Bear Some Risks, Insure Others

Risk is broad. There’s obviously financial risk like losing money on a bad investment. But that’s just a piece of the puzzle. There’s everything else: from minor inconvenience like missing the bus, all the way to getting run over by a car.

Here is my system for thinking about risk.

Bearable vs. Unbearable Risk

Bearable risks are ones where if you get the worst possible outcome, you can recover with a mostly unaffected lifestyle. Here are two examples:

  • Car totaled - Even if your car is not insured, or it’s a hit and run, most people can put things back together, with some discomfort and anger.

  • Flight cancelled - It’s terribly inconvenient, and will probably cost you, but you will be okay.

In other words, for bearable risks, you could get the worst possible outcome, and still go on with a mostly unaffected lifestyle.

All bearable risks are capped: Even the worst possible loss has a fixed maximum loss. Most bearable risks are mostly financial, where you can be legitimately “made whole” with a check.

But not all capped risks are bearable: If your house burns down, you may not be able to pay to rebuild, rent elsewhere, and replace your belongings, all simultaneously. This risk might be bearable for a rich person though.

Don’t insure bearable risks

Insurance companies have to make money, and on average pay out less than they take in. They also have to pay salaries and to keep the lights on. Insurance has to be a losing bet on average.

If you can bear the risk, just bear the risk. Spend the money on mitigating the risk. For example, instead of buying comprehensive auto insurance, drive slower or get a car with advanced safety features.

I’ll harp against comprehensive auto insurance some more - if you can’t afford to replace the car you’re driving around without sincere hardship, you may be driving a car that’s too fancy.

One major caveat here is that I just said that insurance has to be priced above the expected payout on average. There’s a few situations where the insurance is underpriced and you should buy it.

  • Insurer has bad information - You know and I know that you’re a terribly reckless driver, but your insurance company doesn’t know. They are quoting you an average rate based on your age, sex, and zip code. Buy as much auto insurance as possible. Probably get some underpriced life insurance while you’re at it.

  • Group rate or legal limitation - If you have a chronic disease, but the health insurance company can’t charge you more, because it’s through your employer or because of the Affordable Care Act, buy the underpriced health insurance.

Mitigate Unbearable Risk

For most unbearable risks, you simply cannot be made whole by money. In the next section I’m going to list off a bunch of insurances you can get for various personal tragedies, but honestly, there’s no insurance that can truly make you whole if you lose a leg, or if your child dies.

Insurance should be secondary to prevention and preparation. Invest in smoke alarms and seat belts. Insurance is just picking up the pieces afterwards. Still important, but secondary.

The prevention and preparation will be detailed in a separate article.

Insure Unbearable Financial Risks, but…

Some unbearable risks are partly financial though, and you can insure that aspect. These have generally unlimited downsides, or bigger downsides than you car reasonably bear. Insure those, even if it’s a losing bet.

Some examples:

  • Health insurance - If you come down with an extremely rare cancer and you need Dr. House, your health care bills are going to be unlimited if you live in the United States. You should have health insurance, ideally one without a lifetime maximum. It’s okay to have a high deductible or high copay though. We care more about the long tail.

  • Home insurance - If your house burns down and you can’t afford to simultaneously rebuild your home, rent somewhere else, and replace all your belongings all at once, maybe consider having home insurance. More important than that, make sure you have good liability insurance in case someone slips and falls in your home.

  • Umbrella Insurance - I strongly think that if you have any substantial assets, like if you own a home, you become a target for personal liability lawsuits. The potential loss is uncapped, and I’d rather have the insurance company on the hook. Umbrella insurance is comparatively cheap. $300 for each million in coverage. But it doesn’t kick in until you have a multi-hundred-thousand dollar loss. Low probability, high impact - perfect for insurance.

  • Life Insurance - If you have dependents to support, and they would be in trouble if you died suddenly, you might want some Term Life Insurance. Whole Life is pretty much always unnecessary.

  • Disability Insurance - Kind of the same reasoning as Life Insurance, but potentially even more important. If you aren’t dead, but merely can’t work and need extensive medical care, that may be an even greater burden on your family than if you actually died. Disability Insurance is nice for that reason. Your government does likely provide some form of this, so it’s not critical, but you may be able to get Disability Insurance for a cheap rate through your employer.

Prevention and Preparation Over Insurance

Again though, I think prevention and preparation is more important than the above insurance. All of the above have preventative measures you can take like: eating well, smoke alarms, not being an asshole, not skydiving, or being careful.

I’m not advocating living your life under a rock, but there a lot of things you can do to mitigate the unbearable risk in your life without much cost or lifestyle change. Unless being an asshole is your lifestyle I guess.