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Nick_Tarleton comments on Open Thread: June 2010 - Less Wrong
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I'd like to pose a related question. Why is insurance structured as up-front payments and unlimited coverage, and not as conditional loans?
For example, one could imagine car insurance as a options contract (or perhaps a futures) where if your car is totaled, you get a loan sufficient for replacement. One then pays off the loan with interest.
The person buying this form of insurance makes fewer payments upfront, reducing their opportunity costs and also the risk of letting nsurance lapse due to random fluctuations. The entity selling this form of insurance reduces the risk of moral hazard (ie. someone taking out insurance, torching their car, and then letting insurance lapse the next month).
Except in assuming strange consumer preferences or irrationality, I don't see any obvious reason why this form of insurance isn't superior to the usual kind.
For one thing, insurance makes expenses more predictable; though the desire for predictability (in order to budget, or the like) does probably indicate irrationality and/or bounded rationality.
What's unpredictable about a loan? You can predict what you'll be paying pretty darn precisely, and there's no intrinsic reason that your monthly loan repayments would have to be higher than your insurance pre-payments.
You can't predict when you'll have to start paying.