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All insurances are Ponzi schemes ?

Posted by Harry Seldon on June 30, 2009

Madoff is condemned. Good, he is the biggest swindler of all time. However, in this Madoff case the real question is: isn’t our western society a huge Ponzi scheme? Specifically, aren’t our insurances huge Ponzi schemes (Pension, unemployment, health (Medicare), but also finance, car and home insurances)?
The founding principle of an insurance is: the ones (young, employed, rich and healthy) pay for the others, provided that most people are young, employed, and healthy*. Even for private insurances (cars, home…) the principle is the same, everybody contributes, only a few people need insurance reimbursements. That is, some pay for the others. So what is the link with a Ponzi scheme? “Newcomers pay for the old ones”. Yes, it is the same!

Moreover, any insurance company will be in deadly troubles if all their subscribers happen to be eligible for a reimbursement. Let’s imagine the troubles if everybody was a little sick** or if everybody had a car accident today. Any insurance? No, not exactly, on the paper, if the insurance company sets a price that is equal to the maximum it can reimburse to you, there won’t be any trouble. But there won’t be any interest either! Thus the job of the insurance is to estimate the risks they have to reimburse you. Thanks to this reimbursement probability they will be able to set you up a price inferior to the maximum they may have to reimburse you.
Problem is this risk estimation is a very dangerous game. Most risk estimations are based on gaussian distributions of probabilities which are proved to be over optimistic. Benoit Mandelbrot, father of the fractal theory, proved that financial risks are way too often completely underestimated (see “The (Mis)behaviour of Markets: A Fractal View of Risk, Ruin and Reward.” for instance). And that is the problem of our insurance companies (AIG, Medicare,…). To be perfectly clear, risks are totally underestimated even for private insurance companies.
Today, as a rule of thumb, and seen the current global systemic crisis, about all insurance companies (including most banks) underestimate risks, are thus at the mercy of a huge increase in reimbursements requests following some catastroph and are therefore simple Ponzi schemes.
To come back to the Madoff case, it blew up exactly like any insurance or bank can go bankrupt: when too many customers ask for their money. And this happened because of “a highly unlikely event”: the collapse of the market. The funny thing is that this market collapse is itself due to another Ponzi scheme: the mortgage insurances who allowed the subprimes market. The subprime crisis itself was due to a Ponzi scheme.

Conclusion

AIG, Lehmann Brothers (and the ones who did not yet go bankrupt), Medicare or Madoff it’s all the same. As long as it works we feel like billionaires and suddenly it blows up and we are in the shit for 150 years!

Bonuses

Some thoughts:

  • Get as many insurances as you can: it is not expensive (enough) and it can make you win a lot of money (Even if I, also, think that I am a milk cow for my insurers)
  • Do not be surprised if the insurance company puts a maximum of bad will to reimburse you. That is their job! That is why you pay them. If they had to reimburse easily everybody you would have to pay them a lot more.
  • I might be the only guy on Earth who think all insurances should be more expensive!

A few links about that

If you have another interesting link, feel free to leave it in the comments.

(1) Who coughed?
(2) Who said that it is the case? Again you?
(3) Not so unlikely, is it?

PS This article can be found in French as a comment for this Slate translation of this WSJ article.

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