As negotiations for the $700B rescue plan for the U.S. financial system proceed in Washington, it’s interesting to note that insurance has cropped up as a part of the answer. This is the view, at least, of House Republicans who’ve said they want the Treasury department to collect premiums from financial institutions to cover bad loans rather than have the government buy all the bad loans outright. Whether this insurance proposal will be a part of the final bill is hard to say at this point. In any case, it’s good to know there are politicians who appreciate the value of insurance when it comes to solving financial problems.
Insurance is a fascinating mechanism: it reduces risk by aggregating it. Consider homeowners insurance: An individual homeowner can probably not withstand the financial loss of having his or her house burn down. But if an insurer gathers enough of such homeowners facing that contingency, it can collect a manageable sum from each homeowner and have enough funds to pay for the relatively few homes that will actually burn down in the course of a year. Pooling individually unmanageable risks makes them manageable. Hence, the more risk, the less risk. Fascinating!
Whether or not an insurance mechanism will work for this rescue plan, we’ll have to wait and see. (Insurance only works well when the frequency of loss is a fraction of the insured risks.) In the meantime, it’s probably worth noting that if regulators and industry participants had not begun waiving for so many home buyers the mortgage insurance premium that used to be required when the down payment on a home was less than 20 percent, we taxpayers might have to be ponying up something less than $700B right about now.
Insurance helps.
