It struck me the other night, as I was reading a book and came upon a section on Ponzi Schemes, that insurance companies are borderline ponzi’s themselves. The definition of a ponzi scheme is when the broker/banker/agent takes money and promises a unusually high return and then pays said return from the incoming money from other investors. Eventually, when the incoming investors dry up, the agent can no longer pay the returns and the scheme comes crashing down.
Now, let’s look at insurance companies. We, as the insured, pay the insurance company our premiums in return for insurance against some sort of event. With health insurance it’s against some sort of health event. With car insurance, it’s against some sort of accident. In any case, it’s a payment. Or a return on the premium. Very seldom will you actually come out with your entire investment. What would happen if the premium payers dried up? It would get more difficult for the insurance companies to pay any claims.
Where the key difference lies is that if you stop paying your premiums, they stop paying any claims for you. Also, as a premium payer, you never really expect your money back unless you have a claim. You’re paying for the “in case”, if it were to happen. In a Ponzi, you’re investing your money specifically for the return. You’re not going to stop investing as long as the returns are stable. And a Ponzi only really dies when the new investors stop coming. If new insured stopped coming to the insurance company, they would still have their current insured to collect premiums from.
So, no. Insurance companies are not Ponzi Schemes. But, it sure feels that way sometimes.
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I started this blog to share what I know and what I was learning about personal finance. Along the way, I've discovered the Yakezie group, and many other blogging friends.
Interesting take on insurance companies…hah =).
There is, however, insurance where you can recapture the cost of premiums paid: whole life insurance. You can use the benefits of this insurance when you aren’t in the position where a claim needs to be paid (when you are alive).
Other insurance products benefit you only when something bad happens…
I think a huge difference is that the insurance company still has an underlying asset. Maybe it is a building or maybe it is a note/bond, but they have something. I think most ponzi schemes don’t have any underlying assets.
Cool way of thinking though…I sometimes get jumbled up with value inevesting…think about it you buy a stock that you hope someone else will believe is worth more money…
Insurance is its own thing, closer to a casino than a Ponzi. The bet is not on the roll of dice but the chance events in the real world. And just like a casino with only one gambler in which one big win followed by a walk-away from the table will wipe it out, insurance companies rely on the statistical power of large numbers of insured people to essentially guarantee their return on investment. Joe Doakes might collect a big insurance payout, but he is offset by a million premium payers.
But unlike a casino, insurance–particularly medical or life insurance–is the only time when you hope you don’t get a return on your investment! This is because you are hedging, with money, against a life outcome you really don’t want.
I think a huge difference is that the insurance company still has an underlying asset. Maybe it is a building or maybe it is a note/bond, but they have something. I think most ponzi schemes don’t have any underlying assets.
Cool way of thinking though…I sometimes get jumbled up with value inevesting…think about it you buy a stock that you hope someone else will believe is worth more money…