Going through my list of bill payments that were required for the week, the thought occurred to me that we are all willing participants in one of the oldest financial scams in the books. Whether it be for our home, health, or automobiles, we all buy insurance.
Is insurance a Ponzi scheme?
According to Merriam-Webster a Ponzi scheme is defined as, “An investment swindle in which early investors are paid with sums obtained from later ones in order to create the illusion of profitability.”
On the surface, this sounds much like how insurance works. I “invest” my money with the insurance company each month. If a catastrophe occurs, I expect to be paid from the insurance company an amount that potentially far exceeds my investment. One could theorize the extra funds would come from premiums paid by other customers. Is this an accurate portrayal of how insurance works? Is insurance a Ponzi scheme?
There are actually several very important differences between how insurance works versus a Ponzi scheme.
You Know What You’re Getting Into
People are attracted to the advertised potential high rate of return of a Ponzi scheme. If you’re lucky enough to actually get money in return from the scheme, there likely won’t be anything real (market increases, interest rates, etc) that correlates to your return. With an insurance company it’s very cut and dried: You pay a specific amount each month with a well documented benefit should a claim be filed.
Legally Enforceable Contract
An insurance policy is a legal document complete with signatures. If the insurance company refuses to pay a valid claim, a policy holder can take them to court and win a judgment. People running a Ponzi scheme are breaking the law. People might be able to bring a civil suit against the person or people behind the Ponzi scheme to recover the amount of money invested, but promised returns can not be recovered.
Insurance Companies Are Regulated
Insurance companies make much of their profits through the proceeds of investing the premiums paid by policy holders. However, investments don’t always make money. There are government regulations that outline how much of an insurance company’s assets can be invested, and how much must be kept liquid to pay potential claims.
Protected if Insurance Company Goes Out Of Business
Occasionally and insurance company does actually go bankrupt and close up shop. However, a well informed policy holder would be aware the company wasn’t doing well, and may choose to take their business elsewhere. If a policy holder was caught off guard, every state in the United States has insurance company-funded guaranty associations. While the guaranty associations may not pay the full value of a policy, they will help mitigate the losses of policy holders that are left in the wake of a failed insurance company.
As much as it might seem like insurance is a scam, there are several key attributes that make it legitimate. It’s not a scam, and the answer to the question, “Is insurance a Ponzi scheme,” is a resounding, “No.”
Brought to you courtesy of Brock
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