I’d like to pose a related question. Why is insurance structured as up-front payments and unlimited coverage, and not as conditional loans?
For example, one could imagine car insurance as a options contract (or perhaps a futures) where if your car is totaled, you get a loan sufficient for replacement. One then pays off the loan with interest.
The person buying this form of insurance makes fewer payments upfront, reducing their opportunity costs and also the risk of letting nsurance lapse due to random fluctuations. The entity selling this form of insurance reduces the risk of moral hazard (ie. someone taking out insurance, torching their car, and then letting insurance lapse the next month).
Except in assuming strange consumer preferences or irrationality, I don’t see any obvious reason why this form of insurance isn’t superior to the usual kind.
Well, look at a more extreme example. Imagine an accident in which you not just total a car, but you’re also on the hook for a large bill in medical costs, and there’s no way you can afford to pay this bill even if it’s transmuted into a loan with very favorable terms. With ordinary insurance, you’re off the hook even in this situation—except possibly for the increased future insurance costs now that the accident is on your record, which you’ll still likely be able to afford.
The goal of insurance is to transfer money from a large mass of people to a minority that happens to be struck by an improbable catastrophic event (with the insurer taking a share as the transaction-facilitating middleman, of course). Thus a small possibility of a catastrophic cost is transmuted into the certainty of a bearable cost. This wouldn’t be possible if instead of getting you off the hook, the insurer burdened you with an immense debt in case of disaster.
(A corollary of this observation is that the notion of “health insurance” is one of the worst misnomers to ever enter public circulation.)
Alright, so this might not work for medical disasters late in life, things that directly affect future earning power. (Some of those could be handled by savings made possible by not having to make insurance payments.)
But that’s just one small area of insurance. You’ve got housing, cars, unemployment, and this is just what comes to mind for consumers, never mind all the corporate or business need for insurance. Are all of those entities buying insurance really not in a position to repay a loan after a catastrophe’s occurrence? Even nigh-immortal institutions?
I wouldn’t say that the scenarios I described are “just one small area of insurance.” Most things for which people buy insurance fit under that pattern—for a small to moderate price, you buy the right to claim a large sum that saves you, or at least alleviates your position, if an improbable ruinous event occurs. (Or, in the specific case of life insurance, that sum is supposed to alleviate the position of others you care about who would suffer if you die unexpectedly.)
However, it should also be noted that the role of insurance companies is not limited to risk pooling. Since in case of disaster the burden falls on them, they also specialize in specific forms of damage control (e.g. by aggressive lawyering, and generally by having non-trivial knowledge on how to make the best out specific bad situations). Therefore, the expected benefit from insurance might actually be higher than the cost even regardless of risk aversion. Of course, insurers could play the same role within your proposed emergency loan scheme.
It could also be that certain forms of insurance are mandated by regulations even when it comes to institutions large enough that they’d be better off pooling their own risk, or that you’re not allowed to do certain types of transactions except under the official guise of “insurance.” I’d be surprised if the modern infinitely complex mazes of business regulation don’t give rise to at least some such situations.
Moreover, there is also the confusion caused by the fact that governments like to give the name of “insurance” to various programs that have little or nothing to do with actuarial risk, and in fact represent more or less pure transfer schemes. (I’m not trying to open a discussion about the merits of such schemes; I’m merely noting that they, as a matter of fact, aren’t based on risk pooling that is the basis of insurance in the true sense of the term.)
I wouldn’t say that the scenarios I described are “just one small area of insurance.” Most things for which people buy insurance fit under that pattern—for a small to moderate price, you buy the right to claim a large sum that saves you, or at least alleviates your position, if an improbable ruinous event occurs.
Intrinsically, the average person must pay in more than they get out. Otherwise the insurance company would go bankrupt.
Since in case of disaster the burden falls on them, they also specialize in specific forms of damage control (e.g. by aggressive lawyering, and generally by having non-trivial knowledge on how to make the best out specific bad situations).
No reason a loan style insurance company couldn’t do the exact same thing.
I’d be surprised if the modern infinitely complex mazes of business regulation don’t give rise to at least some such situations.
‘Rent-seeking’ and ‘regulatory capture’ are certainly good answers to the question why doesn’t this exist.
For one thing, insurance makes expenses more predictable; though the desire for predictability (in order to budget, or the like) does probably indicate irrationality and/or bounded rationality.
What’s unpredictable about a loan? You can predict what you’ll be paying pretty darn precisely, and there’s no intrinsic reason that your monthly loan repayments would have to be higher than your insurance pre-payments.
I’d like to pose a related question. Why is insurance structured as up-front payments and unlimited coverage, and not as conditional loans?
For example, one could imagine car insurance as a options contract (or perhaps a futures) where if your car is totaled, you get a loan sufficient for replacement. One then pays off the loan with interest.
The person buying this form of insurance makes fewer payments upfront, reducing their opportunity costs and also the risk of letting nsurance lapse due to random fluctuations. The entity selling this form of insurance reduces the risk of moral hazard (ie. someone taking out insurance, torching their car, and then letting insurance lapse the next month).
Except in assuming strange consumer preferences or irrationality, I don’t see any obvious reason why this form of insurance isn’t superior to the usual kind.
Well, look at a more extreme example. Imagine an accident in which you not just total a car, but you’re also on the hook for a large bill in medical costs, and there’s no way you can afford to pay this bill even if it’s transmuted into a loan with very favorable terms. With ordinary insurance, you’re off the hook even in this situation—except possibly for the increased future insurance costs now that the accident is on your record, which you’ll still likely be able to afford.
The goal of insurance is to transfer money from a large mass of people to a minority that happens to be struck by an improbable catastrophic event (with the insurer taking a share as the transaction-facilitating middleman, of course). Thus a small possibility of a catastrophic cost is transmuted into the certainty of a bearable cost. This wouldn’t be possible if instead of getting you off the hook, the insurer burdened you with an immense debt in case of disaster.
(A corollary of this observation is that the notion of “health insurance” is one of the worst misnomers to ever enter public circulation.)
Alright, so this might not work for medical disasters late in life, things that directly affect future earning power. (Some of those could be handled by savings made possible by not having to make insurance payments.)
But that’s just one small area of insurance. You’ve got housing, cars, unemployment, and this is just what comes to mind for consumers, never mind all the corporate or business need for insurance. Are all of those entities buying insurance really not in a position to repay a loan after a catastrophe’s occurrence? Even nigh-immortal institutions?
I wouldn’t say that the scenarios I described are “just one small area of insurance.” Most things for which people buy insurance fit under that pattern—for a small to moderate price, you buy the right to claim a large sum that saves you, or at least alleviates your position, if an improbable ruinous event occurs. (Or, in the specific case of life insurance, that sum is supposed to alleviate the position of others you care about who would suffer if you die unexpectedly.)
However, it should also be noted that the role of insurance companies is not limited to risk pooling. Since in case of disaster the burden falls on them, they also specialize in specific forms of damage control (e.g. by aggressive lawyering, and generally by having non-trivial knowledge on how to make the best out specific bad situations). Therefore, the expected benefit from insurance might actually be higher than the cost even regardless of risk aversion. Of course, insurers could play the same role within your proposed emergency loan scheme.
It could also be that certain forms of insurance are mandated by regulations even when it comes to institutions large enough that they’d be better off pooling their own risk, or that you’re not allowed to do certain types of transactions except under the official guise of “insurance.” I’d be surprised if the modern infinitely complex mazes of business regulation don’t give rise to at least some such situations.
Moreover, there is also the confusion caused by the fact that governments like to give the name of “insurance” to various programs that have little or nothing to do with actuarial risk, and in fact represent more or less pure transfer schemes. (I’m not trying to open a discussion about the merits of such schemes; I’m merely noting that they, as a matter of fact, aren’t based on risk pooling that is the basis of insurance in the true sense of the term.)
Intrinsically, the average person must pay in more than they get out. Otherwise the insurance company would go bankrupt.
No reason a loan style insurance company couldn’t do the exact same thing.
‘Rent-seeking’ and ‘regulatory capture’ are certainly good answers to the question why doesn’t this exist.
For one thing, insurance makes expenses more predictable; though the desire for predictability (in order to budget, or the like) does probably indicate irrationality and/or bounded rationality.
What’s unpredictable about a loan? You can predict what you’ll be paying pretty darn precisely, and there’s no intrinsic reason that your monthly loan repayments would have to be higher than your insurance pre-payments.
You can’t predict when you’ll have to start paying.
It’s not predictable when you’ll have to start making payments.