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Features of insurance
Highlighting three key differences between insurance and
bailouts helps us to see what problems bailouts have in
terms of risk mitigation:
1) Ex ante payment of premiums
A key feature of insurance is that all the insured pay an
insurance premium (a monetary contribution) to the pool of
funds that is kept and used to protect them from risk. The
funds are held by an insurance company (in the case of
privately organised insurance) or by the State or one of its
agencies (in the case of social or public insurance), which
disburses funds to those who have paid their premiums and
then subsequently suffered the misfortune of the insured
risk occurring. Insurance premiums are paid ex ante to the
insurance pool of funds. This is hugely beneficial because
it means that each individual’s contribution (i.e. their
insurance premium) is pre-determined and therefore each
individual knows, from the outset, the full extent of their
ultimate liability to the insurance fund. It is also advantageous
because there is an attempt, when setting premiums, to
calculate each individual’s insurance premium according to
the risk that person poses to the insurance fund, for example
people living in flood-prone areas might pay flood insurance
premiums higher than for those in areas of low flood risk. This
apportioning of premiums based on the risks posed by the
individual represents a much fairer way of spreading the cost
of disasters than most other risk protection strategies.
Bailouts, on the other hand, often occur without any prior or ex
ante preparation for them. This is highly problematic because
those who end up paying for the bailout (in the case of banks,
the taxpayer) do not know in advance the full extent of their
liability to the bailout fund. For example, governments in the
UK and US have not really done a good job of explaining to
taxpayers the full and final cost of the bank bailouts in those
countries. In the US, the initial bank bailout proved to be
inadequate and the government had to ask taxpayers for a
further, larger bailout. It is also problematic because the costs
of the bailout are not borne by those who posed the ultimate
risk to the bailout fund. This failure to allocate costs based on
the risks posed by the individual represents a very unfair way
of spreading the cost of disasters.
2) Insurance is often Voluntary and based on Prior Consent
Another important feature of private insurance is that it is
usually voluntary and consensual, although some public
insurance is mandatory (for example National Insurance
contributions in the UK and social security contributions in the
US). Even some privately organised insurance is mandatory,
such as compulsory third-party insurance for motorists in the
UK. The insured want the benefits of insurance conferred on
them, and for this reason, consent to contributing to the pool
of funds available to protect the less fortunate amongst them.
Insurance is therefore in accordance with the rule of law and
the principles of natural justice (duty to act fairly). It is also in
accordance with most people’s preference for autonomy over
themselves and their decisions.
Taxpayer-funded bailouts, by contrast, are never voluntary
or consensual as amply demonstrated by the hostility of a
vast majority of citizens, in the UK, Ireland, Spain and US to
the bank bailouts in those countries. Instead the decision to
impose the bailout on taxpayers is carried out by governments
who are faced with the threat made by the banking industry,
that the consequences of not bailing out the troubled banks
will be calamitous. Former US Treasury Secretary Henry
Paulson appeared before US Congress warning US lawmakers
that if ^H