6 ms·

When Is Insurance Worth It?

32 points by kqr 2y ago

Etheryte 2y ago
I don't think this is sound advice. The Kelly criterion has been thoroughly explored in the finance world and pretty much everyone agrees it's way too optimistic in situations where it's hard to determine accurate probabilities, such as real life. It's given rise to many alternatives such as Half-Kelly, Kelly minus constant, etc, but that just goes to show you how inaccurate of a proxy it is. Insurance companies have a reasonably good grasp of probabilities because they have actual data. They can see how many of their clients actually use the insurance and when and this gives you real inputs to go from. It's complete nonsense to make up a number like oh my car has a 33% chance of developing a big fault this year out of thin air, and to then make financial decisions based on that.
- kqr 2y ago
  I'd consider fractional Kelly (whether half, quarter, two-thirds, etc.) still a member of the Kelly family. After all, it arises when one performs a full Kelly allocation on some fraction of one's wealth, keeping the rest out of the market. It's not that Kelly is an "inaccurate proxy" -- it is provably the allocation that maximises growth -- but that people for various reasons don't want to maximise growth. They prefer slower growth in exchange for other properties, such as more cash being available for emergency needs. > It's complete nonsense to make up a number like oh my car has a 33% chance of developing a big fault this year out of thin air Are you claiming regular people cannot learn to make calibrated probability judgments and/or look up car failure rates? Maybe that is the problem with the Kelky-based framework: it requires forecasting a probability distribution and many people are not great at that, although they could learn it. Since it wasn't clear from your comment, what alternative framework are you proposing for the insurance decision?
  - taneq 2y ago
    Insurance isn’t about maximising overall outcome (we know it doesn’t do that!) It’s about managing critical (often existential) risks. You buy insurance when you need to protect against an unrecoverable loss (house burned down, car was stolen, permanently injured and unable to work, etc.) that you can’t just “ride out” and self-finance.
    - kqr 2y ago
      > (we know it doesn’t do that!) ...but it does do that under the assumption of compounding, and that's part of why it exists. I recommend learning about the Kelly criterion and E log X strategies to see why. The key insight is we shouldn't look at the arithmetic expectation of profits of isolated bets beccause that causes us to overinvest in uncertain profits and underinvest in insurance.
- kidros 2y ago
  This was my exact thought when I hit that point in the article. How am I supposed to know the probability to make these calculations? And if I make up numbers that "seem" reasonable, how is that better than buying insurance to sleep better?
  - kqr 2y ago
    Many of these probabilities can be looked up in official statistics. Then you can adjust a tiny bit depending on whether you think you have more or fewer risk factors than the average. When I feasibility tested by asking my wife to guesstimate a couple of these she ended up very close to official statistics. The first-level trick she used is Fermi estimation. You can totally do it and it's worth practicing. There are even competitions in it open for anyone! I like the Quarterly Cup at Metaculus. The next iteration starts early January.
- aoanevdus 2y ago
  I don’t believe I can come up with accurate numbers like that. I have no chance against a big company with a bunch of actuaries who do that for a living. I think I really can sometimes tell if I’m riskier or safer than the average person. I can observe other people’s behavior and compare it to mine. But even then, my impressions will be subject to a lot of biases (eg. everyone thinks they are an above-average driver). If I assume the insurance company has done the math so they make a decent margin, and if I’m confident I’m a better or worse risk, it’s possible I can use that reasoning to guess whether insurance is a good value for me.
  - kqr 2y ago
    It seems like you're assuming a zero-sum game here where you are hoping to earn more from insurance claims than you paid in premium. This is not how insurance is supposed to be evaluated, as TFA points out. You're not against the insurance company. Your decision is relatively separate from theirs.
    - aoanevdus 2y ago
      If I believe insurance is well-priced, the cost ought to be pretty close to the value it’s providing me, maybe cheaper if the insurance industry has some advantage like good rate of return or higher if they are uncompetitive. That makes me indifferent to whether I have insurance in a lot of areas. Therefore, I’m not spending a lot of time purchasing insurance. Nothing against the industry. Given I’m unable to produce the probabilities necessary to compute the Kelly criterion, I can’t use that to make the decision. Instead, I have to use dumb heuristics like “I need liability insurance to get rid of my risk of ruin” or “I can easily afford to replace my car, but my passion is parking underneath dead trees during storms, so I should pay for comprehensive coverage.” In either case I have no idea how to compute the probabilities, but I’m still pretty sure I made the right decision.
      - kqr 2y ago
        > If I believe insurance is well-priced, the cost ought to be pretty close to the value it’s providing me The value of insurance to the buyer depends on the buyer's wealth. The insurance the electronics store offers on the tablet I buy is well-priced for their target audience but not for someone with my emergency expense buffer.
3eb7988a1663 2y ago
>The purpose if insurance is not to help us pay for things that we literally do not have enough money to pay for. It does help in that situation, but... 56% of Americans cannot cover a $1000 emergency expense. Insurance absolutely is a lifeline that most people need to avoid financial ruin. Edit: My source for the 56%: https://www.cnbc.com/2022/01/19/56percent-of-americans-cant-cover-a-1000-emergency-expense-with-savings.html https://www.cnbc.com/2022/01/19/56percent-of-americans-cant-... Which downthread was pointed out that it was derived from this survey: https://www.bankrate.com/banking/savings/emergency-savings-report/#sudden-bill https://www.bankrate.com/banking/savings/emergency-savings-r...
- MathMonkeyMan 2y ago
  If I were to buy health insurance, it would cost between $400 and $800 per month. It would likely not cover me from financial ruin anyway. If I'm uninsured, I receive treatment and never pay the bill. Maybe this affects my credit, but it is not financial ruin. In reality, I get good health insurance through an employer. When I am employed. $1000 is nothing compared to the expense of being insured.
  - pavel_lishin 2y ago
    > If I'm uninsured, I receive treatment I think this is true if you walk into an emergency room with a life-threatening illness; is this true if you start developing tooth problems, or diabetes? Can I walk into the ER with bad kidneys and get a round of dialysis on the house?
    - nradov 2y ago
      Yes, you can get a round of dialysis. Patients with end-stage renal disease qualify for Medicare which covers most of the cost.
      - pavel_lishin 2y ago
        How long does it take to get approved? I guess renal failure isn't exactly a thing that sneaks up on you, but I do wonder what happens if there's some catastrophic incident that results in an ongoing medical issue; can you just keep showing up to the ER for treatment while enrollment goes through?
pavel_lishin 2y ago
> The purpose if insurance is not to help us pay for things that we literally do not have enough money to pay for. It does help in that situation, but the purpose of insurance is much broader than that. What insurance does is help us avoid large drawndowns on our accumulated wealth, in order for our wealth to gather compound interest faster. Neat. What about people who don't have accumulated wealth?
- riggsdk 2y ago
  The linked article explains it further down. In common cases it boils down to "if you're rich don't bother with insurance, if you're poor you should pay it". > In a concrete example, let’s say that our household wealth is $25,000, and we’ve just gotten a motorcycle with some miles on it already. > Assuming no deductible, would this be worth it? Yes! > If our wealth had been $32,000 instead, the insurance would no longer have been worth it
  - wakawaka28 2y ago
    >In common cases it boils down to "if you're rich don't bother with insurance, if you're poor you should pay it". This is way too simple. If you're rich then you stand to lose more in many situations, and may be deemed a lower risk so insurance is cheaper. If you're in reasonably good health and on the verge of being evicted if you miss a paycheck, paying hundreds per month for health insurance to head off unlikely risks is a bad idea. Probability is supposed to account for this but you might know that you're not getting pregnant or having expensive surgery, for example. An insurance company cannot assume such a thing. So they are obligated to charge you way more than you can ever get back. It is also relevant that if you miss insurance payments, you will lose coverage. Another wrench in this methodology is that some costs are not purely financial. What price do you put on the risk of dying from a lack of treatment? Is that risk higher than the risk of ending up destitute and uninsured anyway?
NAHWheatCracker 2y ago
I've been thinking about this lately. For a couple weeks, I was worried about my health insurance for next year through my state's marketplace and I was considering whether it would be worth the unsubsidized price of $350-450 per month. Ultimately, I don't have enough information about my risks to feel comfortable with my analysis. While it would be mentally soothing to use the calculator, it's not really helpful. I'm also curious what's going on with insurance prices this year. The health insurance premiums this year are 33% more and just today I got my home insurance renewal asking for 25% more with the exact same coverage amounts. Did something happen to justify these increases?
- relaxing 2y ago
  > I got my home insurance renewal asking for 25% more with the exact same coverage amounts. Did something happen to justify these increases? Climate change.
  - xboxnolifes 2y ago
    This is a nothing answer. Climate change has been happening for decades. What exactly changed this year that led to this increase.
    - relaxing 2y ago
      What happened this is year is the need to cover payouts from last year’s record losses due to wildfire, flooding and wind. https://www.nytimes.com/interactive/2024/12/18/climate/insurance-non-renewal-climate-crisis.html https://www.nytimes.com/interactive/2024/12/18/climate/insur... https://www.nytimes.com/interactive/2024/05/13/climate/insurance-homes-climate-change-weather.html https://www.nytimes.com/interactive/2024/05/13/climate/insur... https://www.nytimes.com/interactive/2024/05/13/climate/home-insurance-profit-us-states-weather.html https://www.nytimes.com/interactive/2024/05/13/climate/home-...
- kqr 2y ago
  General economic conditions prevents new capital from entering the market to undercut current insurers. Behind the scenes much of this tighening of available capital happened more than a year ago but it's being passed on to consumers only now. Nothing in particular has happened this year -- it was fairly ordinary in terms of catastrophies.
crazylogger 2y ago
[dead]
deleted 2y ago
[deleted]
rsanek 2y ago
setting aside the difficulty in getting probabilities that sister commenters have brought up, i think what these kinds of articles often miss is that these decisions actually often are about vibes. even if i had accurate numbers and Kelly says that it's not worth it to buy insurance, it very well could be worth the peace of mind for me personally, regardless of wealth. in general i don't like when someone else tries to tell me how i should be using a product i buy, and that includes insurance.
- maxerickson 2y ago
  In general i don't like when someone else tries to tell me how i should be using a product i buy, and that includes insurance. You shouldn't make yourself miserable thinking about advice you don't like. Just ignore it.
Tarrosion 2y ago
This makes sense in the context of trying to maximize log wealth (or I think any concave function of wealth, though the arithmetic is different). But in one of OP's other articles [1], he says the Kelly criterion doesn't require trying to maximize log-wealth, that this is just a common misconception -- all that's required is maximizing something growing geometrically over time. This I don't understand, maybe someone help me out? Say the real growth rate of capital (or interest rate available to me, whatever) is 2%/year and I have a 10 year time horizon. So $1.00 today is ~$1.22 in 10 years. More generally, if I have wealth X today I will have 1.22X in 10 years. And if X is not a constant but a random variable and I want to maximize future expected wealth (not log wealth), that's just max(E[1.22X]) and by linearity of expectation I should just maximize wealth today to maximize in 10 years time. So Kelly being appropriate must have some other conditions, right? Wanting to maximize log wealth is surely sufficient (and individually probably ~rational). What else? [1]
- Tarrosion 2y ago
  Whoops forgot the link https://entropicthoughts.com/the-misunderstood-kelly-criterion https://entropicthoughts.com/the-misunderstood-kelly-criteri...

32 points by kqr 2y ago

I don't think this is sound advice. The Kelly criterion has been thoroughly explored in the finance world and pretty much everyone agrees it's way too optimistic in situations where it's hard to determine accurate probabilities, such as real life. It's given rise to many alternatives such as Half-Kelly, Kelly minus constant, etc, but that just goes to show you how inaccurate of a proxy it is. Insurance companies have a reasonably good grasp of probabilities because they have actual data. They can see how many of their clients actually use the insurance and when and this gives you real inputs to go from. It's complete nonsense to make up a number like oh my car has a 33% chance of developing a big fault this year out of thin air, and to then make financial decisions based on that.

kqr 2y ago
I'd consider fractional Kelly (whether half, quarter, two-thirds, etc.) still a member of the Kelly family. After all, it arises when one performs a full Kelly allocation on some fraction of one's wealth, keeping the rest out of the market. It's not that Kelly is an "inaccurate proxy" -- it is provably the allocation that maximises growth -- but that people for various reasons don't want to maximise growth. They prefer slower growth in exchange for other properties, such as more cash being available for emergency needs. > It's complete nonsense to make up a number like oh my car has a 33% chance of developing a big fault this year out of thin air Are you claiming regular people cannot learn to make calibrated probability judgments and/or look up car failure rates? Maybe that is the problem with the Kelky-based framework: it requires forecasting a probability distribution and many people are not great at that, although they could learn it. Since it wasn't clear from your comment, what alternative framework are you proposing for the insurance decision?
- taneq 2y ago
  Insurance isn’t about maximising overall outcome (we know it doesn’t do that!) It’s about managing critical (often existential) risks. You buy insurance when you need to protect against an unrecoverable loss (house burned down, car was stolen, permanently injured and unable to work, etc.) that you can’t just “ride out” and self-finance.
  - kqr 2y ago
    > (we know it doesn’t do that!) ...but it does do that under the assumption of compounding, and that's part of why it exists. I recommend learning about the Kelly criterion and E log X strategies to see why. The key insight is we shouldn't look at the arithmetic expectation of profits of isolated bets beccause that causes us to overinvest in uncertain profits and underinvest in insurance.
kidros 2y ago
This was my exact thought when I hit that point in the article. How am I supposed to know the probability to make these calculations? And if I make up numbers that "seem" reasonable, how is that better than buying insurance to sleep better?
- kqr 2y ago
  Many of these probabilities can be looked up in official statistics. Then you can adjust a tiny bit depending on whether you think you have more or fewer risk factors than the average. When I feasibility tested by asking my wife to guesstimate a couple of these she ended up very close to official statistics. The first-level trick she used is Fermi estimation. You can totally do it and it's worth practicing. There are even competitions in it open for anyone! I like the Quarterly Cup at Metaculus. The next iteration starts early January.
aoanevdus 2y ago
I don’t believe I can come up with accurate numbers like that. I have no chance against a big company with a bunch of actuaries who do that for a living. I think I really can sometimes tell if I’m riskier or safer than the average person. I can observe other people’s behavior and compare it to mine. But even then, my impressions will be subject to a lot of biases (eg. everyone thinks they are an above-average driver). If I assume the insurance company has done the math so they make a decent margin, and if I’m confident I’m a better or worse risk, it’s possible I can use that reasoning to guess whether insurance is a good value for me.
- kqr 2y ago
  It seems like you're assuming a zero-sum game here where you are hoping to earn more from insurance claims than you paid in premium. This is not how insurance is supposed to be evaluated, as TFA points out. You're not against the insurance company. Your decision is relatively separate from theirs.
  - aoanevdus 2y ago
    If I believe insurance is well-priced, the cost ought to be pretty close to the value it’s providing me, maybe cheaper if the insurance industry has some advantage like good rate of return or higher if they are uncompetitive. That makes me indifferent to whether I have insurance in a lot of areas. Therefore, I’m not spending a lot of time purchasing insurance. Nothing against the industry. Given I’m unable to produce the probabilities necessary to compute the Kelly criterion, I can’t use that to make the decision. Instead, I have to use dumb heuristics like “I need liability insurance to get rid of my risk of ruin” or “I can easily afford to replace my car, but my passion is parking underneath dead trees during storms, so I should pay for comprehensive coverage.” In either case I have no idea how to compute the probabilities, but I’m still pretty sure I made the right decision.
    - kqr 2y ago
      > If I believe insurance is well-priced, the cost ought to be pretty close to the value it’s providing me The value of insurance to the buyer depends on the buyer's wealth. The insurance the electronics store offers on the tablet I buy is well-priced for their target audience but not for someone with my emergency expense buffer.

3eb7988a1663 2y ago

>The purpose if insurance is not to help us pay for things that we literally do not have enough money to pay for. It does help in that situation, but... 56% of Americans cannot cover a $1000 emergency expense. Insurance absolutely is a lifeline that most people need to avoid financial ruin. Edit: My source for the 56%: https://www.cnbc.com/2022/01/19/56percent-of-americans-cant-cover-a-1000-emergency-expense-with-savings.html https://www.cnbc.com/2022/01/19/56percent-of-americans-cant-... Which downthread was pointed out that it was derived from this survey: https://www.bankrate.com/banking/savings/emergency-savings-report/#sudden-bill https://www.bankrate.com/banking/savings/emergency-savings-r...

MathMonkeyMan 2y ago
If I were to buy health insurance, it would cost between $400 and $800 per month. It would likely not cover me from financial ruin anyway. If I'm uninsured, I receive treatment and never pay the bill. Maybe this affects my credit, but it is not financial ruin. In reality, I get good health insurance through an employer. When I am employed. $1000 is nothing compared to the expense of being insured.
- pavel_lishin 2y ago
  > If I'm uninsured, I receive treatment I think this is true if you walk into an emergency room with a life-threatening illness; is this true if you start developing tooth problems, or diabetes? Can I walk into the ER with bad kidneys and get a round of dialysis on the house?
  - nradov 2y ago
    Yes, you can get a round of dialysis. Patients with end-stage renal disease qualify for Medicare which covers most of the cost.
    - pavel_lishin 2y ago
      How long does it take to get approved? I guess renal failure isn't exactly a thing that sneaks up on you, but I do wonder what happens if there's some catastrophic incident that results in an ongoing medical issue; can you just keep showing up to the ER for treatment while enrollment goes through?

pavel_lishin 2y ago

> The purpose if insurance is not to help us pay for things that we literally do not have enough money to pay for. It does help in that situation, but the purpose of insurance is much broader than that. What insurance does is help us avoid large drawndowns on our accumulated wealth, in order for our wealth to gather compound interest faster. Neat. What about people who don't have accumulated wealth?

riggsdk 2y ago
The linked article explains it further down. In common cases it boils down to "if you're rich don't bother with insurance, if you're poor you should pay it". > In a concrete example, let’s say that our household wealth is $25,000, and we’ve just gotten a motorcycle with some miles on it already. > Assuming no deductible, would this be worth it? Yes! > If our wealth had been $32,000 instead, the insurance would no longer have been worth it
- wakawaka28 2y ago
  >In common cases it boils down to "if you're rich don't bother with insurance, if you're poor you should pay it". This is way too simple. If you're rich then you stand to lose more in many situations, and may be deemed a lower risk so insurance is cheaper. If you're in reasonably good health and on the verge of being evicted if you miss a paycheck, paying hundreds per month for health insurance to head off unlikely risks is a bad idea. Probability is supposed to account for this but you might know that you're not getting pregnant or having expensive surgery, for example. An insurance company cannot assume such a thing. So they are obligated to charge you way more than you can ever get back. It is also relevant that if you miss insurance payments, you will lose coverage. Another wrench in this methodology is that some costs are not purely financial. What price do you put on the risk of dying from a lack of treatment? Is that risk higher than the risk of ending up destitute and uninsured anyway?

NAHWheatCracker 2y ago

I've been thinking about this lately. For a couple weeks, I was worried about my health insurance for next year through my state's marketplace and I was considering whether it would be worth the unsubsidized price of $350-450 per month. Ultimately, I don't have enough information about my risks to feel comfortable with my analysis. While it would be mentally soothing to use the calculator, it's not really helpful. I'm also curious what's going on with insurance prices this year. The health insurance premiums this year are 33% more and just today I got my home insurance renewal asking for 25% more with the exact same coverage amounts. Did something happen to justify these increases?

relaxing 2y ago
> I got my home insurance renewal asking for 25% more with the exact same coverage amounts. Did something happen to justify these increases? Climate change.
- xboxnolifes 2y ago
  This is a nothing answer. Climate change has been happening for decades. What exactly changed this year that led to this increase.
  - relaxing 2y ago
    What happened this is year is the need to cover payouts from last year’s record losses due to wildfire, flooding and wind. https://www.nytimes.com/interactive/2024/12/18/climate/insurance-non-renewal-climate-crisis.html https://www.nytimes.com/interactive/2024/12/18/climate/insur... https://www.nytimes.com/interactive/2024/05/13/climate/insurance-homes-climate-change-weather.html https://www.nytimes.com/interactive/2024/05/13/climate/insur... https://www.nytimes.com/interactive/2024/05/13/climate/home-insurance-profit-us-states-weather.html https://www.nytimes.com/interactive/2024/05/13/climate/home-...
kqr 2y ago
General economic conditions prevents new capital from entering the market to undercut current insurers. Behind the scenes much of this tighening of available capital happened more than a year ago but it's being passed on to consumers only now. Nothing in particular has happened this year -- it was fairly ordinary in terms of catastrophies.

crazylogger 2y ago

[dead]

deleted 2y ago

[deleted]

rsanek 2y ago

setting aside the difficulty in getting probabilities that sister commenters have brought up, i think what these kinds of articles often miss is that these decisions actually often are about vibes. even if i had accurate numbers and Kelly says that it's not worth it to buy insurance, it very well could be worth the peace of mind for me personally, regardless of wealth. in general i don't like when someone else tries to tell me how i should be using a product i buy, and that includes insurance.

maxerickson 2y ago
In general i don't like when someone else tries to tell me how i should be using a product i buy, and that includes insurance. You shouldn't make yourself miserable thinking about advice you don't like. Just ignore it.

Tarrosion 2y ago

This makes sense in the context of trying to maximize log wealth (or I think any concave function of wealth, though the arithmetic is different). But in one of OP's other articles [1], he says the Kelly criterion doesn't require trying to maximize log-wealth, that this is just a common misconception -- all that's required is maximizing something growing geometrically over time. This I don't understand, maybe someone help me out? Say the real growth rate of capital (or interest rate available to me, whatever) is 2%/year and I have a 10 year time horizon. So $1.00 today is ~$1.22 in 10 years. More generally, if I have wealth X today I will have 1.22X in 10 years. And if X is not a constant but a random variable and I want to maximize future expected wealth (not log wealth), that's just max(E[1.22X]) and by linearity of expectation I should just maximize wealth today to maximize in 10 years time. So Kelly being appropriate must have some other conditions, right? Wanting to maximize log wealth is surely sufficient (and individually probably ~rational). What else? [1]

Tarrosion 2y ago
Whoops forgot the link https://entropicthoughts.com/the-misunderstood-kelly-criterion https://entropicthoughts.com/the-misunderstood-kelly-criteri...