5 ms·

What? The point of insurance is to pool risk. The expected value of insurance is not automatically negative. Look up the term "actuarially fair". Yes, there is

What? The point of insurance is to pool risk. The expected value of insurance is not automatically negative. Look up the term "actuarially fair". Yes, there is moral hazard in insurance and it is sometimes necessary to exclude bad actors to prevent markets from unraveling, but to not to the extent which has become common in many sectors. Your whole post reads like an specious apology for bad behavior in the insurance industry.

chimeracoder 11y ago
> The point of insurance is to pool risk. The point of insurance is to smooth risk, not to pool it. Pooling risk is not the point of insurance as a product; it's the mechanism by which that product (risk smoothing) becomes feasible as a business model. > Look up the term "actuarially fair". There's really no need to condescend by telling me to look up basic terminology; I am quite well-versed in this topic. I didn't bring up moral hazard in this post, because it actually isn't necessary to explain why insurance has a negative expected value (which is equivalent to the statement that premiums are always non-zero[0]). It sounds like you're confusing a few different concepts here. [0] Moral hazard is generally addressed by deductibles, not by premiums.
- TeMPOraL 11y ago
  Could you ELI5 it all then, please? I was always under the impression that the whole point of insurance is that expensive accidents don't happen to everyone, so if everyone pays a little regularly, then there's enough money to both pay out the ones who end up having an expensive accident AND for the insurer to make money. On an infinite timescale it may not add up but it surely can on any practical one, right?
  - mreiland 11y ago
    The best description I've seen is that insurance is peace of mind. from an individual perspective, insurance means you don't have to worry about unexpected expenses from things beyond your control (ie, peace of mind). Now, the mechanism by which this is achieved may be described as a pool in that it's a single company with a pool of money that everyone pays into and the input into that pool necessarily must be greater than the output. But from the "customers" perspective, insurance is peace of mind. ie, it smooths their total risk over time.
    - vinceguidry 11y ago
      "Peace of mind" is false advertising, you should not expect insurance to provide that to you. You will always have to worry about unexpected expenses, because insurance companies are never going to insure everything that could possibly happen, even if you get a good policy that doesn't dick you around on claims. If you are expecting insurance to protect you from not knowing the risks, then you are taking a much bigger risk than not having insurance at all, because of the complacency that the belief you're insured engenders.
    - TeMPOraL 11y ago
      We have a whole subthread here about how insurance companies will refuse to pay when push comes to shove; I don't really believe in the peace of mind anymore. What I'm looking for is the ELI5 for what insurance really is about (especially from the POV of insurers) given that, if I understand correctly, 'chimeracoder is disputing the insurance-as-everyone-pooling-money model.
      - mreiland 11y ago
        For some definition of "reall", amirite? people and business purchase insurance to cover unexpected loss, ie, "peace of mind". Maybe insurance companies are evil scumbags, but that's STILL the reason why people PURCHASE insurance.
      - mreiland 11y ago
        For some definition of "reall", amirite? people and business purchase insurance to cover unexpected loss, ie, "peace of mind". Maybe insurance companies are evil scumbags, but that's STILL the reason why people PURCHASE insurance.
- zo1 11y ago
  I'm a tad disappointed that people are downvoting you on this. It sounds like you have quite a bit of knowledge in this area, and if you are wrong, I'd prefer if the individuals actually commented how/why you're wrong, and back it up. It would yield more information/insight to all of us reading the discussion.
runako 11y ago
> The expected value of insurance is not automatically negative. I'm curious how this math works. In my (quite likely incomplete) mental model of insurance, there are only a few terms: premiums, payouts, profits. It would seem that they have to balance. So if you pool risk, you are summing the payouts. Those payouts are covered by the sum of premiums. Any profit is the sum of premiums minus the sum of payouts. Profits = Premiums - Payouts Is this right so far? Because then it seems that the expected value of insurance to the customer is the negated value of the expected profit of the insurer. Put another way: if the expected value of insurance is not negative, shouldn't the insurer raise premiums or exit the business? Again, I know next to nothing about insurance and I'm asking to learn.
- Retric 11y ago
  Insurance companies need a lot of cash on hand to cover low probability events. However, they can invest this money, so things like life insurance where risks increase over time but the premiums are fixed, can end up with a higher average payout than insurance premium, the difference being time value of money. In other words you end up paying the opportunity cost, but not nessisarily a nominal cost in the long term.
  - deleted 11y ago
    [deleted]
- cronjobber 11y ago
  If money has diminishing marginal utility (to the insured) then insurance can have both positive expected utility for the insured and positive expected profit for the insurer.
imjustsaying 11y ago
Right, the risk is pooled, the funds are pooled. But everyone seems to forget that there's a huge part of that pool taken by the things sitting in the insurance office's chairs.

chimeracoder 11y ago

> The point of insurance is to pool risk. The point of insurance is to smooth risk, not to pool it. Pooling risk is not the point of insurance as a product; it's the mechanism by which that product (risk smoothing) becomes feasible as a business model. > Look up the term "actuarially fair". There's really no need to condescend by telling me to look up basic terminology; I am quite well-versed in this topic. I didn't bring up moral hazard in this post, because it actually isn't necessary to explain why insurance has a negative expected value (which is equivalent to the statement that premiums are always non-zero[0]). It sounds like you're confusing a few different concepts here. [0] Moral hazard is generally addressed by deductibles, not by premiums.

TeMPOraL 11y ago
Could you ELI5 it all then, please? I was always under the impression that the whole point of insurance is that expensive accidents don't happen to everyone, so if everyone pays a little regularly, then there's enough money to both pay out the ones who end up having an expensive accident AND for the insurer to make money. On an infinite timescale it may not add up but it surely can on any practical one, right?
- mreiland 11y ago
  The best description I've seen is that insurance is peace of mind. from an individual perspective, insurance means you don't have to worry about unexpected expenses from things beyond your control (ie, peace of mind). Now, the mechanism by which this is achieved may be described as a pool in that it's a single company with a pool of money that everyone pays into and the input into that pool necessarily must be greater than the output. But from the "customers" perspective, insurance is peace of mind. ie, it smooths their total risk over time.
  - vinceguidry 11y ago
    "Peace of mind" is false advertising, you should not expect insurance to provide that to you. You will always have to worry about unexpected expenses, because insurance companies are never going to insure everything that could possibly happen, even if you get a good policy that doesn't dick you around on claims. If you are expecting insurance to protect you from not knowing the risks, then you are taking a much bigger risk than not having insurance at all, because of the complacency that the belief you're insured engenders.
  - TeMPOraL 11y ago
    We have a whole subthread here about how insurance companies will refuse to pay when push comes to shove; I don't really believe in the peace of mind anymore. What I'm looking for is the ELI5 for what insurance really is about (especially from the POV of insurers) given that, if I understand correctly, 'chimeracoder is disputing the insurance-as-everyone-pooling-money model.
    - mreiland 11y ago
      For some definition of "reall", amirite? people and business purchase insurance to cover unexpected loss, ie, "peace of mind". Maybe insurance companies are evil scumbags, but that's STILL the reason why people PURCHASE insurance.
    - mreiland 11y ago
      For some definition of "reall", amirite? people and business purchase insurance to cover unexpected loss, ie, "peace of mind". Maybe insurance companies are evil scumbags, but that's STILL the reason why people PURCHASE insurance.
zo1 11y ago
I'm a tad disappointed that people are downvoting you on this. It sounds like you have quite a bit of knowledge in this area, and if you are wrong, I'd prefer if the individuals actually commented how/why you're wrong, and back it up. It would yield more information/insight to all of us reading the discussion.

runako 11y ago

> The expected value of insurance is not automatically negative. I'm curious how this math works. In my (quite likely incomplete) mental model of insurance, there are only a few terms: premiums, payouts, profits. It would seem that they have to balance. So if you pool risk, you are summing the payouts. Those payouts are covered by the sum of premiums. Any profit is the sum of premiums minus the sum of payouts. Profits = Premiums - Payouts Is this right so far? Because then it seems that the expected value of insurance to the customer is the negated value of the expected profit of the insurer. Put another way: if the expected value of insurance is not negative, shouldn't the insurer raise premiums or exit the business? Again, I know next to nothing about insurance and I'm asking to learn.

Retric 11y ago
Insurance companies need a lot of cash on hand to cover low probability events. However, they can invest this money, so things like life insurance where risks increase over time but the premiums are fixed, can end up with a higher average payout than insurance premium, the difference being time value of money. In other words you end up paying the opportunity cost, but not nessisarily a nominal cost in the long term.
- deleted 11y ago
  [deleted]
cronjobber 11y ago
If money has diminishing marginal utility (to the insured) then insurance can have both positive expected utility for the insured and positive expected profit for the insurer.

imjustsaying 11y ago

Right, the risk is pooled, the funds are pooled. But everyone seems to forget that there's a huge part of that pool taken by the things sitting in the insurance office's chairs.