People buy insurance to protect themselves and their families from financial risk, especially risks that are too large for savings to cover, like a car accident, house fire, or death. When times get tough, you would expect people to become more dependent on insurance because they are less able to handle financial risk on their own. But economists say the opposite seems to be the case – rich households tend to be better insured than poor households, and one reason is because you have to pay for the insurance up front.
There’s a lot of conflicting evidence about when the next recession will happen, but you should consider what people do with their insurance during a recession and how to handle yours.
Do people buy less insurance during a recession?
Adriano Rampini, a professor of finance at Duke University’s Fuqua School of Business who co-authored a paper working with Duke professor Vish Viswanathan said households prioritize their immediate finances over the risks in the future. future when deciding to buy insurance.
“The general pattern it proposes is that as households become less affluent, they reduce coverage and sometimes give it up altogether,” says Rampini.
The authors created a mathematical model that shows the reason for this is how you pay for insurance. To get covered and still qualify for a claim, you must first pay a regular premium. You can adjust your coverage, but it’s not always flexible to pay more when you’re good or less when you’re in trouble.
“When you are particularly constrained, you have to make a living and you are thinking about your limited resources and how to use them,” says Rampini.
This trade-off leads to “insurance inequality”, where richer households with less need for insurance are better insured than poor households. Rampini says that poorer households don’t make mistakes – they just make tougher decisions about their finances.
Insurance ultimately works like a luxury item, meaning you buy more when your income is higher, when it should have worked the other way around.
The data backs this up: Households are more likely to be without health and car insurance during a recession. As a result, those who are least affluent and least likely to take on financial risk without insurance are more likely to be uninsured or uninsured.
In a 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 between September 2015 and 2019 and found “a very strong positive relationship between a person’s wealth and coverage secured through life and homeowner and other property-related insurance, controlling for value of the property insured.”
In other words, Kuhnen, a professor of finance at the University of North Carolina’s Kenan-Flagler School of Business, says: “As a person’s wealth or income changes, so does their insurance coverage. .
“During a recession, I would argue that people with a decrease in income or wealth will be more likely to expire or reduce coverage limits on life or property insurance,” says Kuhnen.
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 premiums during the 2007 and 2008 recessions.
This “risk-management paradox” also exists in the business world, says Rampini. Small businesses, who are more vulnerable to economic risks, are less likely to take steps to hedge against those risks, because they do not have the funds to do so.
In a study published in 2014, Rampini, Viswanathan and Amir Sufi looked at the aviation industry. Airlines are exposed to fluctuations in jet fuel prices and use financial strategies to hedge the risk of high prices. Similar to household and insurance, research shows that airlines with higher net worth, cash flow and credit ratings tend to be more hedging. Rampini says farmers in India are also behaving similarly, with well-off farmers buying more rain insurance than poorer farmers.
“We see it in American companies, we see it in American households, we see it in villages in India,” he said. “It’s the same basic model.”
Rampini hopes future studies can track household income and insurance coverage over time.
How should you adjust your coverage during a recession?
Nicholas Bunio, a certified financial planner, says that it’s completely normal to reduce coverage during tough times. But make sure you have adequate insurance.
For example, if you have a $3 million life insurance policy, you might want to reduce your death benefit to $1 million if you’re having trouble paying your premiums.
“But of course, cutting it all off is wrong,” says Bunio. “Because once something happens, it’s over. One go, no return.”
The same goes for home and car insurance, he said. Bunio makes sure to regularly review coverage with its clients to see if they need to increase or decrease coverage.
Sometimes insurance companies will give you a discount for paying your premiums annually or every six months instead of monthly. It might be a good idea to do this when you have extra cash and distribute payments when time is tight.
When you buy insurance, shop carefully. Many people buy insurance when they have disposable income, but consider whether you can afford the premiums even if time is tight.
“A reduction in coverage would be much more advisable than a complete loss of potency,” says Rampini.
