Obviously if you know your utility function and the true distribution of possible risks, it’s easy to decide whether to take a particular insurance deal.
The standard advice is that if you can afford to self-insure, you should, for the reason you cite (that insurance companies make a profit, on average).
That’s a heuristic that holds up fine except when you know (for reasons you will keep secret from insurers) your own risk is higher than they could expect; then, depending on how competitive insurers are, even if you’re not too risk-averse, you might find a good deal, even to the extent that you turn an expected (discounted) profit, and so should buy it even if you have zero risk aversion. Apparently in California, auto insurers are required to publish the algorithm by which they assign premiums (and are possibly prohibited from using certain types of information).
Conversely, you may choose to have no insurance (or extremely high deductible) in cases where you believe your personal risk is far below what the insurer appears to believe, even when you’re actually averse to that risk.
Of course, it’s not sufficient to know how wrong the insurer’s estimate of your risk is; they insist on a pretty wide vig—not just to survive both uncertainties in their estimation of risk and the market returns on the float, but also to compensate for the observed amount of successful adverse selection that results from people applying the above heuristic.
I suppose it may also be possible that the insurer won’t pay. I don’t know what exactly what guarantees we have in the U.S.
to compensate for the observed amount of successful adverse selection that results from people applying the above heuristic.
Actually, I think that for voluntary insurance, the observed adverse selection is negative, but I can’t find the cite. People simply don’t do cost-benefit calculations. People who buy insurance are those who are terribly risk-averse or see it as part of their role. Such people tend to be more careful than the general population. In a competitive market, the price of insurance would be bid down to reflect this, but it isn’t.
Obviously if you know your utility function and the true distribution of possible risks, it’s easy to decide whether to take a particular insurance deal.
The standard advice is that if you can afford to self-insure, you should, for the reason you cite (that insurance companies make a profit, on average).
That’s a heuristic that holds up fine except when you know (for reasons you will keep secret from insurers) your own risk is higher than they could expect; then, depending on how competitive insurers are, even if you’re not too risk-averse, you might find a good deal, even to the extent that you turn an expected (discounted) profit, and so should buy it even if you have zero risk aversion. Apparently in California, auto insurers are required to publish the algorithm by which they assign premiums (and are possibly prohibited from using certain types of information).
Conversely, you may choose to have no insurance (or extremely high deductible) in cases where you believe your personal risk is far below what the insurer appears to believe, even when you’re actually averse to that risk.
Of course, it’s not sufficient to know how wrong the insurer’s estimate of your risk is; they insist on a pretty wide vig—not just to survive both uncertainties in their estimation of risk and the market returns on the float, but also to compensate for the observed amount of successful adverse selection that results from people applying the above heuristic.
I suppose it may also be possible that the insurer won’t pay. I don’t know what exactly what guarantees we have in the U.S.
Actually, I think that for voluntary insurance, the observed adverse selection is negative, but I can’t find the cite. People simply don’t do cost-benefit calculations. People who buy insurance are those who are terribly risk-averse or see it as part of their role. Such people tend to be more careful than the general population. In a competitive market, the price of insurance would be bid down to reflect this, but it isn’t.