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After watching this video from the WSJ about long term care its problem, it seems to indicate the following:

  1. Actuaries didn't think people would live as long as they have, so they wouldn't need the full amount of money. In other words, if 100 new people paid into the system, the theory is that only 60-70 of them would collect.
  2. Actuaries didn't think that people would live outside of family care, so they wouldn't need that much of the money. In other words, of the 60-70 people who lived to collect, in theory, these people may only need 50% of their payment.
  3. Actuaries miscalculated interest rates. Here I give them full credit, as this is not their fault and I can make a strong case that higher interest rates would make sense for long term care, since each payment would be earning interest and wouldn't be fully paid out.

It seems that actuarial science is hoping on two facts outside the sensible action of investing:

  1. Most people won't collect.
  2. Most people won't need the full amount of their collection.

If we consider a Ponzi scheme where new people pay in while old people get money out, if enough of the new people paying don't make it to become old people getting, in theory, a Ponzi scheme could continue indefinitely. This is further strengthened if enough old people getting don't collect the full amount of what they could be getting.

I know the difference is that insurance actually invests while Ponzi schemes are not, but in looking at the fundamentals of how they function, they both seem to require some eerily similar "hopes" about the people who put in and get out of the system.

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  • 5
    Maude Flanders: "Neddy doesn't believe in insurance. He considers it a form of gambling."
    – Rocky
    Jan 18, 2018 at 19:18
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    is the question about all insurance types, or only "long term care" insurance, where it appears the actuaries mismodeled what exactly they were covering?
    – user662852
    Jan 18, 2018 at 20:44
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    The element missing from your argument is that a Ponzi scheme involves fraud and the embezzlement of the funds. Dec 27, 2018 at 16:02
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    So Point 3 is not their fault because? But point 2 is their fault for miscalculating the future number of convalescent homes and other LTC relevant service providers? And Point 1 is their fault for miscalculating the rate of expansion of average lifespan? It's all just reading a crystal ball.
    – quid
    Dec 27, 2018 at 18:16

9 Answers 9

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Insurance is about pooling risk. Insurance companies will collect premiums from several clients with the expectation that it will pay out to a few clients a grand total slightly less than what it collects. The fact that the actuaries did not calculate the odds of individuals getting more than they paid from long term care insurance does not make it a scheme or fraudulent. It just means that the insurance companies will pay more than they expected, requiring them to raise premiums going forward to account for that loss.

From an individual standpoint, most of the people that carry insurance will not get back what they paid in, but that should be expected - you pay a relatively small amount to be protected in the event that you are one of the unlucky few that needs a larger payout. So your expectation should not be that you will "profit" from insurance.

With a Ponzi scheme, all investors have an expectation that they will get back more than what they pay in. In reality, though, the money taken from a large number of investors is given to a smaller number with the expectation that they will "invest" even more, encourage others to invest, etc.

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    @UnicornsSeem4EverHorny The difference is the individual expectation. Insurance is not about making money (for the individual). It's about limiting how much you can lose.
    – D Stanley
    Jan 18, 2018 at 19:45
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    @RonJohn Really? You think most people who buy 10-year term insurance expect to die in the next 10 years? If you're statistically likely to die in the next 10 years then 10-year term insurance would probably be prohibitively expensive.
    – D Stanley
    Jan 18, 2018 at 19:47
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    Non-authoritative source: "Some sources suggest that less than two percent of term policies ever result in a death claim"
    – D Stanley
    Jan 18, 2018 at 19:53
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    @RonJohn Sure, but as you continue to renew the premiums get higher and higher.
    – D Stanley
    Jan 18, 2018 at 19:54
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    That's the point. You should never expect to get all of your premiums back in life insurance. If you have an 80% change (statistically) to die in the next 10 years, you should expect to pay 80% of the face value (plus overhead and reasonable profit) for term life insurance. It's fundamentally the same as other insurance products.
    – D Stanley
    Jan 18, 2018 at 20:10
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The difference is that an insurance scheme has to collect enough in premiums and gains on its investments to cover the claims. A Ponzi scheme pays the schemers (and anyone who wants out) with the deposits from new victims, while lying to the existing victims about how much money is in the scheme.

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You seem to be speaking of a particular type of insurance, not specifying exactly what it is, and treating it as simply generically "insurance". A full answer would require you saying exactly what sort of insurance you are talking about. For instance, whole life insurance is quite different from term life insurance. Whole life insurance is more comparable to a Ponzi scheme than term is, but that is because whole life involves both life insurance and an element of an investment, and it is that investment part that best admits a comparison to Ponzi scheme. So if you want to know how the investment part of whole life differs from a Ponzi scheme, it would be better to simply ask how investment in general differs from a Ponzi scheme, rather than asking about insurance, which is only tangentially involved.

they both seem to require some eerily similar "hopes" about the people who put in and get out of the system.

One difference is who bears the cost if those hopes don't come through. With a Ponzi scheme, there is no money backing up the obligations, so if it fails, the participants are the ones who lose out. Insurance companies are required to hold capital to back up their obligations, so if their projections end up being too optimistic, they are the ones who lose out.

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All investments, not just insurance, involve hope. Hope is just a response to risk, and all investments involve risk. You do research, evaluate opportunities, lay down your money, and hope that your research and evaluations are correct. Actuaries don't just make up numbers like "expected life span of males born in 1956". The numbers are carefully measured, subject to all sort of mathematical analysis, debated and argued about. If they get the numbers right the investment will actually pay off, and provide the coverage their clients purchased. Are they always right? Of course not, but then Warren Buffet isn't always right about what companies will increase in value. When Buffet bought Dairy Queen, he had to make some sort of estimate of how much ice cream Americans would eat in the coming years.

By contrast, somebody running a Ponzi scheme knows that the investment cannot pay off, and their hope is that a miracle will happen, or that they can grab cash and flee before they get caught.

The one area of overlap might be an insurance company that already knows it's insolvent, but continues to sell policies it knows it can't pay on. It happens, and that's why there is usually government oversight of insurance companies.

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    Insurance is not an investment. Insurance is a product, like an iPhone. You BUY insurance, you do not invest in insurance.
    – quid
    Dec 27, 2018 at 18:18
  • @quid Whole life is a form of investment, albeit not a great one. Dec 28, 2018 at 4:05
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    Whole life is two parts. One part insurance one part investment. If you look at an illustration there is a cost of insurance. Insurance is a product that you buy, the product is the transference of financial risk.
    – quid
    Dec 28, 2018 at 5:21
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In a Ponzi scheme, every investor believes that he will receive an extraordinary annual return and, eventually, on demand, the return of his initial invested capital. He has, in fact, been fraudulently promised it.

In insurance, no-one expects any return at all and certainly not the return of his annual premiums. In fact, he hopes that he will never, ever receive a dime! I willingly pay about $1800 per year to insure my car, but I hope and pray every time I drive it that I will not have an accident and collect insurance. I willingly pay my homeowners insurance and yet I’m quite happy if my house doesn’t burn down requiring me to collect insurance.

By pooling risk, the insurance company can collect a relatively small premium from many, perhaps millions of homeowners and therefore pay the claims of the few who suffer losses each year.

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Very simply, premium dollars are not investment dollars.

Premium dollars buy a transference of risk and financial liability. Insurers actually pay claims based on that transference of liability.

Ponzi schemes are investment schemes where the schemers lie to participants about the value of their investment then embezzle the money.

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The key difference is that life insurance companies, in general, tell their customers the truth about the nature of the product, while sellers of Ponzi schemes lie.

With a term life policy, the customer knows that if does not die within the term of the policy, he collects zero. If you cancel the policy, you stop paying premiums but you get nothing back. You know that the day after the policy expires or you cancel, it is worth nothing. The insurance company does not tell you that if you cancel the policy before you die that they will give you back your premiums and some profit on top of this, and then when the time comes it turns out that was a lie. They tell you up front that if you cancel the policy, you get nothing.

With a Ponzi scheme, the expectation is that you can cash out at any time and go home with a profit. You are not waiting for some essentially uncontrollable and unpredictable event, like your death. The seller of the Ponzi scheme tells you that you can quit at any time and walk away with a profit. But this is a lie. Some early investors make a profit, but most of the investors find when they try to collect that there is no money.

Term life may or may not be a good deal for you, but the time the insurance company honestly tells you what you are paying in and what you will collect and under what circumstances. (Well, honestly 90% of the time. As in any business, there are dishonest insurance salesmen.) With a Ponzi scheme the seller lies to you about how much you will collect and under what circumstances.

If a Ponzi scheme operator told you honestly up front, "I'm making payouts to early investors using money collected from later investors. If you try to cash out early, you can make a nice profit. If you wait too long, there won't be any money left and you'll lose your investment", and you decided to invest on that basis, I suppose it wouldn't be a con game. It would just be a very bad investment.

As @DStanley says, the fact that some insurance companies miscalculated expenses doesn't turn an honest product into a con game. The way insurance works in America, it's unlikely that any customers will not be paid the benefits they were promised. If a department store calculates that they can make a profit selling me a toaster for $15, and so I give them $15 and they give me a toaster and I take it home, and then the store discovers that it really cost them $16 to sell me this toaster so they lost money ... it's difficult to see how you could say that I was cheated or conned in any way on this transaction. Too bad for the store that they lost money, but that's not my problem. Presumably they'll raise the price so future customers will pay more, but again, not my problem.

I suppose that if a Ponzi scheme had enough new customers coming in, and a large percentage of the existing customers didn't try to cash out, the scheme could, theoretically, continue forever. In practice, for a Ponzi scheme to work you have to have ever-increasing numbers of new customers. Eventually you run out of people in the world who could join. But in any case, a Ponzi scheme is based on a lie. If someone gets away with a lie and lives out his entire life and goes to his grave without his lie ever being discovered, he's still a liar.

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  • Note that if the customer does die within the term of the policy, he doesn't collect anything either :-)
    – jamesqf
    Dec 27, 2018 at 21:04
  • @jamesqf Well, his beneficiaries collect. If he's dead, presumably he has little use for the money. Whether he's in Heaven, Hell, or has ceased to exist, money isn't going to do him any good in any of those places.
    – Jay
    Dec 2, 2023 at 2:48
  • I once read that with life insurance, the insurance company is betting/hoping that you will live long enough to pay more in premiums than they pay out in benefits. So if you die young, you win!
    – Jay
    Dec 2, 2023 at 2:49
  • The Devil's Dictionary defined insurance as "A modern game of chance, in which the player is allowed the comfortable illusion that he is winning." If you insist on thinking in terms of winning and losing rather than buying purity, that's an accurate summary.
    – keshlam
    Dec 2, 2023 at 19:08
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Possibly useful: Think of insurance as being more like the fire department than like an investment. The ideal case for any given year is that you get absolutely no return in your money. When a disaster hits, though, is too late to go out and create a fire department, so you pay in advance against that risk.

And you pay a relatively small surcharge for the overhead of running the system. Including profits if it's a commercial business, because without profits they wouldn't be there to offer the service. So overall it is expected to be a net cost. You're paying for an extended warranty, not buying something that will make a profit.

(In fact there was a time when fire departments were run by insurance companies. Only those who bought policies would be protected; if you didn't subscribe they would let your house burn while protecting your insured neighbor. Society decided that it made more sense to move that to taxes and nonprofit status and protect everyone, but the comparison is more valid than you might have expected.)

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In addition to @DStanley's answer: insurance companies actually invest their premiums. That's why insurance isn't a Ponzi scheme.

(Replace "Insurance" with "Social Security" and then you've got a Ponzi scheme.)

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  • Don't say that about SS; I'm losing 15% of dinero to that without any option to opt out! ;) Jan 18, 2018 at 19:41
  • @UnicornsSeem4EverHorny Well, remember that your employer is required by law to only show half the social security tax on your pay stub. So double that.
    – Jay
    Dec 2, 2023 at 2:51

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