says Kuhnen, a professor of finance at the University of North Carolina’s Kenan-Flagler Business School. 

“In a downturn, I expect to see that those experiencing a drop in income or wealth will have a heightened probability of lapsing their insurance coverage, or reducing their coverage limit, for life insurance or property insurance,” Kuhnen says.

Research on life insurance policies found that people living in areas with low home prices and low income growth were more likely to stop paying their premiums during the recession of 2007 and 2008. 

This “risk management paradox” exists in the business world as well, Rampini says. Small businesses, who are more vulnerable to economic risks, are less likely to take steps to hedge against those risks, because they don’t have the finances to do so. 

In a study published in 2014, Rampini, Viswanathan, and Amir Sufi looked at the airline industry. Airlines have to contend with the volatility of jet fuel prices, and use financial strategies to hedge against the risk of high prices. Similar to households and insurance, the study found that airlines with higher net worth, cash flow, and credit ratings tended to hedge more. Rampini says farmers in India exhibit similar behavior, with better-off farmers buying more rainfall insurance than poorer farmers.

“We see it in corporate America, we see it in households in the U.S., we see it in villages in India,” he says. “It’s the basic same pattern.”

Rampini hopes future studies can track household income and insurance coverage over time. 

How should you adjust your insurance coverage during a recession?

Nicholas Bunio, a certified financial planner, says it’s OK to reduce insurance coverage during tough times. But make sure you have adequate coverage.

For example, if you have a $3 million term life policy, you may want to reduce the death benefit to $1 million if you’re struggling to afford the premiums. 

“But of course, cutting it all out is wrong,” Bunio says. “Because once something happens, that’s it. There’s no going back.”

The same goes for home and car insurance, he says. Bunio makes sure to review insurance coverage with his clients regularly to see whether they need to increase or decrease coverage.

Sometimes insurance companies will give you discounts for paying your premium annually or every six months instead of every month. It could be a good idea to do this when you have extra cash, and spread out the payments when times get tight. 

When you’re buying insurance, shop carefully. Many people buy insurance when they have disposable income, but consider whether you can afford the premium even if times get tight. 

“Reducing the level of coverage will be much more advisable than lapsing altogether,” Rampini says.

Image: Marko Geber / Getty