The Middle-Aged Genius’s Guide to Almost Everything 14 – Insurance
May 8, 2018
[Beginning of recorded material]
Scott Douglas Jacobsen: So, what is insurance? You described off tape it as something about smearing risk.
Rick Rosner: Alright. So, part of growing up or at least growing older, one part of it is deciding if you are going to get various types of insurance. If you are in your early twenties all the way into your maybe even early 30s, maybe, some of your stuff is carried under your parent’s insurance policies and insurance always sounds a good idea if you do not know anything about insurance.
However, basically, every time you buy insurance you are overpaying on a bet that something shitty is going to happen to you. You were talking about smearing out risk; the deal is that I assume that insurance started with the Lloyds of London insuring ships in the 16th or 17th century where maybe one ship out of fifteen goes down and before then you were gambling that your ship, that the ship you are paying for, wouldn’t be the one ship out of fifteen that goes down.
However, I am guessing Lloyd’s of London formed some syndicate among shippers that says, “Pay us enough that reflects the value of your ship divided by the odds or times the odds that your ships are going to go down. Plus, a little profit for us and we will pay your losses if you lose your ship.”
So, fifteen shippers get together with Lloyds and say, “Alright, we’ll each pay you one-fifteenth of value or one-twelfth value of our ship,” then Lloyds is like, “Okay.” Lloyds is playing the odds that they only lose one ship out of fifteen and then Lloyds pays off based on getting all the money from this group of people.
That is how insurance works in general where an insurance company finds a group of people, figures out the statistics of the rate at which bad stuff should happen to people, and pays people off based on everybody kicking in to avoid the hundred percent cost of something happening to that specific person.
However, insurance can be pricey. One hideous example is in the state of California. They have earthquake insurance. You are making a bet every year if you buy this stuff of a thousand bucks. You are betting that an earthquake will hit your house and will cause your house to lose more than fifteen percent of its value, which is if you do the math.
It is a crappy bet because of the deductible, which means the amount that you have to pay before the insurance company pays anything is fifteen percent. So, if you own a half a million dollar house, you are paying a thousand dollars a year to the insurance company to bet that an earthquake is going to mess up your house to the tune of more than seventy-five grand with you picking up the 75 grand.
So, it is a terrible dilemma because it is a rip-off of a policy, but otherwise, you are completely vulnerable to being uninsured in an earthquake. One piece of advice that my wife and I took is instead of wasting your money on earthquake policies take that same money and use it to beef up your house against an earthquake.
We did that. That turned out to be a bad bet too because we spent way more than the cost of 10 or 20 or 30 years of earthquake insurance. So, when applied to other situations, insurance is generally a bad bet because you are betting more than your expected payoff is going to be because it includes profit for the insurance company; often a lot of profit.
It is one of those things like a car lease where so many numbers flying around and numbers that most people are throwing up their hands and do not even try to analyze, but you can make all sorts of bad bets with all sorts of insurance: card, coverage, extended warranties on electronics, life insurance.
The way to think of life insurance is if you are young and you do not have any assets then you can buy assets in the case of your death. Your premature death to protect your family. However, if you manage your life well for the next several decades through your 20s or 30s, your 50s, and your 60s.
At some point, it makes sense to quit making the bad bet and to have accumulated enough assets to leave your family when you die. So, there is a point at which you do not need to keep getting insurance because insurance is a good bad bet when you are starting out and you do not have any assets.
When you are old and you’ve accumulated some assets, you do not need to keep wasting money on these bad bets, except that if you bought whole life as opposed to term life. Term life is where you are making the bet for the period covered while you buy a policy that covers you for a year and when the year passes you are either dead or not.
If you are dead, the family gets some money. If you are not the money goes away and the insurance company keeps it. With whole life, you are paying for insurance, but you are also investing in the insurance company so that you pay year after year after year and you end up accumulating a cash value.
That is, the extra cash, you are kicking in, is the difference between a whole life policy and a term life policy that can be a not terrible investment because often the insurance companies will pay 5% dividends on your cash value.
However, again, it is another one of those things where there are all these numbers flying around and it is hard to tell whether it is a good value or not. I was lucky. My stepdad was a small businessman. He liked to give business to a lot of small businesses in the town in Boulder, Colorado, where we were living.
One way that he could give business to his friends who were insurance dealers. He would buy policies on himself and on me and my brother: little policies. Because of that, I have more than half a dozen policies on my life that my dad mostly paid for.
These things have accumulated a decent cash balance that keeps growing every year. I tell Carol, “Do not kill me even though I have all these insurance policies in my life. I am still worth more alive than dead.”
So, it is complicated, but the way to think about it, in general, is it is a bad bet for you to make when you want to protect your family and you do not have a lot of assets yet. As you get older, one more thing is long-term care insurance. That is where you or your spouse get into your 80s and say you get Alzheimer’s.
You have to be put in a joint. You live for another 11 years. It would be great if there were an insurance policy that would pay for the 11 years of care that could in a city like LA run eight or ten thousand dollars a month times eleven years.
It can be as much as a hundred and thirty thousand dollars, which you may or may not have. However, that coverage is now super expensive because people live longer than ever before and more and more people end up in law needing long-term care at some point, which has changed it from an insurance bet to pay for your care upfront bet.
Let’s say Lloyds of London and a hundred percent of the ships are going to go down. Then you have to charge your shippers a hundred percent of the value of each ship. It is that way with long-term care now.
That you are not making an odds based bet. It is so expensive that you are basically paying for long-term care ahead of time on the policies that were issued thirty years ago when not everybody lived long enough to get put in a home for ten years.
You think of insurance as a bad bet and try to learn as many numbers as you can to decide whether it is a bad bet that you want to make, which I will provide with one more example. Let’s say you buy a flat-screen TV for 500 bucks.
You can buy two-year warranty extended coverage for a hundred bucks or 20% of the value of the TV. What you should ask the person who is trying to sell you the policy at Best Buy is “Oh! Is there a 20% chance that what percent of TVs go bad within the first two years?”
He will say, “I do not know,” because he doesn’t know. They do not tell the salesmen the statistics on that. Then you say, “Well, do 20% of the TVs go bad in the first two years?” He’ll say, “I do not think so.” And that is probably more accurate than the extended buying/paying 20% of the cost of the TV to cover that TV for two years it is probably a bad bet.
The way they make flat screens now is that a lot of them do break pretty fast and they are basically un-repairable. You can have somebody try. Anyway, that is the thinking that goes into insurance. Do you want to make this bad bet? How bad is it?
[End of recorded material]
American Television Writer
Scott Douglas Jacobsen
Editor-in-Chief, In-Sight Publishing
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