Insurance policies and bonds are quite similar in an important respect: they both are instruments used by industries that are founded on the transfer of risk from one person or entity to another in return for a fee of some sort, a fee which most often is characterized by an ongoing transfer payments from the one transferring the risk to the other accepting the risk. The policies and bonds are the documents that represent these exchanges of risk and fee.
In essence, insurance transfers both the risk—the likelihood—of an undesirable event happening (vis., a person getting sick or dying, or one’s house burning down) and the cost of that event, to another entity, an insurance company. In return for paying out that cost to an insuree, the insurer receives from the insuree a stream of premiums. Notice that: the exchange is solely between the two parties; no one else is involved.
It’s quite similar with bonds. A lender transfers a sum of money to a borrower in return for a stream of payments from the borrower back to the lender. Here the risk transferred from the borrower to the lender—the undesirable event—is the risk that the borrower won’t repay the principle transferred at the start. In return for accepting this risk, the lender charges a premium to the borrower—the interest to be charged that represents an additional amount included in each payment beyond simply a prorated repayment of the principle. Notice here, too: the exchange is solely between the two parties; no one else is involved.
The insurer makes its money by insuring lots of people so that the cost of having to pay out on any particular policy is covered by the totality of the stream of premium payments from all of the company’s customers, and the expectation that those customers will not suffer their loss simultaneously. Similarly, the lender makes its money by pooling borrowers so that the cost to the lender due to default of a particular borrower is covered by the totality of the stream of bond repayments from all of the lender’s customers, and the expectation that those borrowers will not all default simultaneously.
The aspects of these two risk transfer industries that are of interest here are the sizes of those premiums and the relationships of the risks from one insuree/borrower to another. In both cases, the risk transfer fees must be commensurate with the risk being accepted. If an event—dying, or defaulting on a loan—is highly likely, than the fee must approximate the cost of the event, else the risk acceptor quickly will go bankrupt from routinely paying out more than it receives in return for taking on the risk. If the event is not very likely at all, than the risk transfer fee similarly can be quite small.
Note, though, that insurance only works if the risks being pooled are similar. Forcing into a pool people of significantly different risks—mixing a healthy, exercising young women into the same pool as octogenarian, heavily smoking men, for instance—artificially inflates the cost of that insurance to those young women, who won’t benefit from the insurance; it artificially deflates the premiums for those geriatrics who would benefit from the (relatively high risk) insurance; and it distorts the measures of risk for the pool insured, making it difficult for the risk acceptor to accurately price the cost of that risk transfer.
Bonds, also, only work only if the risks being pooled are similar. Forcing fiscally sound, low borrowing entities to pay the same interest rates as unstable, heavily spending (with little income to cover the spending) borrowers makes such bonds similarly riskier: the risk is pooled on artificial criteria and so the interest required can have nothing to do with the condition of the borrowers in the pool. This makes it next to impossible for a lender accurately to price this risk transfer.
This arbitrariness also makes it difficult for investors to evaluate the efficacy of a bond or an insurance company investment.
Wealth transfer schema, welfare payment plans, on the other hand, make no pretense of transferring risk, nor should they—that’s not their purpose. Wealth transfer programs have only one purpose—to subsidize those whom the relevant government has determined should be subsidized.
That’s a long-winded introduction for my briefly stated thesis. Only when the concepts of risk transfer and welfare are understood to be separate, and kept that way, can we have serious discussions of the utility of providing health cost welfare for some in the form of tax payments from all, or of the utility of providing debt cost national welfare for some nations (their citizens) in the form of tax payments from all nations (their citizens). Both Progressives and modern Conservatives (and social philosophies in between) routinely ignore these differences. Instead, the insurance industry gets treated as a privately funded, government controlled welfare program, and the bond industry (of which the proposed Eurobond is an example) gets treated as a privately funded, meta-government controlled national welfare program. This conflation invalidates argument on both sides of the question.
