E.G.

There is some disagreement over whether we should think of social security as a form of investment, or as a form of insurance.  In order to answer this question, we should first be able to distinguish investments from insurances.  To understand this distinction, one could consult the work of economists and accountants, who I am sure have already worked it out in great detail; or one could engage in baseless, uninformed armchair speculation.  In this post, I will do the latter.

People ordinarily say that insurance is meant to insure against events.  So, for instance, people take out insurance against medical emergencies, and it is said that this form of insurance insures one against the event of a medical emergency.  Investments, on the other hand, need not be "against" any particular event.  For instance, if I buy a bunch of stocks, I might do so in order to be financially prepared for some future event (e.g., retirement), or I might do so simply in order to make my money grow.

So, initially, we might say that insurance is the sort of "financial product" which is purchased with particular future events in mind, while an investment is the sort of financial product which may or may not be purchased with future events in mind.  But this is not a very careful way to draw the distinction.  For there probably are some sorts of investments which are always purchased with some particular future event in mind.  A "college fund," for instance, is a type of investment, yet when one purchases a college fund, one does seem always to have in mind a certain kind of event, i.e. the event of "going to college."

Thus: Both insurances and investments can be purchased with an eye toward some future event, so that is not the important difference between them.  Still, it is possible that we can distinguish between insurances and investments by looking at the kinds of events to which each of them are related.  I take it that this is what Will Wilkinson is doing in this post.  In that post, Wilkinson seems to think that one insures oneself only against unlikely events.  I might buy insurance against, say, losing my arm in a combine, but it would be absurd to buy insurance against paying my rent.  Losing my arm in a combine is highly unlikely, but I am fairly certain I will have to pay my rent.  So if I buy a financial product which is meant to help me pay my rent in the future, it would not make sense to classify that product as a form of "insurance"; we would instead want to call it an "investment."

So Wilkinson’s idea, I take it, is that if one buys a product to help prepare one for some unlikely future event, then it is a form of insurance, whereas if one buys a product to help prepare one for some likely future event, then it is an investment.  I do not think this is quite right; anyway, it does not seem to square with our ordinary use of the words "insurance" and "investment."  Two counterexamples: 1. I have medical insurance which will pay for a doctor visit when I get the flu.  I am virtually certain that I will get the flu sometime in the next few years, but I still want to say that my medical insurance really is insurance, and not just an investment masquerading as insurance.  2. Some wealthy people, I have heard, choose not to buy medical insurance, opting instead to invest some money in some sort of low-risk, low-yield investment fund.  They reserve this fund for the unlikely event that they will have an expensive medical emergency.  I take it that this fund is an alternative to insurance; it is not simply another form of insurance. 

The counterexamples just discussed show, I think, that a person could be insured against highly likely events, and could buy an investment with an eye toward some highly unlikely event.  So, it seems to me, the likelihood of the event with which a financial product is concerned does not determine whether the product is a form of insurance or a form of investment.

Here’s how I want to distinguish investments from insurances.  Consider that, typically anyway, one only "gets paid" by one’s insurance company if the event against which one is insured actually happens.  So for instance, if I have insurance against some natural disaster, and the natural disaster never happens, I never see a penny; but if the natural disaster does happen, then I will receive some form of compensation.  But suppose that, instead of buying insurance against the disaster, I simply set aside a sum of money in, say, a savings account, and plan to use the money only in case of a natural disaster.  In that case, I get paid either way.  Whether the natural disaster happens or not, I get the same interest rate at the bank.

So, I think, the difference between an investment and an insurance is this: When one invests a sum of money with an "eye toward" some future event, one gets a return on that money whether the future event happens or not.  On the other hand, when one uses money to purchase insurance with an "eye toward" some future event, one gets a return on one’s money only if the future event actually happens.  (Usually, the "future event" in question is something bad, but I don’t think it needs to be.  One could conceivably buy insurance against the possibility that one’s children will get into an extremely expensive college.  I think this would count as insurance as long as one will only get paid if one’s children do in fact get in to such a college.  And, incidentally, I think it would still count as insurance in that case even if it is highly likely that one’s children would get into such a college.)

So: Is Social Security an investment or is it an insurance?  I don’t know the actual workings of Social Security well enough to answer this question, but my lack of knowledge hasn’t stopped me up to this point, so I won’t let it stop me now.  The person behind Sick Transit provides the following two scenarios for our consideration:

1. A 55-year-old factory worker gets laid off. At his age, it makes no economic sense to go back to school and learn a new profession. As manufacturing jobs are scarce, he ends up spending the last 10 years of his working life as a WalMart greeter. By basing his pension on his 35 highest years of income, Social Security insures him against this risk.

2. An office worker invests a third of her 401k in her employer’s stock. (As boneheaded as this is, a lot of people do it. Remember, close to half of all people are below-average investors.) As the employer declares bankruptcy and the stock tanks, a third of her retirement savings go out the window. Because Social Security has a defined rate of return, she is insured against that risk.

In both these scenarios, the worker’s plans for retirement somehow fall through, and the worker is left with much less to live on than the worker had planned to have.  Let’s assume it is this sort of event which Social Security is supposed to "guard against."  In that case, to know whether Social Security functions as an investment or as an insurance, we should ask: Does the worker get paid even if this sort of event never occurs?  For instance, if the factory worker hadn’t gotten laid off, would he have still gotten his Social Security benefits?  If so, then I think Social Security ought to be characterized as investment which society makes on behalf of workers; if not, then I think Social Security ought to be characterized as a form of insurance which society provides to workers.

My impression is that workers "get paid" by Social Security whether their normal retirement plans fall through or not.  If that’s right, then Social Security, I think, is a form of investment.  The bigger question, of course, is whether Social Security ought to be an investment, or a form of insurance, or something else entirely.  I won’t try to answer that question here.