Subsidize Me

Jonathan Clements  |  February 24, 2018

ARE YOU GETTING RICH off your neighbors—or are they mooching off you? You might imagine your financial success, or lack thereof, rests squarely on your own shoulders. But much also hinges on the behavior of your fellow citizens.

In numerous financial situations, one group in society effectively subsidizes another. Much of the time, you want to be the recipient of the subsidy—but not always. Consider seven examples:

  1. Spenders subsidize those who save prodigious amounts. The profligate keep the economy humming along, ensuring plenty of jobs and healthy GDP growth. We savers reap the reward, as the strong economy keeps us employed, while also driving up the price of the investments we buy.
  2. Active investors subsidize those who index. As our overconfident neighbors try—usually without success—to pick market-beating investments, they keep the market reasonably efficient and liquid, allowing us indexers to collect the market’s return while incurring minimal investment costs.
  3. Those who carry credit card balances and pay late fees subsidize those of us who make money off our credit cards, by collecting handsome credit card rewards while never carrying a balance. What if the financially sloppy got their act together, paid on time and paid off their balances? Credit card companies would be forced to slash the rewards they offer—and we freeloaders would collect less.
  4. Those of us without insurance claims subsidize those whose cars get clocked, whose homes burn down and who need major medical care. But in these cases, we should be happy to pay the subsidy. Policyholders with claims often suffer physical distress and have their lives disrupted, plus they may have to pay a deductible and face higher insurance premiums down the road.
  5. When it comes to Social Security, traditional employer pensions and income annuities, those who die young subsidize those who live long lives.
  6. The reverse is true of life insurance: Those who live long lives subsidize the beneficiaries of policyholders who die young. Still, given a choice, I suspect most owners of life insurance would prefer to pay the subsidy, rather than have their family receive it.
  7. Those who let their life insurance lapse effectively subsidize those who keep paying their premiums. The cost of both term and cash-value life insurance is front-loaded, with policyholders paying more in the early years than their mortality risk justifies. This, however, doesn’t mean you should hang onto life insurance for as long as possible. If your family would be okay financially if you died tomorrow, you may want to let your policy lapse.

When insurance companies set premiums, they’re often banking on some policyholders doing just that. In the case of long-term-care insurance, however, the lapse rate has proven far lower than insurers had expected. Result: There’s been less “wasted” premium dollars from lapsed policies to subsidize the policyholders who stick around. This has been a key reason behind the sharp increase in premiums on existing long-term-care policies.

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