The Upside of Irrationality

Likewise, consider the way insurance companies describe their products in terms of deductibles, limits, and co-pays. What does that really mean when we end up having to get treatment for cancer? What does a “maximum liability” tell us about how much we’ll really be out of pocket if we and other people are badly injured in a car accident? Then there’s that wonderful insurance product called an annuity, which is supposed to protect you against running out of money should you live to be a hundred. Theoretically, buying an annuity means that you will be repaid in the form of a fixed salary for life (essentially, Social Security is a sort of annuity system). In principle, annuities make a lot of sense, but sadly, it’s very difficult to compute how much they are worth to us. Worse, the people who sell them are the insurance industry’s equivalent of sleazy used-car salesmen.

(Though I’m sure there are exceptions, I haven’t run into them.)

They use the difficulty of determining how much annuities are really worth to overcharge their customers. The result is that most annuities are a rip-off and this very important market doesn’t work well at all.

So how can markets be made more efficient and effective?

Here’s an example of social loans: Let’s say you need to scrabble together money for a car. Many companies have now set up social lending constructs that allow families and friends to borrow and lend from each other, which cuts the middlemen (banks) out of the equation, reduces the risk of nonpayment, and provides better interest rates to both the lender and borrower.

The companies that manage these loans take no risk and deal with the logistics of the loan behind the scenes. Everyone but the banks benefits.

The bottom line is this: even when markets are not working for us, we are not utterly helpless. We can try to solve a problem 228