Why Don't We Insure Against Recessions

Question

I'm not an economics student or anything like that, but I've had a question on my mind for a while now. Why don't insurance companies insure against recessions. Like if the economy were to downturn, you get a payout which can help your business survive longer without as many layoffs or maybe even weather the event.

Insurance companies in general exist to decrease risk, you pay them a certain amount of money and should some negative event happen they bail you out in a sense. They make money overall because the positive expectation of money paid from many people over time beats the negative expectation of the unpredictable event.

Even if the event has a huge cost, this just means insuring it should be more expensive. There are some close concepts like hedges which insure your stock investments against a downturn, but why can't I directly just pay to insure against the economy going down?

I can think of some explanations for myself. Like maybe it's because instead of the event happening at random across many actors, it tends to happen to all the actors at once. This means the insurance would need seriously large amounts of money on hand in case of such a large payout. But if this is the case, wouldn't it just explain why it would be expensive not entirely non-existant?

Answer 1

This is a good and difficult question!

Part of the answer is indeed linked to the idea that the recession "tends to happen to all the actors at once". Insurance companies generally do not insure against recessions because recessions are considered to be large-scale, systemic events that are difficult to predict and insure against.

A recession is likely to affect a large part of the economy and many different sectors making it difficult to spread the risk among a large enough pool of policyholders to make it financially viable.

Additionally, the cause of a recession is often complex and can be difficult to identify, making it challenging to determine the likelihood of a recession occurring. Insurance companies generally focus on insuring against specific, identifiable risks such as accidents, and illnesses. These risks can be measured and modeled, allowing insurers to set premiums and assess the likelihood of a loss occurring.

Another point is that it is generally not easy to date a recession and assess its severity. A recession is typically defined as a period of significant economic decline characterized by falling gross domestic product (GDP), rising unemployment, and declining industrial production. However, the exact timing and duration of a recession can be difficult to determine. I assume that insurance companies would dispute the severity and duration of recessions when evaluating policyholder claims. They could also argue that an individual loss may not be caused directly by the recession because assessing the severity of a recession can be a complex task, as it depends on multiple factors.

That being said, the National Bureau of Economic Research (NBER) dates when recessions begin and end in the United States. NBER defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales". NBER identifies the peaks and troughs of the business cycle, which mark the beginning and end of a recession but again only for the US.

Answer 2

Well I think you partially answered your own question. The payout happens to a lot of people all at once and is very large. Furthermore, it is conceptually different from existing insurance risk.

To put rough numbers on it, US recession insurance would have a payout of say 3% of the 25TN GDP so about USD750bn. The largest insured event ever was Hurricane Katrina which cost about USD100bn.

Apart from the unmanageable size there is a conceptual problem: businesses exist to take risk across economic cycles. Insuring that would concentrate all the risk in insurance companies which doesn’t make much sense and would potentially lead to suboptimal decision making and poor risk management by corporations. Generally speaking insurance companies like to insure events that happen to people (death, accident etc) which can be statistically predicted and which people can’t control. Allowing managers to offload business risk doesn’t really fall into those categories.

Practically speaking there would also be difficulty in defining for an individual claim what losses might have been caused by a recession versus idiosyncratic factors.

Overall this type of risk is better handled through the financial markets (for example, options on the stock market) than through insurance contracts.

Answer 3

The premise that insurance companies don't insure against recessions is wrong. Just go to Lloyds and ask for a quote! They insure against almost everything if the price is right.

The issue is really that there is no demand for that general type of insurance. The costs wouldn't outweigh the benefits for policyholders. For example, why would you want to pay a premium for, and insure against, the case where the unemployment rate in your country goes from 6% to 7% if your own job is safe? You'd rather insure against more specific events, such as you yourself being let go. That may or may not have to do with an economic downturn.

Similarly, businesses can take out insurance for the case where a client doesn't pay the bill.

So there is insurance against recession impacts on the individual household and firm levels.

One additional reason why insurance companies may not be used for the general recession case may also be that there is already widespread insurance against recessions on a macro level. In the case of households, this is called consumption smoothing, and firms build reserves to draw on in downturns. In both cases, this is done by saving in good times, and the vehicle is often financial markets.

Answer 4

Robert Shiller came up with a fascinating idea how to insure against recessions in terms of a sudden drop in GDP and a collapsing house market by some new financial instruments ( I think it was in chapter 3 and using some sort of hedging strategy using GDP futures). Partly he wrote about them in his books "Macro markets" and in what I think is a condensed version of his PhD thesis "Market volatility". Another idea to hedge against some economic shocks was described in Haliassos book "Financial innovation", there the "macros shares case study" by Luis Viceira ( if I recall all of this correctly).