Aug

14

what is the most important thing to insure?

Filed Under insurance | 4 Comments

The answer to this question depends on what your financial worst case scenario really is.

If you are single without dependants and you work for a living, then the worst thing that could happen is that you become completely unable to work. In this case the most important thing to insure is your income.

If you are single with dependants and you work for a living, then its still the case that the worst thing that could happen is that you become completely unable to work. But a very close second is that you die before your dependants are able to make their own way in the world. You need to insure your income and your life as the highest priority.

If you are married / whatever with a partner, and no dependants, then you aren’t in too bad a position. The worst case would be that you both lost your ability to provide an income, so you need income insurance, but it might not need to be as generous (since the other partner should still have an income).

If you are married with dependants, then the worst possible scenario is that you both die before your dependants are financially secure. You need life insurance first, with income insurance second for all the reasons above.

If you have a secure independent income with no access to capital (like you have an annuity or similar) and you have dependants, then you need life insurance. Unfortunately, if you are in this position you are likely to be older and not get a good deal on life insurance. Your best bet might be to save as much as possible and hope that you live long enough.

Of course, I’ve painted broad generalisations here. What you should really do is take an honest look at the risks and outcomes of all bad financial situations and plan accordingly. The safety net of an emergency fund will help in almost every situation.

Jun

29

insurance is important

Filed Under insurance | 2 Comments

Recently many parts of England have been affected by flooding. Many people have had to be evacuated from their homes.

I was watching the news the other day where they did a report on some of the afflicted returning to their homes and surveying the damage. I honestly felt for these people as pretty much all their possessions were trashed.

In one of the areas, they’d previously had a major flood before. Apparently, some of the residents had been told that such a flood was a once in a hundred years event and since they’d had one already they cancelled their insurance thinking that it was too rare to happen again. Ignoring the possibility that the climate is changing or that the odds were incorrect in the first place, they’ve been looking at it all wrong. Its not really how likely it is to happen, its how much damage it will do if it does.

I bet they cancelled the insurance because the premiums went up. The thing is though, that the premium will only go up if there is increased risk i.e. the chance of the event happening has increased or the cost of fixing it has increased. To me, this means that your need for insurance is greater not less.

The lesson for everyone should be that if you live in a floodplain you need insurance against catastrophic floods. Anything catastrophic that has a small chance of happening probably needs to be insured against.

Jun

11

randomness and insurance

Filed Under insurance | 1 Comment

I’ve recently been thinking about randomness. I like randomness in general, but this has been prompted in particular by my reading of Fooled by Randomness by Nassem Nicholas Taleb. The message (?) that I got from the book was that randomness plays a massive part in the ability of traders to make money. That is to say that most traders do not make money because they are good but because they are lucky. And also that the reason that they get caught out in the end is that they don’t realise that they are lucky.

One of the key things that I took out of it that could actually be applied to personal finance was the role of insurance. In the world of Taleb, the important factor that should be determining whether or not you need insurance (in the general sense) is the expeced value (or cost) of the event.

For those of you that aren’t big fans of probability, this means the probability of the event multiplied by the cost outcome of the event. Taleb argues that most people consider only the frequency of the event and ignore the outcome of the event. This is catastrophic if the cost of the event is literally unbearable. An example of this in general life is the event of your house burning down. This is pretty unlikely, but the cost of it happening is unbearable if you cannot afford to rebuild it. In this case you need to have insurance. In fact, Taleb goes further, for example you need to have insurance not against the specific cause of your house burning down, which is very unlikely, but the more general ‘needing to rebuild your house’.

With insurance, its not about how likely it is, its about how likely it is and how bad the worst possible outcome is. Thats what you need to protect yourself from.

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