How much insurance do you have on your coffee maker? On that single Disney stock your grandmother gave you when you were ten? On your commute time to work? For the most part, unless you really like coffee, you aren’t worried about losing most things in your life. You buy protection against losses you can’t afford to pay for yourself (a house fire, hitting someone with your car), or against things you’re irrationally afraid of (travel insurance, extended warranties). Companies will always find ways to part the fearful from their money, but this is for the mostly rational (mythical creatures, admittedly).
While it’s interesting to think about preventing and mitigating risk, as long as the risk of your upstairs toilets raining on your breakfast cereal or backing into your neighbor’s BMW is non-zero, you’re going to want assurances that you won’t have to declare bankruptcy every time something bad happens. The problem insurance solves isn’t how dangerous our world is, but the degree to which most consumers suffer from an egregious lack of diversification in their assets.
Why don’t investors have the same concerns about their portfolios? Wouldn’t they be just as fearful about putting their capital into Enron or Theranos at just the wrong time? Investors do worry about their investments coming out to zero, and this is why both public market and private investors diversify. Insurance is by and large not available to investors against losses. Instead of putting much of their net worth at risk in a single asset (see most homeowners), investors seek uncorrelated risks across a diverse portfolio. The reasonable investor acknowledges that some bets will burn down or crash, and “self-insures” against that risk by making bets that are not likely to lose value simultaneously.
Home and car owners pay an extra “tax” on their less than diverse investment portfolios in the form of insurance. Now auto insurance is mostly required by states for drivers, so we’ll focus on homes (though autonomous vehicles should eliminate the liability component of auto insurance, and it’s debatable whether anyone would own their own autonomous car; or even own a car at all). Buying a home: “the American Dream”, “the biggest purchase you’ll ever make”. Such an investment requires for most taking on significant debt in the form of a mortgage. Banks require borrowers to buy home insurance to protect the value of their debt investment in your home, so unless you paid for your house in cash and have a large enough asset base to self-insure, you’re probably a home insurance customer.
While there are tax benefits to home ownership, this situation makes homeowners look like less than intelligent investors. What’s the alternative? People need a place to live, and the cultural sacredness of owning one’s own home is far from trivial. A part of the solution is to separate the asset from the service that a home provides:
- Asset Value:
- A “savings account” as the principal on the mortgage gets paid up
- Potential for appreciation
- Service Value:
- A place to sleep and eat
- Access to water, electricity, and temperature control
- Shelter from the elements
Considering these two elements separately should make everyone a renter (as well as owner of a bicycle, rather than a car, that one fears not losing). Assets ought be owned that can be internally hedged against losses, via other owned assets, not by renting an insurance company’s balance sheet. But perhaps I should fall back asleep into the American Dream.
Roman Ryan 