8 ms·

My take as a finance person but not an insurance person: - Some events are low probability but high cost. You're unlikely to crash your car, but if you do, it

My take as a finance person but not an insurance person: - Some events are low probability but high cost. You're unlikely to crash your car, but if you do, it might cost you a heck of a lot to fix. Nearly everyone is in this situation, so it makes sense for everyone to pay a little at a time and give that pot to whoever ends up crashing. - The insurance pool cares about the average outcome, ie average cost. They need to collect more than this. The insurance buyer cares about the extreme case, where they end up crashing. So in there we have space for a trade. Yes they care about the extremes too of course, since they wouldn't want a bunch of payouts at the same time, but that's something actuaries have thought extensively about. - 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. - If the thing you're insuring isn't a catastrophic cost, you're less likely to want to pay over the odds. Maybe your £200 phone doesn't need a £30 annual insurance, because you have lots of money to buy a new phone. If you're really rich maybe that car crash scenario doesn't matter for you either (but of course there are laws about insurance). - The insurance company holds a free float. All the premiums are coming in, but only pay out now and again. That gives some room for investing the free float.

tshaddox 5y ago
> 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.
- csa 5y ago
  Also your address, which is surprisingly useful in predicting likely outcomes (even if the range of outcomes in a neighborhood are wide at the extremes).
  - rolleiflex 5y ago
    It really is depressing just how much information, from life expectancy to health outcomes, can be gathered from a simple five digit zip code. Very accurate too.
  - tshaddox 5y ago
    Insurance companies apparently seem to think it’s useful, but I find it extremely hard to believe it would be more useful than, say, even the most basic information about one’s driving behavior, like whether one drives 1,000 miles a year or 50,000.
    - riffraff 5y ago
      I don't think that'd be less useful, but they can't trust what you say: "sure, I only drive very little, very carefully, and very slowly" is not something they can check. If they can, they'll use it: that is why black box car insurance exists.
      - SilasX 5y ago
        If you’re just going by mileage count, you can look at the odometer.
    - samtho 5y ago
      They mostly deal with numbers on the macro scale. If 10,000 miles per year is a good representation of how much the general populous drives, it’s good enough for them. This is why we’re seeing more niche insurance companies pop up (MetroMile, et al) who can offer “smarter” rates based on a more granular assessment of risk.
      - SilasX 5y ago
        All else equal a driver who does 5000 miles a year will have half the adverse events of Someone driving 10,000 miles/year. That’s a huge difference that makes no sense of lump together. And yet only a few (non-commercial) insurers, like metromile, account for it. It makes no sense.
- lordnacho 5y ago
  Two things to this: - That bit of info you give can be used to infer other info. Also it's possible those first three things explain most of the variation. We've all heard that young men in their 20s crash their cars a lot, I get the feeling it's true though I've never checked. - You only need the risk groups to be granular enough that it isn't totally obvious that people are different risks (footballers and grannies).
- oceanplexian 5y ago
  They use a heck of a lot more than that. They use your name and DOB to run a backdoor credit pull and it turns out that is a pretty reliable indicator of what risk pool you belong in. There is also a "credit check" for insurance (You can get your report from LexisNexis) and they can see how many times you applied for other insurance products and how long you had them, which is another indicator.
- ClumsyPilot 5y ago
  To use more information, you make more granular risk pools. The pools need to ne large enough to actually pull risk. If you try to ise 10 pieces of information with 10 possible values each, that could give you 10 billion risk pools, i.e. individual person. Alternatively 33 Yes/No questions alsp let you identify an insividual person on planet earth. Having "individual" insurance has no real meaning, because at that point its not spreading risk.
rolleiflex 5y ago
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.
- Scoundreller 5y ago
  I’ve always wondered about this logic: it makes sense for life insurance where the average person pays in for decades before withdrawing. But for geico (primarily auto), where’s the float? I thought it was like a pyramid scheme: this years payments pay out this year’s claims. There would be minimal float for the future except to cover black swan events like a hurricane hitting a state every 10 years, and that might be what Reinsurance is for (something else BH does a lot of, and probably self-deals a lot). Float would be great for the insureco, but any insurer charging anything more annually than average annual claims will lose all their business.
  - DangitBobby 5y ago
    > Float would be great for the insureco, but any insurer charging anything more annually than average annual claims will lose all their business. What are you basing the assumption that insurance companies are working with low margins on? There are many competitors, sure, but what reason is there to believe that they must compete on price?
elcomet 5y ago
> - 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).
- xwolfi 5y ago
  Yes but there's also a time factor: do you want young people to pay while healthy. When you're young you want to think only abt yourself, when you're old you want younger people to think abt you so :D
  - elcomet 5y ago
    Yeah, that's why I think everyone should pay, not based on their age, but on their ressources.
    - thatguy0900 5y ago
      Do you think there should be differences based on lifestyle? For instance, should someone that works out everyday pay the same as someone who is 400 pounds?
      - elcomet 5y ago
        I think they should both pay based on their income, not their lifestyle.
        thatguy0900 5y ago
lclarkmichalek 5y ago
> 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?
- lordnacho 5y ago
  Yep, there's a whole market in insurance risk where it can be sliced and diced and traded, much like most financial risks.
- occz 5y ago
  That's correct. As an insurance company you buy reinsurance to insure yourself from catastrophic outcomes (i.e too many claims for your reserves to handle).
OJFord 5y ago
Car insurance is almost entirely not about repairing the damage to your car.
OJFord 5y ago
> 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'.
- lordnacho 5y ago
  You're absolutely right, the thing to look at here is the St Petersburg problem. You have a coin, and each time you don't get heads the payout doubles. Get heads and get the payout. What do you pay to play this? It turns out that you can't work out an E[X] for this, as it's a series that doesn't converge. But also if you go around and ask people what they'd pay, surprisingly they don't say infinity. Expectation is thus not the last word in decision making. Turns out utility is a thing that matters, and we can come up with some thoughts on it (von Neumann-Morgenstern etc).
  - portent 5y ago
    re: surprisingly they don't say infinity I'm not sure it's that surprising, the expectation is only infinity if you think the person making the payout has the capacity to pay an infinite amount. The second you think this amount is finite (which must always be the case in reality), then the expectation becomes finite and probably quite small. I agree in the more general point, expectation is not always the best tool for extremely rare / extremely significant scenarios.
    - Tomminn 5y ago
      The parent is correct, and shouldn't be downvoted IMO. If you set the max payout to world gdp of ~$100 trillion, you get an expected value of ~$50 for the game. So people are actually calculating expected value correctly with their intuition. It's just that in their instinctive calculation they're also making better assumptions about reality than mathematicians do.
tarsinge 5y ago
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.
muskox2 5y ago
> 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.
- antognini 5y ago
  It's usually possible "self-insure," too. Basically, you put up some amount of money (of order $30-50k) to the DMV as a surety bond. Then if you're held liable for an accident the state doesn't have to worry about you paying up because they already have the money.
  - SilasX 5y ago
    $50k is comically insufficient to cover the damage you can do in a car in a single incident, though, and such a bond is a limp assurance at best.
    - dehrmann 5y ago
      I wonder if there should be a per-vehicle cap on damage where a vehicle is so expensive that the owner insures it for any damage over some amount, say $60,000, or the 95th percentile new car sale price.
      - UncleMeat 5y ago
        Damage to vehicles isn’t the problem. The tail is hitting a car full of surgeons and ruining their careers so you are paying out gazillions in personal damage.
JumpCrisscross 5y ago
> 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.
- nraynaud 5y ago
  insurances cost a lot of time too. I don't think you can really avoid that, we're in a society where everybody believe that other people's time and attention are disposable.
- usrusr 5y ago
  Not only time, also market knowledge in certain exceptional insurance fields: the insurance that takes care of flying you out when you end up in a hospital abroad likely knows a thing or two about procuring that service that you don't know.
deleted 5y ago
[deleted]
maest 5y ago
> 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.
truetraveller 5y ago
Fantastic summary. Thanks.
perl4ever 5y ago
> 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.

tshaddox 5y ago

> 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.

csa 5y ago
Also your address, which is surprisingly useful in predicting likely outcomes (even if the range of outcomes in a neighborhood are wide at the extremes).
- rolleiflex 5y ago
  It really is depressing just how much information, from life expectancy to health outcomes, can be gathered from a simple five digit zip code. Very accurate too.
- tshaddox 5y ago
  Insurance companies apparently seem to think it’s useful, but I find it extremely hard to believe it would be more useful than, say, even the most basic information about one’s driving behavior, like whether one drives 1,000 miles a year or 50,000.
  - riffraff 5y ago
    I don't think that'd be less useful, but they can't trust what you say: "sure, I only drive very little, very carefully, and very slowly" is not something they can check. If they can, they'll use it: that is why black box car insurance exists.
    - SilasX 5y ago
      If you’re just going by mileage count, you can look at the odometer.
  - samtho 5y ago
    They mostly deal with numbers on the macro scale. If 10,000 miles per year is a good representation of how much the general populous drives, it’s good enough for them. This is why we’re seeing more niche insurance companies pop up (MetroMile, et al) who can offer “smarter” rates based on a more granular assessment of risk.
    - SilasX 5y ago
      All else equal a driver who does 5000 miles a year will have half the adverse events of Someone driving 10,000 miles/year. That’s a huge difference that makes no sense of lump together. And yet only a few (non-commercial) insurers, like metromile, account for it. It makes no sense.
lordnacho 5y ago
Two things to this: - That bit of info you give can be used to infer other info. Also it's possible those first three things explain most of the variation. We've all heard that young men in their 20s crash their cars a lot, I get the feeling it's true though I've never checked. - You only need the risk groups to be granular enough that it isn't totally obvious that people are different risks (footballers and grannies).
oceanplexian 5y ago
They use a heck of a lot more than that. They use your name and DOB to run a backdoor credit pull and it turns out that is a pretty reliable indicator of what risk pool you belong in. There is also a "credit check" for insurance (You can get your report from LexisNexis) and they can see how many times you applied for other insurance products and how long you had them, which is another indicator.
ClumsyPilot 5y ago
To use more information, you make more granular risk pools. The pools need to ne large enough to actually pull risk. If you try to ise 10 pieces of information with 10 possible values each, that could give you 10 billion risk pools, i.e. individual person. Alternatively 33 Yes/No questions alsp let you identify an insividual person on planet earth. Having "individual" insurance has no real meaning, because at that point its not spreading risk.

rolleiflex 5y ago

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.

Scoundreller 5y ago
I’ve always wondered about this logic: it makes sense for life insurance where the average person pays in for decades before withdrawing. But for geico (primarily auto), where’s the float? I thought it was like a pyramid scheme: this years payments pay out this year’s claims. There would be minimal float for the future except to cover black swan events like a hurricane hitting a state every 10 years, and that might be what Reinsurance is for (something else BH does a lot of, and probably self-deals a lot). Float would be great for the insureco, but any insurer charging anything more annually than average annual claims will lose all their business.
- DangitBobby 5y ago
  > Float would be great for the insureco, but any insurer charging anything more annually than average annual claims will lose all their business. What are you basing the assumption that insurance companies are working with low margins on? There are many competitors, sure, but what reason is there to believe that they must compete on price?

elcomet 5y ago

> - 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).

xwolfi 5y ago
Yes but there's also a time factor: do you want young people to pay while healthy. When you're young you want to think only abt yourself, when you're old you want younger people to think abt you so :D
- elcomet 5y ago
  Yeah, that's why I think everyone should pay, not based on their age, but on their ressources.
  - thatguy0900 5y ago
    Do you think there should be differences based on lifestyle? For instance, should someone that works out everyday pay the same as someone who is 400 pounds?
    - elcomet 5y ago
      I think they should both pay based on their income, not their lifestyle.
      - thatguy0900 5y ago

lclarkmichalek 5y ago

> 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?

lordnacho 5y ago
Yep, there's a whole market in insurance risk where it can be sliced and diced and traded, much like most financial risks.
occz 5y ago
That's correct. As an insurance company you buy reinsurance to insure yourself from catastrophic outcomes (i.e too many claims for your reserves to handle).

OJFord 5y ago

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

OJFord 5y ago

> 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'.

lordnacho 5y ago
You're absolutely right, the thing to look at here is the St Petersburg problem. You have a coin, and each time you don't get heads the payout doubles. Get heads and get the payout. What do you pay to play this? It turns out that you can't work out an E[X] for this, as it's a series that doesn't converge. But also if you go around and ask people what they'd pay, surprisingly they don't say infinity. Expectation is thus not the last word in decision making. Turns out utility is a thing that matters, and we can come up with some thoughts on it (von Neumann-Morgenstern etc).
- portent 5y ago
  re: surprisingly they don't say infinity I'm not sure it's that surprising, the expectation is only infinity if you think the person making the payout has the capacity to pay an infinite amount. The second you think this amount is finite (which must always be the case in reality), then the expectation becomes finite and probably quite small. I agree in the more general point, expectation is not always the best tool for extremely rare / extremely significant scenarios.
  - Tomminn 5y ago
    The parent is correct, and shouldn't be downvoted IMO. If you set the max payout to world gdp of ~$100 trillion, you get an expected value of ~$50 for the game. So people are actually calculating expected value correctly with their intuition. It's just that in their instinctive calculation they're also making better assumptions about reality than mathematicians do.

tarsinge 5y ago

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.

muskox2 5y ago

> 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.

antognini 5y ago
It's usually possible "self-insure," too. Basically, you put up some amount of money (of order $30-50k) to the DMV as a surety bond. Then if you're held liable for an accident the state doesn't have to worry about you paying up because they already have the money.
- SilasX 5y ago
  $50k is comically insufficient to cover the damage you can do in a car in a single incident, though, and such a bond is a limp assurance at best.
  - dehrmann 5y ago
    I wonder if there should be a per-vehicle cap on damage where a vehicle is so expensive that the owner insures it for any damage over some amount, say $60,000, or the 95th percentile new car sale price.
    - UncleMeat 5y ago
      Damage to vehicles isn’t the problem. The tail is hitting a car full of surgeons and ruining their careers so you are paying out gazillions in personal damage.

JumpCrisscross 5y ago

> 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.

nraynaud 5y ago
insurances cost a lot of time too. I don't think you can really avoid that, we're in a society where everybody believe that other people's time and attention are disposable.
usrusr 5y ago
Not only time, also market knowledge in certain exceptional insurance fields: the insurance that takes care of flying you out when you end up in a hospital abroad likely knows a thing or two about procuring that service that you don't know.

deleted 5y ago

[deleted]

maest 5y ago

> 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.

truetraveller 5y ago

Fantastic summary. Thanks.

perl4ever 5y ago

> 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.