Insurance and Innovation - How Managing Risk Encourages Risk

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Pop quiz: What's the main driver of innovation?

Promise of fame and riches? Humanity's innate urge to be creative? Sure, those are important. But what about protection from failure?

Insurance, and risk transfer, in general is actually a key historical invention that led to increased innovation around the time of the Industrial Revolution. As detailed in the most recent Innovation Issue of The New York Times Magazine, legal and financial advancements like modern insurance policies were just as significant to innovation as technological breakthroughs, because they allowed us to view risks as opportunities.

Before that, creative risks were, well, a lot riskier. The piece explains:

"In pre-modern times, when starvation was common, and there was little social insurance outside your clan, every individual bore the risk of any new idea. As a result, risks simply weren't worth taking. If a clever idea for a crop rotation failed or an enhanced plow was ineffective, a farmer's family might not get enough to eat. Children might die. Even if the innovation worked, any peasant who found himself with an abundance of crops would most likely soon find a representative of the local lord coming along to claim it. A similar process, one in which success was stolen, and failure could be lethal, also ensured that carpenters, cobblers, bakers and other skilled artisans would only innovate slowly if at all."


Insurance, along with the popularity of stocks, bonds, patents, and other financial tools, allowed people to share the risks and rewards of creativity. Because the downside of failure wasn't so steep, mankind was empowered to take bigger creative leaps.

Insurance and risk management is now so ingrained in the innovation process that it's taken for granted. When you hear about modern space travel, you don't hear about the insurance policies that make it possible for entrepreneurs to launch - literally, in this case - ambitious new projects. Sadly, the only time you do hear about insurance and innovative efforts is when something goes wrong, like when an unmanned commercial rocket exploded this past fall, and articles noted that it was insured for about $200 million.

Today, there are other creative ways insurance is stepping in to lower innovators' risks. One example is a firm that created insurance protection from so-called "patent trolls." While patents are supposed to protect inventors, some people have found ways to exploit the patent system to enrich themselves while also limiting actual innovation. This new solution steps in to help organizations keep creating.

Adam Davidson, the writer of the aforementioned NYT piece, interviewed a prominent M.I.T. economist about how important insurance and risk management will be to keep society advancing. "We'll need modern insurance and financial products that encourage us to pursue entrepreneurial ideas or the education needed for a career change," Davidson paraphrases. "And we'll need incentives that encourage us to take these risks; we won't take them if we fear paying the full cost of failure."

In other words, the better we manage risk, the more risks we take, and the better off we may all be.