The inductive fallacy
An article in today’s (Nashville) Tennessean newspaper reveals that the worker’s compensation liabilities of the state’s bankrupt Tennessee Restaurant Association self-insurance fund are being transferred to a small, unrated insurance carrier. The recipient of the transfer, Brentwood National Insurance Company, is heavily criticized by former participants in the self-insurance fund as being “unrated”. Former participants seem certain that Brentwood National will go the same way as the association’s fund – out of business.
This type of faulty reasoning is all too common in risk management and insurance. Just because the TRA’s self-insurance fund crashed and burned does not mean that all future insurers will do the same with the same risks. This is a textbook definition of the inductive fallacy, which warns us that we must understand the sample and its “representativeness” of the population before we generalize from the sample.
Certainly Brentwood National is small, and they are not rated. But if the restaurant fund’s participants, and presumably their insurance agents, attorneys, and other advisers, had done their due diligence, they would have spotted the fact that such group self-insurance arrangements are much riskier than “regular” insurance, even from a small, unrated carrier. Just one question captures the essence of the necessary diligence – why was the TRA’s coverage 30% less expensive than standard markets?