24 February 2009

When is a risk not a risk?

Today the the talk is all of the additional money we are now required to find in the future to pay for the past mistakes of banks. This time the discourse has shifted subtly. Rather than bailouts this is, apparently, insurance.

Let's spend a while to ponder that concept of insurance. The original insurance companies were mutuals, which meant that it was a way of genuinely sharing risk. The risk was that something would happen that you couldn't afford to pay for. Perhaps you would die and there would be nobody to earn money to feed your children; or your house would burn down and you would need money to rebuild.

Once you privatise insurance the risk becomes the sort of risk a gambler enjoys. Now we have a whole new profession - the actuary - whose job is to do the complicated statistics that enables a company to charge each person enough so that the small number of catastrophic events that befall the minority of policy-holders will cost less than the premiums taken from all - thereby generating profits for the company.

In this situation we are still dealing with sharing of risks between people whose chance of facing disaster is more or less the same. But the sort of insurance we are talking about in the financial world - when it comes to AIG, for example - is of a different order entirely.

Companies that ensure 'financial products' that they don't understand and can't investigate closely are gambling on something over which they have no control. The financial companies that create and sell the products are simply passing the risk down the line. In the good times the insurers are raking in premiums and making money for old rope. When the bubble bursts they are going to be the first to go bust, since they are at the bottom of the pile.

Apart from us, of course. Because under the pyramid of bad debt sits Joe Public. Today we are being asked to 'insure' the losses of Lloyds and RBS. The problem with the use of the word 'insurance' to describe the £600bn. we are going to oblige our children to pay is that the disaster has already happened. We know that the loans made by the banks will not be paid back. This must represent another creative move by the financial engineers: a move into ex-post-facto insurance.

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