Insurance is like gambling, don't overdo it

> incredible percentage of your policy that goes into marketing/admin/etc

The expense ratio is something like 30 to 40 percent of premium on commercial policies in case anyone was wondering. This figure is found on annual reports.

I'm not sure if insurers should be blamed for that though. Economically, that can be explained by the concave shape of consumers' Von Neumann Morgenstern utility curves describing their degree of risk aversion. It reflects their willingness to pay for a trading an uncertain outcome to a certain one.

> More than 90% of insurers in one recent industry survey stated that “exclusions or limitations” are a “methodology for recovery.” Translation: that means they’re expecting not to pay you.

To add an anecdote to this, I have a friend who used to work for an insurer and now works in reinsurance and regularly jokes that everytime an insurer pays somethings, someone is getting fired.

This is ihmo one of if not the most dishonest field of work in the modern world.

Hi thanks for doing what ever you're doing to help under- and non-insured people.

I'm disabled, Achondroplasia. Insurers in my country have constantly denied me health insurance. I have documented at length my ordeal with top health insurers in the country, Who are in partnership with leading international insurers[1]. Now there is 100% FDI for the insurance industry.

I've appealed to the regulatory body with each instance, But they always side with the insurance company as the former close my requests under totally different pretext (never mentioning that they denied me a policy) e.g. My complaint is that insurer not providing me the policy, Insurer responds to my complaint as 'Your refund will be processed in 10 days' and my regulatory body closes my complaint as 'Insurer has responded'.

This in-spite of clear supreme court verdicts in similar previous cases asking the insurance regulator to ensure disabled are not denied policies.

[1] https://abishekmuthian.com/insurers-are-putting-the-lives-of...

P.S. I will update some latest developments to the blog tomorrow where a insurer asked me to lie about my disability to get the policy.

What are you building for insurance? I used to be an insurance regulator, still find the space pretty interesting

> You want people in the pool to be similar risks.

And yet my car insurance quotes only ask me my age, gender, and what car I drive. They presumably also use my history of car accidents, serious legal issues like DUIs, and car insurance claims (all nonexistent in my case) as input. This strikes me as a comically low amount of information to place me in a risk pool.

An example to the last part in the real-world: Geico is widely known to be the cash float of Berkshire Hathaway, Buffett’s main investment vehicle. It’s basically a costless margin loan for Berkshire that it can freely use in investment. The main savings Geico passes onto you in part comes from the fact that they have a better use for capital (i.e. BH is wildly good at investing) than most other insurance companies.

> - You want people in the pool to be similar risks. If they aren't and they know they aren't the low risk people will decide they don't need to insure, leaving everyone else with a higher average cost. Also, the high risk people will see a good deal and join. Adverse selection.

I think that is not necessary, and is a choice we have to make for our society.

For example, for health, do we want "sicker" persons to pay more, leaving healthy people the choice to not pay ? Or should we make it mandatory for everyone to pay what they can afford, and insure everyone, even high risks people ?

For cars, it might be a little different, but I think I'd rather have a system where everyone pays the same, and insurance is mandatory (although it's not as critical as health care).

> they care about the extremes too of course, since they wouldn't want a bunch of payouts at the same time

Isn’t that pretty much handled by reinsurance?

Car insurance is almost entirely not about repairing the damage to your car.

> Some events are low probability but high cost.

Yes, and I sometimes think about the inverse - that people like to hate on lottery players (which I'm not) with a clever sounding argument like E[X] < 1, so don't play, you'll lose.

But this fails to acknowledge the harder to model 'but I can pay £1 to play, I won't miss it, who cares, it's insignificant, and on the tiny chance I win, the win is significant'. I.e. 'but Var[X] is massive'.

That’s the theory, I would be surprised if the reality wasn’t more messy with a lot of insuring money going into marketing, management, IT, with insurance price more based on what salespeople are able to decently add to a product, and company profitability discovered afterwards.

> but of course there are laws about insurance

In the U.S. at least, you don't need to insure your own car. You just need liability insurance that will pay out to someone else if you're at fault in an accident.

> You're unlikely to crash your car, but if you do, it might cost you a heck of a lot to fix

There is also time. You may be able to afford the lawsuit that will come from the owner of the car you wrecked. But having your insurance company handle that, something they have developed expertise in, can be worth the cost.

> That gives some room for investing the free float.

That's why Buffet bought National Indemnity, btw. He wanted the float which, for him, was a cheap way of financing investment.

Not a very folksy move, truth be told.

Fantastic summary. Thanks.

> that's something actuaries have thought extensively about

But I don't think there is any solution. The further out on the "tail" you go, the more the total risk depends on the accuracy of information and assumptions you have. If there is an extremely large potential loss that is extremely unlikely, then the average becomes unknowable since the probability estimate in particular could be off by orders of magnitude. Nuclear power plants would be sort of the archetype of that, I think.

I mean, I reason like this to justify what I actually observe - that insurance companies don't want to insure things without strict limits. Despite reinsurance existing.

> you know something about yourself that they don’t

Don’t most insurance T&Cs require you to disclose known risks like having “butter fingers”? I was going to say I was playing the devil’s advocate, but really I’m not, since I’m personally on the hook for other people’s undisclosed risk through my own insurance.

> Another place is where you really just don’t care about the marginal extra cost for the peace of mind you get

Of course, there’s no peace of mind unless you think the insurance is likely to be a better deal for you than just saving the premiums yourself, right?

I rent cars frequently and never take their predatory extra insurance. It can frequently add 50% to the cost of the rental, and in about 50 rentals I've only had to pay damage out of pocket 3 times (all three because of parking bumps while the car was parked over night and the other person just left without leaving a note or anything). The out of pocket costs easily come below the total amount of insurance fees I'd have paid. Plus you always have a maximum you'd have to pay out of pocket that is not even close to the total cost of the vehicle, usually under €1.5k, and with minor bumps from parking or something like that it won't ever get even close to the max, sometimes it's even under what the insurance would've cost in the first place. I think it makes no sense and the "piece of mind" is overrated, even if you drive in to return a car with minor damage they'll just charge your card, it's not like you have any extra work or worries to deal with.

You can post a bond as an alternative to insurance in most states (it's $35,000 in California). The system is opt-out and people can self-insure if they feel like it's a bad deal.

Generally, it's a better deal to stick with the insurance. The real killer for a car accident is if there is a lawsuit and the insurer can do those much more cheaply than you can.

I lived in Melbourne, AU for a while, and their system seemed good. The third-party insurance wasn't mandatory (like here in the EU), only recommended. But you could buy insurance (something like reverse third party insurance) where if someone crashed into you, the insurance would pay you for the damages and then they'd get the money from the other person. It was very cheap.

> I can't prove collusion, but mandatory insurance seems wrong.

I do not know how it works in the USA. But in Spain the mandatory insurance is for 3rd parties, for the damage that you may cause to others.

It has historical roots. A driver will crash their car and damage or kill others. That driver has no insurance and no cash. So the victims are left with high costs and probably in poverty. Mandatory for 3rd party insurance assures that when that happens, the victims can collect some money that will alleviate their economic situation.

Not sure I fully follow. Indeed in a way it's a gift to the industry to make insurance mandatory as it creates a bigger market. But there's no 'mandatory profit'. At the end of the day the world of finance is highly competitive, there's thousands of insurance companies. These are all pushing pricing down to the average costs of the loss events. The fact insurance is mandatory doesn't prevent that competition, if anything, it increases it, and through economies of scale makes it more efficient. I'd bet that ceteris paribus, the premiums for an insurance package for a large market are closer to the average uninsured costs than insurance for small niche markets.

Second, it's mandatory because otherwise the incentives don't really line up, especially psychologically, for a lot of people.

After all, the point isn't just to insure yourself, it's also to insure against damage to other property or bodies than your own. If you're poor, old, sick, and drive a worthless car, you wouldn't be so much incentivised to carry insurance to pay out damages when hitting an expensive car another person. It could very well be that without mandatory insurance you'd have all kinds of damages on the road that would never be compensated due to the financial situation of the driver.

> And yes--there will be the obligatory story about the uninsured driver, but 15k, 30k, 5k liability doesn't cover much. So little why mandate it?

You may say 'but it's a small amount so who cares', but that's a bit silly. Either make the argument that the premiums/coverage are too low, or too high, you can't do both. If it'd make sense for $300k coverage but not for $30k, then you'd have to be making the argument that minimum insurance premiums should 10x, not to go away completely.

Self-insure is no magic panacea. For one it typically involves putting up a bunch of cash in a no/low-return bond, typically averaging around 50k, which has opportunity costs (in the form of returns on investment) that aren't too dissimilar from just paying out an insurance premium. After all, if you take the S&P500 returns, cut it by 50% for good measure, you're still at 2.5k a year in opportunity costs, which is a multiple of the average annual car insurance in California.

This idea that rates would be halved comes completely out of nowhere, says who? Hell, insurance companies are de facto law firms, which take much of the headache of many claims out of your hands, and efficiently because it's their bread & butter, and with much more power. Not cheap or fun doing that yourself.

Insurance isn't perfect and the article's discussion on over-insurance is valid, but a lot of insurance packages (if properly negotiated) are actually quite competitive and efficient.

Where mandatory insurance completely sucks is differentiation. For example, if you drive 5% of the average rate, you're overpaying massively. If you're driving in a village with 5% the amount of traffic and lower loss probabilities, you're overpaying massively. But states with self-insurance suffers from the same issues lacking differentiation. It's at the end of the day a data issue you have to solve, regardless of whether you insure yourself or purchase insurance.

> 15k, 30k, 5k liability doesn't cover much. So little why mandate it?

Capped liability seems stupid to mandate.

In the Netherlands, liability insurance is mandatory and uncapped. The insurance company will pay, and then do their best to recover money from you. It doesn't take you of the hook. It just ensures the hurt party gets their payout immediately and unconditionally.

That seems like a better system than what you described.

It depends on how it’s implemented, but mandatory insurance should help lower the premium of everyone.

Like OP says, you should only buy insurance if it’s worth it. I never had an accident in 10 years of driving so I probably would not pay for insurance if I didn’t have to.

Now, if my record wasn’t so clean, I probably would pay voluntarily.

This means that now I pay a little bit but crash-prone people pay less.

…ideally.

For comparison, in the EU the minimum coverage for mandatory liability insurance for motor vehicles is:

- in case of personal injury, €1 200 000 per victim or €6 070 000 per claim, whatever the number of victims

- in case of material damage, €1 220 000 per claim, whatever the number of victims

Wouldn't competition among insurance providers drive the cost down to breakeven?

Does anyone know why in the US it is common to only be car liability insured up to around $200k while in Europe the standard is tens of millions? (The US maximum that I've seen possible is $2m when adding "umbrella" insurance.) This just doesn't make sense to me, especially in the face of local health care cost: what do you do if you're at fault in an accident that disables a family a four who have to spend millions in health care costs over the next several decades? (I'm even more confused because US car liability insurance is not cheaper than in Europe, despite two orders of magnitude difference in coverage.)

Eh, I know people who work in insurance (Cali specifically) and auto insurance is not their bread winner. It's _heavily_ regulated, and not in the insurer's favor. So any supposed "collusion" isn't really helping them. If you're with a reputable company and took the time to set up your policy optimally, your auto insurance ends up being about as good a deal as you're going to get anywhere.

(FYI, the real steak and potatoes in that industry is life insurance policies. They can make more on that than anything else combined.)

The article actually says that you should insure only if it creates financial distress. So, in the case you describe they should insure for the floor flooding eventuality but not for the dog ruining the carpet (as a cheaper example).

As someone whose floor was flooded, it did not cost £7000. It cost the insurance company £274,000, just to (badly) fix it, then a further £15k in compensation for everything they screwed up on the way, then another £100k for loss of value as a result of their contractors.

The problem with floor flooding is it isn’t the floor that was flooded. The floor is just a symptom. The whole house needs to be stripped and dried after a flood, during which time the house is inhabitable.

> The article assumes that everyone has a lot of savings

No it didn't. The article just gave an example of one financial situation (income + savings) and examples of potential loss events, and showed how to reason through that. It didn't assume that example applied to everyone.

The article is written according to basic principles in a way that it's pretty easy to apply it to other examples or in fact your own financial situation.

Indeed, same with healthcare. For example here in the Netherlands there's universal (mandatory) healthcare. The basic premium for full standard coverage (which is pretty much anything you'd want that affects health) is about $150 a month regardless of age. So me (30) and my dad (75) pay the same amount.

You can see here [0] that I'm averaging about 2k per year in costs and he's averaging about 12k a year in costs, or 6x the amount. For us it's actually closer to 0 vs 20k.

No difference in premiums.

Of course it must be noted that the state pays something like 80% of it through taxes which are progressive, my dad on low-income pays essentially nothing, I pay at high-income essentially everything between us.

It makes sense to set a high deductible for me, that's the only way to get a discount on the premiums.

I'm super happy with this system, don't get me wrong. But financially it makes no sense, and if the state allowed it, our premiums would be massively different. (mine much lower, his much higher to the extent of completely unaffordability).

The life insurance market is interesting in that at a young age the rates are really tiny (at least in certain countries, for term-coverage), like the cost of an expensive coffee or a couple sandwiches per month, for those ultra-rare early-death risks. I guess people just aren't that price sensitive around $5 or $15 a month, when insuring against half a million in coverage. Maybe that explains it? Otherwise you'd think the first competitor to offer insurance at say 5x the actuary table instead of 10x would just simply take the market, while still massively profiting.

[0] https://www.rivm.nl/sites/default/files/2018-11/kosten%20van...

That sounds like self-insuring but with zero control over the investments?

> The insurer must earn enough income from investing the deposits to cover losses and operating expenses for the model to be economically viable

The above is a quote from the Wikipedia article. I suspect that with interest rates at an all time low, the environment is not exactly ripe for this kind of insurance model.

> what happens if you get unlucky and are at fault with a top end Lamborghini

That would be liability insurance, not comprehensive, wouldn't it? Comprehensive insurance covers damage to your car (could be glass, vandals, natural events, hitting something with your bumper, etc.)

> Its good to be able to let friends/family grab the car

Dont some companies have conditions which say only the people who are on the policy can drive the car?

This is interesting, how much do you save? I imagine that liability insurance has to be the lion's share of a more vanilla policy, no?

Insurance for those cases only makes sense if you can’t afford for the washing machine to break. In that cases, however, it might be the right call

Because for like £200 a year I get insurance for literally all of my appliances including the boiler. And yes, boilers break and need replacement, that's usually at least £1500. Washing machines are cheaper but not insignificant. Same with the dishwasher, the dryer, the hob, the oven......

I'd rather pay that £200 once a year and have a complete peace of mind about it.

Liability insurance is legally required in the US as well, yet it’s still common to pay for “uninsured driver insurance” in case you get hit by a driver who is illegally driving without insurance. There’s also “underinsured driver insurance” for cases where the at-fault driver has only the legal minimum insurance coverage and your medical bills are higher than that.

> The industry is well regulated and ensures margins aren’t indulgent.

Home insurance, auto insurance are often very competitive.

But these days it's common when you buy a TV, phone, laptop, that the checkout button online also offers "insurance".

I see the same renting a vacation home, offer for a cancellation insurance.

Sure, it sucks if I'm sick and need to cancel my vacation and I can't get my money back -- but insuring against such events is often a bad idea.

There is a lot of unnecessary "insurances" being offered to consumers today.

For the record: health, home, auto, travel, disability, and generic liability insurances is usually a necessity.

What author is saying is don't insure against spilled milk, even if many shops offer these easy add-on "insurances" at checkout.

Personally, I sometimes find it hard to know what I should and should buy when renting a vacation home or car. I don't care for the cancellation insurance, but I do want a liability insurance (which most always include automatically, at-least where I live).

Because of the 80% preventing financial ruin?

Yes this is true. They often lose money on the premiums, actually, and then make money on the float. A very simplified example: You pay $1,000 per year for 10 years on home insurance. Then a hail storm ruins your roof and it costs about $10k to replace. So they end up paying out the $10k in premium they collected over 10 years, but were able to make money on the interest they made while they held it.

Well the payout to repair the cars and pay medical bills or whatever maybe around 66% of the money customers in aggregate pay them, the other 33% mostly goes to pay the claims adjusters, hire lawyers to defend against fraud, and do a ton of other stuff. At the end of the day they’re going to have just a couple percent of profit directly from the actual premium payments if they are lucky. But then the investment returns gets them more profit.

It requires more than common sense to stash away cash. It requires sufficient income, and a stable situation. No medical debt, no family that needs help with their car to keep their job.

Not having cash on hand for these kinds of risks is a part of the poverty trap. It is a ststemic issue more than it is a personal one.

You have probably done this already anyway, but it is worth checking the travel insurance included with your credit card. Many people are overinsured when it comes to travel (overseas medical) insurance.

> European so I don't need domestic health insurance

Just a reminder that Europe is not a country, and this statement is not accurate for many Europeans. It's perfectly fine to say this about a country in which you understand the system, but this doesn't even apply to all EU countries, let alone the continent.

> When it comes to something like a phone, I just figure 'it's a risk I am willing to take'.

I feel like the option to insure a phone is a money grab.

An add-on that allows you to upsell a bit more.. it seems like a thing nobody should need.

Same for insuring against have to cancel you vacation.. nobody should ever do that.

But people do, probably because there is a checkbox at checkout that allows you to easily add an "insurance".

I can buy another phone if I broke my phone, but I prefer to sign up insurance for about 1-2 years as a fee to use my phone roughly. It makes me to be able to use phone without much care, like using a case and avoid water even though the phone is IPX8.

This assumes that by taking more risk, you end up gaining more if the risk didn't pan out.

But not all situations are like that.

Do you use a cell phone cover or anything to protect it...?

Who sells you that insurance policy?

The crazy part is that they don't attempt to repair, nor have any deductible, nor use residual values. That's usually how they prevent people from executing on their insurance rights. You got a really nice package, or the company has very loose procedures at the claims department.

In the EU the standard warranty is 2 years, so if there's a software boot issue you'd be covered without insurance, too. But you wouldn't get a new phone or a cheque, you'd typically get to send it in for repairs and be without your phone for two weeks (which is kind of unheard of for many people nowadays, plenty of people I know don't even have a computer anymore. All banking, voting, taxes, booking flights, booking gym classes, work calls etc, is all dependent on that phone), then get back your 2 year old phone that afterwards often gets replaced a year later anyway due to it getting old. Same with if your screen breaks -> send it in for a replacement through a crappy company.

And some insurance companies will only pay-out 'residual value', after all you're not insuring depreciation. So you'd get back what the 2nd hand value pre-breakage would've been...

Add a deductible and people often don't even bother with an old phone.

Yes, but the restrictions on investment that insurance companies are under means that you'd be better of if you invested it yourself

Apple Care are truly helpful beyond just replacing your product. My MacBook was damaged by a cast iron tonka truck dropped off the balcony above directly on top of it, but it was about 6 months out of Apple Care. Much to my surprise, a few keys on the keyboard were destroyed, but apart from that it looked like it should have been fine. Anyway, it was not. It wouldn't turn on.

I took it to the Apple Care team anyway, and they diagnosed it for over 2 hours before finally telling me that one of the RAM modules was faulty, but it wasn't an easy repair because it was soldered to the mobo. They gave me a quote to replace the mobo on the spot.

It was around $900 and had a lead time of a few weeks, so I said I couldn't afford to wait that long. Even though my Apple Care was out of date, they gave me around a 25% discount on a brand new MacBook Pro 15". I was shocked because that's more than I ever paid on Apple Care. And had I walked away at that point, the Apple Care team would have spent 2 hours diagnosing my 3.5 year old broken MacBook for free just because it had Apple Care at some stage.

Apple Care is a user experience, not necessarily just an insurance plan. I wish my car insurance were like that.. Someone rear ended my fairly new car the other day and it has been in and out of repair shops for 8 months with recurring quality problems. I would have loved if I could have said to the insurance company: please, fix up my old car, private sale it for the best price and get me a new one at a discount straight away. I'll pay the difference.

I wouldn't say so.

In gambling you bet $10 in the hope you'd win $100, if you don't, you'll be very unhappy.

In insurance you pay $10 understanding you may otherwise lose $100, but whether it happens or not you're now quite indifferent to. I'm not happy or sad if I pay premiums for years without necessity, nor happy or sad if I pay premiums and I am covered by insurance when a loss event happens. I'm not gambling in the hopes of a potential event that occurs, or doesn't occur, I'm insuring so that I'm indifferent.

Gambling increases risk, insurance decreases it. The Expected Value (EV) of spending $10 to have a 10% chance of winning $100, vs spending $10 to prevent a 10% chance of losing $100, might be exactly the same, but the risk is entirely different. In case A there's 9 losses (cost>EV) and 1 win (cost<EV), in case B the cost=EV every single time, that's what it means to reduce risk. It's very different from gambling in that sense.

Gambling is a hedonistic enterprise. If you get a thrill from buying car insurance, I guess it could be considered gambling, but for most people it’s more akin to a chore.