Archive for July, 2013

Archive for July, 2013

On Insurance

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Most people in the west are familiar with the concept of insurance. Most of us pay at least one insurance policy. What is it that we really hope to be accomplishing by this?

Insurance works by having customers pay fees in return for protection against some money-related disaster. When a specified disaster (such as a car crash) happens, the insurance company then pays (some of) the cost. The idea is that you would not be able to afford this unexpected disaster, and the insurance company takes that burden off of you. If nothing bad ever happens, then you just keep paying.

That is, insurance is a bet against yourself. The only way the insurance ever “pays off” is when you experience a disaster. Car insurance is a bet that you will crash. Life insurance is a bet that you will die sooner rather than later. The insurance company itself is actually betting on you. As long as nothing bad happens to their customers (on average), they make money.

So, if you have bad things happen to you all the time, insurance is a good deal. Otherwise, you will end up paying more than it would cost to recover from the disaster, just for the “protection”, in which case a savings account would be a better investment.

Why do we buy insurance, then? Why not just save? Well, the biggest reason is that if some disaster occurs before the savings account has filled up, insurance is a better deal. There is a fear that, if disaster strikes, we might end up in debt (or worse). We want protection. There has to be a better way to get it.

Let’s say I have a barn, and it burns down. I don’t have insurance, and I have not yet saved enough money to build a new barn. I cannot live without a barn (my livelihood depends on it), so I cannot just alter my lifestyle to a barnless lifestyle. A very traditional solution to this problem was/is the barn raising. A barn raising is when the entire community comes together, pools their resources, and rebuilds my barn. Why do they do this? Well, because if their barn burns down I’ll do the same for them. Essentially we are treating our pooled savings (and other resources, primarily manpower) as an on-the-fly insurance pool. This is a bet on the community, because if nothing bad happens, everyone keeps their money.

Barn raisings are great, but they have a problem: what if community members do not save well? What if they want to help, but the money is simply not around? This is where we get another strategy from: pooled community savings. A group of people open a fund together, and pay dues just like they would to an insurance company. Payments are made out of the fund (based on community vote, or similar) when this is a disaster. If the fund has enough money in it, then dues can be lessened or stopped. Members may even be allowed to transfer “their portion” to another fund if there is a good reason. PeerCover and others are doing pretty innovative work in this area.

What strategy to pick depends quite a bit on the situation, and there are a few places where insurance cannot be avoided (car liability insurance is legally mandated in many places), but there are a number of options available. Let’s stop betting against ourselves out of fear.