When you invest, as any broker will tell you, you want to diversify your holdings. You want to own a variety of stocks in a variety of firms, selling a variety of products, and you also want to own bonds in a variety of different markets. You want to invest some of your money in real estate, some in precious metals, some in housing, some in foreign markets, some in short-term investments, some in long-term investments, etc. The more investments you have, the more likely that your portfolio will survive an economic downturn. But, of course, if you are only investing $10,000, you can’t spread that money very far. So you join in with other hundreds or thousands of other people in different funds which pool all that money together and invest in a variety of things for you all. And the more people involved in any particular fund, the more that fund will be able to diversify its holdings, and the less reliant you are on any one person withdrawing from that fund at an inconvenient time. In other words, the ideal fund would have millions of people putting money into it, and then that fund would invest in millions of different things all over the world.
Insurance is much the same way. Take health insurance, for instance. People, on average, are reasonably healthy. They get a test done for something or another every year or two, maybe break a bone every decade, and that’s about it. There are exceptions, of course. The extremely young and the very old are both more likely to use health care resources, and then there are a few people with extremely serious chronic conditions (Type I diabetes, Crohn’s Disease, kidney failure, to name a few) that require absurd amounts of health care. But because we’ll all get old eventually, most of us will have children eventually, and any one of us could be diagnosed with a chronic condition at any time, we all have incentives to not exclude high risk people from health insurance completely. And so, again, you want to pool your risk; you want to get as many people as possible paying into your health insurance pot, so that way when one person has a child, or develops Crohn’s Disease, or goes into a nursing care facility, then there is plenty of money in that pot to cover them. After all, we all pay into that pool as if we were an average person, and the average person is reasonably healthy.
All of that is pretty basic micro-economic theory. And yet we’ve set up fundamental systems which fly in the face of that theory.
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