Tuesday, June 17th 2014



Monday, June 16th 2014


Pooling Resources Nearly Always Outperforms Self-Reliance

Saturday, June 14th 2014

Let's imagine a simplified world of 100 people. Each person buys a widget. Each widget costs $20,000. 4 in 100 widgets fail per year. Total cost of replacing widgets per year: $80,000. Spread across everybody, the cost is $800 per year.

If all 100 people put $800 into a central fund, each person has to spend $800 per year to insure his or her widget. It's a simple insurance model.

The total amount spent insuring widgets is around the cost of replacing failed widgets.

You could be more self-reliant. Rather than pool your resources with others, you could put aside the replacement cost of your widget.

If your widget failed you'd have to buy a new one and put aside another $20,000. But there's only a 4% chance of your widget failing! Perhaps its worth it. You're not spending $800 per year on nothing that way.

Lets assume each person is self-reliant. Each person puts aside $20,000. $20,000 * 100 = $2,000,000. The total amount put aside to replace widgets is 25 times the amount put aside in the insurance model.

Of course, you could invest your provisional money until you need it. You might even make a return! But that money would have to be available at any time. You'd never know when you might need to replace a failed widget! So you can only invest in things you can get your money out of quickly.

But here's an added complication. Our widgets have a known replacement cost and a known failure rate. But some things are less well understood.

It would be expensive to provision for every possible catastrophe or failure. How do you know how much a catastrophe would cost? How do you know the likelihood of it happening? Do you even know what could happen? Sure, you could try and cover all these risks yourself. Be self-reliant. Take responsibility for yourself. But life is just too unpredictable at an individual level. You can't make provision for every contingency. It would be too complex to compute. It would be too expensive to try.

Health is a classic example. How do you provision for catastrophic illness or accident? There's so much that could go wrong. You have no way of knowing what the costs of your health are going to be over your lifetime.

Over a large enough population size, though, health costs are more predictable. It might be very hard to work out if you're likely to have an accident (although insurance companies will try). It is more sensible to collect statistics on accidents across a large population and provision for the related health care costs that way.

Health care paid for via taxation is an example of pooling resources and spreading the risk across everybody. If you get sick or have an accident, you can get treatment paid for by taxes. It's cheaper and less stressful. No going over the fine details of some insurance contract or putting aside money you hope will cover your costs. After all: what do you know about predicting health care costs, insurance, and so on?

Finally, more capital is available for investment in other things.

There are lots of other examples. Hiring a full-time security guard would make no sense for most people. Imagine if every house was guarded full time by a security guard. It would be nuts. But the police are only a phone call away. If you lose your job you can get income support. Even if you think the chances of losing your job are low, the risk remains. What if you get sick and can't work? What happens when the insurance pay-out is exhausted? What if there's a natural disaster? Can you afford to buy helicopter and hire a pilot on the off-chance you'll need to evacuate yourself? :-)

And so on.

Of course, private or public insurance can end up failing to do the job.

Public provisioning can involve bureaucratic bungling and imperious punctiliousness. It becomes political. It becomes opaque. You often don't get much choice over how it is provisioned.

Business imperatives come to bear on private insurance. They often only pay out in narrow circumstances or after a legal fight. This adds an administrative and legal cost. Prices go up. Fewer people pay. Prices go up even further. Even fewer people pay. It becomes inefficient. People with certain risk profiles can't get insurance at all.

It requires a wise kludge to sort out a good, messy hybrid.

But one thing is for sure. Pooling resources to deal with hard to predict accidents, personal catastrophes, unemployment, and so on, is sound. The approach outperforms self-reliance. A world of rugged self-reliance might appeal to some, but it is an entirely irrational approach for anything except impossibly predictable lives.


Friday, June 13th 2014



Thursday, June 12th 2014



Wednesday, June 11th 2014

A classic!

We're at the bottom of page 65.

Click a page number above to go to that page.