I’ve been thinking about insurance lately. Maybe this is because of my naturally intelligent, inquiring mind. Or maybe because a tree limb fell on my car and I had to make an insurance claim. Take your pick. I’m going with the first.
Voltaire said, “If you want to converse with me, first define your terms.” So let’s begin with a definition of insurance: coverage by contract whereby one party undertakes to indemnify or guarantee another against loss by a specified contingency or peril.
Contingency: an event (such as an emergency) that may but is not certain to occur. A synonym for contingency is risk.
Risk: possibility of loss or injury; the chance of loss or the perils to the subject matter of an insurance contract; also: the degree of probability of such loss.
Notice that insurance is always and only associated with contingency or risk, the possibility that something might happen, but might not. Party A, who foresees the future risk of something happening that will cause him economic loss, enters into a contract with Party B to assume part or all of the economic consequences of the event should it occur. This is the essence of insurance. Should the event occur, Party B indemnifies Party A for all or part of the loss caused by the event as stipulated in the contract. If the event does not occur, Party B keeps the funds paid for the contract. Party A enjoys the ability to use savings that would otherwise have to be put aside for the event. he may invest this in other activities or simply have the peace of mind from knowing that if the even occurs he will not lose more than contracted for.
Compare insurance with a prepaid expense. An expense is, very simply, a product or service on which one spends money. (We could go into trade of non-money goods, as in barter, but let’s keep things simple.) For example, I give the kind person at Starbucks $50 and ask her to credit my Starbucks card for $50. This is a prepaid expense. In my mind, there is no risk that I am not going to spend the $50; I am simply spending it now in one chunk rather than in small individual increments over the next several weeks on whatever quantity of tall, dark roast cups of brewed coffee $50 will purchase. I am not purchasing coffee insurance. There is no risk that I will not spend the money on coffee at Starbucks.
Let’s move to a more common example. Let’s suppose I plan to have my teeth cleaned twice this year. I know my dentist charges $125 for teeth-cleaning, so I could pay him $250 at the beginning of the year as a prepaid expense in anticipation of the two cleanings I will receive from him in the future. My dentist may promote this action, helping to ensure (make sure) that I have my teeth cleaned twice a year by offering a discount for pre-payment. This is in no manner insurance. Just as with my Starbucks example, there is no risk in my mind that I will have my teeth cleaned twice this year. It's a knowable and known event. If I give the dentist a payment on January 1 for two cleanings, I am NOT paying an insurance premium; I am paying a prepaid expense. If you buy dental insurance you should not be forced to purchase a contract that covers the cost of routine cleaning. This is an even that can be planned. Dental insurance, by definition, is only for unplanned expenses related to your teeth.
The practical conclusion to this brief discussion is that insurance does not pay for known future expenses. Insurance is only a contract between two parties to cover financial loss from unknown and unknowable risks. Paying in advance for something that you know is going to happen is only a prepaid expense.
In the next installment we’ll discuss the implications for your finances and the economy of the country and whether you should be forced to pay for risks associated with someone else.
Until then, whether prepaid expense or insurance, providing for known or unknown necessary expenses can be difficult, if not impossible for the majority of people. When there are literally trillion of dollars floating around the planet this should not be the case. There is no money problem; there is only an idea problem. If you're looking for that great idea that will take the strains of insufficient money off your shoulders, check this out.