Saturday, August 8, 2009

Sometimes You're lucky to have Your Business Idea Shot Down

Four or five years ago, I thought I had an interesting business idea: private unemployment insurance. Fortunately, before I spent any time or money pursuing this idea, I was promptly talked out of it in a conversation over dinner with reader S.L., who was kind enough to act as a sounding board. As a seasoned businessman and investor, he spotted the flaw instantly: adverse selection. The people most likely to get laid off would be the ones most likely to apply for private unemployment insurance, which would wreak havoc with your loss ratios.

Yesterday's New York Times featured an article by Ron Lieber ("Good Luck Getting Private Insurance for Unemployment") about an entrepreneur who wasn't lucky enough to run his idea by S.L. before starting his own private unemployment insurance business. The article mentions that this entrepreneur, an insurance industry veteran named John Hartline, started his business in the Spring of 2008, only to have his reinsurers cut him off a year later:

Mr. Hartline said his reinsurance provider, Munich American Reassurance, forced him to stop writing new policies in April of this year.

Why? It turns out that the biggest problem with private unemployment insurance is something that industry insiders refer to as adverse selection. That is a fancy way of saying that the people who take out this sort of policy are the ones most likely to need it.

S.L. could have told him that, and saved him a lot of money and time. Sometimes the best thing a trusted mentor can do is tell us when we have a bad idea.

Update:: Cheryl was nice enough to mention a previous post, "Hedging against Job Loss", in the comment thread of the NY Times article mentioned above.

Another Update: S.L. adds this comment via e-mail:

Munich Re-Insurance Co. is one of the oldest, largest Re-insurance operations in the world.

Amazed that Munich had to wait a year before they took action. Probably after experiencing large losses.


Paul Price said...

Wait till you see adverse selection in action if and when a 'government health care option' becomes available for those with pre-existing conditions.

It will be a financial bloodbath.

Anonymous said...

What about a private unemployment insurance scheme under which people must enroll within a short time period (for example 30 days) of being hired? That would prevent people from enrolling after they've heard of impending layoffs.


DaveinHackensack said...

That's an interesting idea, Peter, although it would limit your potential clientele. Hartline used a different approach with the same goal: he required insureds to have 4 months of coverage before they could submit a claim. With Hartline's approach, you'd have a larger pool of potential clients, since there are more people who have been employed at least 4 months in their current jobs than there are people who have been hired by private employers in the last 30 days.

mack said...

Thanks for sharing such great post, it will help us a lot.