Thursday, 14 February 2008

The functions of insurance or socialism for beginners

I was recently reading a rather dull document, I wont reveal which one but it suffices to say that it was produced by the CII, the Chartered Insurance Institute. There is one passage in particular that I shall copy verbatim:

"the basic concept of insurance is that the losses of the few are met by the contributions of the many. The premiums paid by many insureds form a common pool of funds, from which valid claims are paid. For each premium paid, the insurer accepts the risk of a considerably larger claim being made against his funders, should misfortune strike the Insured."

It makes a lot of sense -- insurance is essentially a risk-transfer mechanism and the losses of the few are met by the contributions of the many. Now if I make a valid claim against my insurance company my fellow assureds are not going to accuse me of stealing their premium money but this is exactly what happens with welfare.

The concept of welfare works in the same way as insurance, let me take the NHS as an example. As a whole British society make a small contribution to the running of a health system so that the when people are sick, which will only be a small proportion of society at any one time, they can get treatment without any additional outlay. The very same risk-transfer systems are in place but for some reason this becomes much more contentious.

Neither system is perfect and it comes down to the issue of incentive; an insurance company has to make a profit in order to justify its existence and this striving for profit means that not all valid claims will be met and not all risks will be taken hence why in America sick people cannot get health insurance. The NHS's problem is the polar opposite in that it is so large that it becomes almost too expensive to work out what expenses are justified, in other words (following the analogy) many 'invalid claims' get paid.

I'm not going to try and convince you that there are no problems with a nationalised health service but if you view the expenditure of tax dollars as being theft then don't take out insurance either as they operate under the same principles. Taxes or premiums are essentially the same it is incentive which makes the two operate differently and for me the choice between the two systems isn't a hard one to make.