Why Is Insurance Worth It (Analytically)?

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pdavi21
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Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 4:27 pm

It seems that many people are very adamant about insurance being 100% non negotiable, you must have it in the following categories:
1. Health Insurance
2. Property Insurance
3. Supplemental Car Insurance (above legal minimum)
4. Umbrella Liability

What seems even stranger to me is that many Bogleheads are adamant about holding insurance policies as well.
What logical reason does a Boglehead have for holding an insurance policy?
Can a policy actually increase your risk-adjusted returns (Mathematically)?

I don't see what I am missing.
Why do people have such a strong belief to promote a product with a statistically negative return (and negative risk) that isn't even 100% reliable on paying out in the event of a claim anyway?

EDIT: While I've argued a bit, I feel the original question posed has been answered. Mathematically, insurance is usually not worth it. However, one could calculate different values for incremental wealth that make insurance mathmatically worth it for them. Insurance also has the value of allowing someone to prevent acting in a way they feel is unethical. Insurance is also valuable becuase it can reduced fear, stress, and anxiety (most of the time).

While the benefits can be intangible...each benefit can be valued financially for each person, and if the benefit value exceeds the cost of the coverage, a perfectly logical investor will pay for the exact amount of insurance coverage that results in the highest value to them specifically.

Even a perfectly logical investor could disagree with another perfectly logical investor on the value of the coverage because both (in a perfectly logical way) have assigned different values to those benefits.

When you add in that none of us are perfectly logical investors (though we may strive to be). It is easy to see why insurance discussion can lead to disagreement and misunderstanding.

Thanks all, for the responses. I feel like the next time I increase or decrease insurance coverage, I will consider the decision more logically and correctly for my needs based on the discussion in this thread.
Last edited by pdavi21 on Wed Dec 05, 2018 3:40 pm, edited 4 times in total.

BruDude
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Re: Why Is Insurance Worth It (Analytically)?

Post by BruDude » Tue Dec 04, 2018 4:33 pm

Insurance agent here. I prefer to avoid things that have a reasonable likelihood of costing me a significant portion of my assets, or more than my assets are worth. Insurance is a losing game for everyone as a whole, but you are one person, not a very large group of people. Ask the people in California whose houses just burned down if they thought insurance was a waste of money.

It's nice that you have enough assets to feel that you can self-insure, the vast majority of the population is not in that position. If you have that much money, I think it is also pretty dumb to not have health insurance, but to each his own.

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Re: Why Is Insurance Worth It (Analytically)?

Post by Blueskies123 » Tue Dec 04, 2018 4:36 pm

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bloom2708
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Re: Why Is Insurance Worth It (Analytically)?

Post by bloom2708 » Tue Dec 04, 2018 4:42 pm

Are you single or married? Kids? Sometimes things aren't for you but for family.

As a stoic, I would say "expect bad things to happen". A lot of them. That is life. On the flip side you can order them in priority and choose to insurance based on your circumstances.

The worst part of insurance is you don't want to use it most of the time. Health insurance isn't really insurance anymore. Auto insurance doesn't pay for my oil changes.

You pay blips and blops here and there to defray potentially catastrophic failure. House burns down. You die leaving a wife and kids. You hit someone in your car and injure/kill them (umbrella).

Drop life insurance when you have a big pile. Drop full coverage on cars when your car falls to a value you can easily replace. Or just keep paying the premiums and keep plugging along.
Last edited by bloom2708 on Wed Dec 05, 2018 9:00 am, edited 5 times in total.
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scimitar
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Re: Why Is Insurance Worth It (Analytically)?

Post by scimitar » Tue Dec 04, 2018 4:46 pm

Always remember that the entire raison d'être of an insurance company is to NOT pay you. To paraphrase the Simpsons' version of Bill Gates, they didn't get rich by writing checks.

megabad
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Re: Why Is Insurance Worth It (Analytically)?

Post by megabad » Tue Dec 04, 2018 4:54 pm

pdavi21 wrote:
Tue Dec 04, 2018 4:27 pm
It seems that many people are very adamant about insurance being 100% non negotiable, you must have it in the following categories:
1. Health Insurance
2. Property Insurance
3. Supplemental Car Insurance (above legal minimum)
4. Umbrella Liability

What seems even stranger to me is that many Bogleheads are adamant about holding insurance policies as well.
What logical reason does a Boglehead have for holding an insurance policy?
Can a policy actually increase your risk-adjusted returns (Mathematically)?

I don't see what I am missing.
Why do people have such a strong belief to promote a product with a statistically negative return (and negative risk) that isn't even 100% reliable on paying out in the event of a claim anyway?

I consider myself to have enough assets (and not too much-for liability) to be "self-insured".
I have the legal minimum for car insurance and nothing else. I have even turned down employer sponsored health because I am currently statistically likely to pay in more than I claim out (including tax breaks). I would consider adding liability insurance as my after-tax holdings increase.
Depends on what you mean by "worth it". Like you, many folks do not find insurance attractive because many Americans have lost sight of the original intent of insurance--to protect against catastrophic losses that would cause undue hardship.

As with any offering from a for profit business, the business intent is that the customer will pay more than the product elements cost. As such, overtime the American population with insurance as a whole will most likely pay more than you would have without for the cost of underlying goods (healthcare, property repairs, injuries, etc) or else all of these business would cease to exist.

But insurance is generally not purchased because it "increases returns". Insurance has value if you encounter a rare cost that would cause undue hardship if it occurred. In other words, statistically you will lose money on umbrella coverage as rare events by definition are not likely to occur. But if you were a doctor and were sued at 35 for a car accident and plaintiff awarded $5 million, you might face great hardship for you and your family for many decades to come as your wages are garnished and you are forced to live in virtual poverty until the debt is paid.

If you don't value financial comfort or don't have assests or a family to worry about, insurance may not be attractive in your eyes. Unlike you, I unfortunately do not have enough assets to withstand the unlikely event of a catastrophic accident, disability, or lawsuit without undergoing a crushing lifestyle change. I have observed regular (though not altogether common) occurrences of these into the 7 and 8 figures in my personal life (relatives) and via news stories. As such, I choose to purchase insurance coverages full well knowing that I will hopefully be throwing money down the drain.

bigred77
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Re: Why Is Insurance Worth It (Analytically)?

Post by bigred77 » Tue Dec 04, 2018 5:01 pm

You are insuring against catastrophic risk. You purchase a product with negative expected value in order to insure you don't get wiped out if the negative tail risk shows up.

It's the same reason I don't lever up on small cap value stocks as my entire portfolio. It has the highest expected value, but that does me no good if I get wiped out in the process.

Thegame14
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Re: Why Is Insurance Worth It (Analytically)?

Post by Thegame14 » Tue Dec 04, 2018 5:01 pm

because for most people the cost of health insurance is heavily subsidized by their employer. My wife pays $40 a month for family coverage, how can we turn that down?

pdavi21
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Re: Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 5:06 pm

megabad wrote:
Tue Dec 04, 2018 4:54 pm
I have observed regular (though not altogether common) occurrences of these into the 7 and 8 figures in my personal life (relatives) and via news stories.
Wow. You come from an unlucky family. Maybe you do need insurance.
However, I'd assume your insurance coverage is over 7 figures and/or you are talking about health (which is currently unlimited under ACA)?

pdavi21
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Re: Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 5:08 pm

Thegame14 wrote:
Tue Dec 04, 2018 5:01 pm
because for most people the cost of health insurance is heavily subsidized by their employer. My wife pays $40 a month for family coverage, how can we turn that down?
Some pay a lot more. I held insurance when I paid a nominal amount too.
I also held it to avoid ACA fees if my Premiums - Tax - ACA Penalties < Weighted Average Payout
Now that I pay a much larger share, I no longer hold health insurance.
Last edited by pdavi21 on Tue Dec 04, 2018 5:10 pm, edited 2 times in total.

MathWizard
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Re: Why Is Insurance Worth It (Analytically)?

Post by MathWizard » Tue Dec 04, 2018 5:08 pm

pdavi21 wrote:
Tue Dec 04, 2018 4:27 pm
It seems that many people are very adamant about insurance being 100% non negotiable, you must have it in the following categories:
1. Health Insurance
2. Property Insurance
3. Supplemental Car Insurance (above legal minimum)
4. Umbrella Liability

What seems even stranger to me is that many Bogleheads are adamant about holding insurance policies as well.
What logical reason does a Boglehead have for holding an insurance policy?
Can a policy actually increase your risk-adjusted returns (Mathematically)?

I don't see what I am missing.
Why do people have such a strong belief to promote a product with a statistically negative return (and negative risk) that isn't even 100% reliable on paying out in the event of a claim anyway?

I consider myself to have enough assets (and not too much-for liability) to be "self-insured".
I have the legal minimum for car insurance and nothing else. I have even turned down employer sponsored health because I am currently statistically likely to pay in more than I claim out (including tax breaks). I would consider adding liability insurance as my after-tax holdings increase.

EDIT: I have kids and wife. Forgot to add kids have free gov't health insurance. Inconsequential, as I'd gladly drop it (or add it) as income changes.
I self insure when I can. Where I do not have the resources to take the hit, and the cost is not too high, I insure.

I only have liability on the cars, because I can buy another car if I wreck it an it is my fault. This could be a problem
when I drive in a no-fault state. I am above the legal minimum because especially medical costs can be enormous, and
I do not have millions. It does not cost much.

I do not have umbrella insurance. I considered it, but have not gone for it.

I have health and disability and life insurance, because I am not financially independent. People who are financially independent
might have only catastrophic health insurance.

I do not have LTCi.

I do have house insurance. That would take quite a bite out of my wealth if I needed to replace my house. The premium
is cheap enough that it is not an impediment.

adamthesmythe
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Re: Why Is Insurance Worth It (Analytically)?

Post by adamthesmythe » Tue Dec 04, 2018 5:11 pm

I have insurance because there are not enough of me to guarantee I will have average costs.

The insurance company, on the other hand, has enough customers to average things out. I give them a commission for the service they provide.

sawhorse
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Re: Why Is Insurance Worth It (Analytically)?

Post by sawhorse » Tue Dec 04, 2018 5:25 pm

pdavi21 wrote:
Tue Dec 04, 2018 4:27 pm
It seems that many people are very adamant about insurance being 100% non negotiable, you must have it in the following categories:
1. Health Insurance
2. Property Insurance
3. Supplemental Car Insurance (above legal minimum)
4. Umbrella Liability
Other than health insurance, I don't get the feeling that people think these are must-have types of insurance.

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Artful Dodger
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Re: Why Is Insurance Worth It (Analytically)?

Post by Artful Dodger » Tue Dec 04, 2018 5:27 pm

scimitar wrote:
Tue Dec 04, 2018 4:46 pm
Always remember that the entire raison d'être of an insurance company is to NOT pay you. To paraphrase the Simpsons' version of Bill Gates, they didn't get rich by writing checks.
The purpose of an insurance company is to pool risk, so many people can pay a small premium to cover a large loss when it occurs.

To the OP. We had three claims in the 80s and 90s (premature birth, meningitis, and a complicated pneumonia) that would have far exceeded my savings at the time, and would probably clock in between $750K to $1.25M in today's cost. So yes, it's worth it (analytically)!

sawhorse
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Re: Why Is Insurance Worth It (Analytically)?

Post by sawhorse » Tue Dec 04, 2018 5:32 pm

Simply put, insurance is a good idea when the cost of needing it and not having it far outweighs the cost of having it and not needing it.

Katietsu
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Re: Why Is Insurance Worth It (Analytically)?

Post by Katietsu » Tue Dec 04, 2018 5:33 pm

Do you have accurate data on the cost of medical care without the contract rate negotiated by insurance companies? The last personal hospital bill I saw had a non negotiated rate for a single 30 minute outpatient procedure and associated costs (anesthesia, hospital fees, etc) of $111,000. Do you have a plan if you are diagnosed with cancer or are severely injured in an accident?

And I know someone with the state minimum liability about to have a wage garnishment of over 50% of their income after a car accident caused injuries. This is after a loss of assets including some in retirement accounts. Do you know the laws of your state?

Only if you have became well versed in these type of liabilities could I see going without insurance. On the other hand, collision coverage, vision insurance, extended warranties and such, I regularly forego as I can self insure for a risk with a definable ceiling in the tens of thousands or even a few hundred of thousands.
Last edited by Katietsu on Tue Dec 04, 2018 5:43 pm, edited 1 time in total.

sawhorse
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Re: Why Is Insurance Worth It (Analytically)?

Post by sawhorse » Tue Dec 04, 2018 5:38 pm

Katietsu wrote:
Tue Dec 04, 2018 5:33 pm
Do you have accurate data on the cost of medical care without the contract rate negotiated by insurance companies?
Good point. By having health insurance and going to an in network provider, you get a big discount off the outrageous list prices. It's not uncommon for labs to charge uninsured patients 10x the price they charge insured patients. Even if you have to pay it all out of pocket because you haven't met your deductible, the very fact that you have insurance means you get a discount.

pdavi21
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Re: Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 5:40 pm

Katietsu wrote:
Tue Dec 04, 2018 5:33 pm
Do you have a plan if you are diagnosed with cancer or are severely injured in an accident?
One option is to (EDIT: not receive care). I'm sorry if that sounds offensive to anyone. Another is to not pay the medical bills. Another is Bankruptcy.
And I know someone with the state minimum liability about to have a wage garnishment of over 50% of their income after a car accident caused injuries. This is after a loss of assets including some in retirement accounts. Do you know the laws of your state?
I study the laws wherever I go, but it's hard to know the intent of the law 100% for everyone. I agree with the premise of liability insurance, but you'll concede that it too comes with coverage caps.
Last edited by pdavi21 on Tue Dec 04, 2018 5:54 pm, edited 2 times in total.

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Phineas J. Whoopee
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Re: Why Is Insurance Worth It (Analytically)?

Post by Phineas J. Whoopee » Tue Dec 04, 2018 5:41 pm

Your question comes up every now and then.

Many here discuss insurance as a method of decreasing their own risks. That's true, it does.

I feel it has a second, perhaps more important aspect. If, by my actions or inactions, I injure somebody, or even just damage their property, the responsible thing, the right thing, is for me to compensate them, although money can never completely compensate for an injury or a death.

Therefore, I view insurance as a way to protect myself from adverse events, and as a way to protect my fellow human beings from me.

I realize mine is a minority view.

PJW

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monkey_business
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Re: Why Is Insurance Worth It (Analytically)?

Post by monkey_business » Tue Dec 04, 2018 5:41 pm

bigred77 wrote:
Tue Dec 04, 2018 5:01 pm
You are insuring against catastrophic risk. You purchase a product with negative expected value in order to insure you don't get wiped out if the negative tail risk shows up.

It's the same reason I don't lever up on small cap value stocks as my entire portfolio. It has the highest expected value, but that does me no good if I get wiped out in the process.
Exactly this.

You are expected, on average, to lose money on insurance. This is the only way insurance can work, and insurance companies can operate as profitable businesses. That said, in the event you fall outside the "average" and do need said insurance, the losses could quickly exceed the premiums and result in potentially catastrophic outcomes. If you would rather save money by not paying insurance premiums, and can financially tolerate events such as: cancer, house burning down, crashing your car into a family and severely injuring them, etc., then by all means cancel such insurance.

pdavi21
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Re: Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 5:42 pm

sawhorse wrote:
Tue Dec 04, 2018 5:38 pm
Katietsu wrote:
Tue Dec 04, 2018 5:33 pm
Do you have accurate data on the cost of medical care without the contract rate negotiated by insurance companies?
Good point. By having health insurance and going to an in network provider, you get a big discount off the outrageous list prices. It's not uncommon for labs to charge uninsured patients 10x the price they charge insured patients. Even if you have to pay it all out of pocket because you haven't met your deductible, the very fact that you have insurance means you get a discount.
The contract rate is often much higher than cash costs. Having insurance with a deductible often guarantees a higher bill for the same procedure. EDIT: I'll clarify it's because 1) the risk and administrative costs associated with filing claims outweighs the benefits of filing claims in many cases, 2) Most doctors are not in most networks, and 3) Contract pricing is often inflated to account for partial coverage.
Last edited by pdavi21 on Tue Dec 04, 2018 5:51 pm, edited 1 time in total.

Whocares1000
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Re: Why Is Insurance Worth It (Analytically)?

Post by Whocares1000 » Tue Dec 04, 2018 5:47 pm

The idea of insurance is that you pay a small loss (the premium) to avoid a large loss (the peril). Some insurance is worth is because the small loss is no where near the what the large loss could be. There are other insurance products where you are better off insuring yourself.

The idea of insurance is not to make money but to protect the assets that you have. In fact, I consider my emergency fund to be insurance from the downturns of life. I don't make much of anything on my emergency fund (the premium which is the loss of return on those funds) but I do not need to dip into my retirement accounts or investments should something happen.

As with all insurance products, there are some that some people need more than others. I do not need collision and comprehensive insurance because I drive a vehicle whose value is doubled if I put new tires on it. However, if I had a $20k vehicle, collision and comprehensive would be worth it unless I had enough of a net worth where I could drive that vehicle off a cliff the day after purchasing it and it would not hit my pocket book at all. I also do not have dependents so I need nothing more than a small life insurance policy to bury me (and eventually hope to self-insure even that).

However, I live is a community that has a huge number of doctors and other 6-figure income earned per capita. Because of that, I get as much liability insurance as I can afford because you can be sure it I was in a car accident that was my fault, I would end up a pauper for the rest of my life to pay for it.

When it comes to health insurance, if you can self-insure a illness that can cost 7-figures and not bat an eye, then more power to you. Most people cannot and that is why health insurance is necessary.

averagedude
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Re: Why Is Insurance Worth It (Analytically)?

Post by averagedude » Tue Dec 04, 2018 5:48 pm

I do agree that alot of people have insurance they dont need. Some people buy life insurance when they have no dependants. Some buy every extended warranty they can. Alot of insurance is sold, not bought. My rule of thumb is if something happens that would cause a financial catastrophe for myself or a dependent, i need to insure against it if it is financially feasible.

123
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Re: Why Is Insurance Worth It (Analytically)?

Post by 123 » Tue Dec 04, 2018 5:49 pm

We have insurance to take advantage of negoitated rates for health services. There are number of ways you can end up in a hospital with a bill of $100,000 plus if you have to pay the "rack" rates. Health insurance negoitatied rates can bring down the cost to under a $10,000 annual deductible.

For auto and homeowners coverage we have insurance to take advantage of the legal services the insurance company provides to defend us against claims. That we get our auto/house fixed in the event of catastrophe is a bonus.
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Re: Why Is Insurance Worth It (Analytically)?

Post by nisiprius » Tue Dec 04, 2018 5:54 pm

1) I don't know whether there's an explanation of it that does not include psychology or utility functions, but most people have opinions about how much risk they are willing to take, and are willing to pay money to reduce that risk. This is familiar in financial economics in the very idea of an "equity risk premium." Given a choice of two alternatives with exactly the same mathematical expectation of return, one of which is completely certain and one of which is risky and uncertain, everyone (I think) prefers the riskless choice.

2) I think we all "get it" that insurance has a negative expected value. We don't hope to beat the insurance company. We are willing to pay money to re-shape the distribution of outcomes.

3) You are not "self-insured." It is a misnomer for an individual to say they are self-insured. The very concept of insurance is to reduce tail risk for an individual by pooling risk with many other individuals.

I think people misunderstand the term. They hear a company say, for example, that to provide disability benefits for their employees, they have chosen to "self-insure." That means that instead of paying an insurance company to pool risk and handle claims, they have chosen to do the same thing an insurance company does and avoid some cost. But they are still "insuring" a large group of employees and are still relying on the law of large numbers to reduce risk.

An individual cannot "self-insure." You cannot pool with yourself in an alternate universe. All that you can do yourself is choose to accept the risk.
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sawhorse
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Re: Why Is Insurance Worth It (Analytically)?

Post by sawhorse » Tue Dec 04, 2018 5:54 pm

pdavi21 wrote:
Tue Dec 04, 2018 5:42 pm
sawhorse wrote:
Tue Dec 04, 2018 5:38 pm
Katietsu wrote:
Tue Dec 04, 2018 5:33 pm
Do you have accurate data on the cost of medical care without the contract rate negotiated by insurance companies?
Good point. By having health insurance and going to an in network provider, you get a big discount off the outrageous list prices. It's not uncommon for labs to charge uninsured patients 10x the price they charge insured patients. Even if you have to pay it all out of pocket because you haven't met your deductible, the very fact that you have insurance means you get a discount.
Not a good point. The contract rate is often much higher than cash costs. Having insurance with a deductible often guarantees a higher bill for the same procedure.
I have racked up hundreds of thousands in medical costs the last few years, so I have seen the bills. The insurance rates are usually much less than the list price for expensive procedures and tests. Over 10x in several instances. I just got a bill two days ago where the list price was over $7000 but the insurance rate was $542.

I was almost bankrupted by a medical bill back when I didn't have insurance due to being excluded for pre-existing conditions. They wouldn't offer any discount even though I was only making $23k a year. I would honestly rather die than go through that again.

Update: I saw your edit. It's very clearly written from a position of inexperience. Your statements are simply not true, and if you actually had to use a lot of healthcare, you would know.
Last edited by sawhorse on Tue Dec 04, 2018 6:01 pm, edited 1 time in total.

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Re: Why Is Insurance Worth It (Analytically)?

Post by bertilak » Tue Dec 04, 2018 5:54 pm

adamthesmythe wrote:
Tue Dec 04, 2018 5:11 pm
I have insurance because there are not enough of me to guarantee I will have average costs.
I like that explanation!
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megabad
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Re: Why Is Insurance Worth It (Analytically)?

Post by megabad » Tue Dec 04, 2018 5:58 pm

pdavi21 wrote:
Tue Dec 04, 2018 5:06 pm
megabad wrote:
Tue Dec 04, 2018 4:54 pm
I have observed regular (though not altogether common) occurrences of these into the 7 and 8 figures in my personal life (relatives) and via news stories.
Wow. You come from an unlucky family. Maybe you do need insurance.
However, I'd assume your insurance coverage is over 7 figures and/or you are talking about health (which is currently unlimited under ACA)?
Personally, I have only been affected on the health side--I have had a close family member undergo a heart transplant. There was an insurance filing issue with some of the documents that I was involved in helping with and in the process I totaled the pre operative, surgical, and post operative treatments well over $1 million over several years. I remember asking a question at the hospital when I saw about 15 or 20 staff crammed into the tiny patient room just for a pre op meeting, "Why are there so many nurses here?" The response---"What nurses? These are all doctors." As a money guy, I almost passed out thinking about how much money that was costing.

The immediate family could not have paid this comfortably (even at a large discount) without health insurance. In contrast, I have continually paid into the health insurance market for years and years and received virtually nothing for it (other than being blessed with a relatively healthy life). I have insurance in case I am unlucky, but I hope I am not. The liability side scares me more and I read news stories about settlements, but I fortunately have not been sued. But millions in coverage for a hundreds a year is fine with me. Actually, I would cancel my health insurance before my liability insurance. I have all of these but I would rank in my order of preference: liability (auto/home/umbrella), disability, life, health insurance. The ordering would obviously change if pre-existing conditions affected health insurance coverage again.

pdavi21
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Re: Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 6:01 pm

nisiprius wrote:
Tue Dec 04, 2018 5:54 pm
1) I don't know whether there's an explanation of it that does not include psychology or utility functions, but most people have opinions about how much risk they are willing to take, and are willing to pay money to reduce that risk. This is familiar in financial economics in the very idea of an "equity risk premium." Given a choice of two alternatives with exactly the same mathematical expectation of return, one of which is completely certain and one of which is risky and uncertain, everyone (I think) prefers the riskless choice.

2) I think we all "get it" that insurance has a negative expected value. We don't hope to beat the insurance company. We are willing to pay money to re-shape the distribution of outcomes.

3) You are not "self-insured." It is a misnomer for an individual to say they are self-insured. The very concept of insurance is to reduce tail risk for an individual by pooling risk with many other individuals.

I think people misunderstand the term. They hear a company say, for example, that to provide disability benefits for their employees, they have chosen to "self-insure." That means that instead of paying an insurance company to pool risk and handle claims, they have chosen to do the same thing an insurance company does and avoid some cost. But they are still "insuring" a large group of employees and are still relying on the law of large numbers to reduce risk.

An individual cannot "self-insure." You cannot pool with yourself in an alternate universe. All that you can do yourself is choose to accept the risk.
While I agree with your points 1 and 2, I respectfully disagree with point 3.
The same way one person cannot "insure" themselves would apply to a pool because the risk of default, while significantly reduced, is not zero.
Additionally, bonding and collateral are forms of insurance in which collateral is held by the payee. If you call yourself your own payee, then your assets are your collateral.

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Re: Why Is Insurance Worth It (Analytically)?

Post by GibsonL6s » Tue Dec 04, 2018 6:06 pm

If you own your house free and clear you are welcome to self insure, if not the lender requires. This weekend my wife and I walked by 4 homes totally lost in the recent fires. I never think any insurance I have bought is a waste.

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Re: Why Is Insurance Worth It (Analytically)?

Post by CppCoder » Tue Dec 04, 2018 6:12 pm

Insurance is a risk management product, not an investment. I buy clothes because my body needs protection from the elements. I expect no return on my clothes. I buy insurance to mitigate my risk. Insurance is worth it not if you receive more than you pay in. It is worth it if it fairly prices the risk mitigation. I expect it to be a consumable, just like my clothes. And, yes, like my clothes, I am constantly using it and getting value from my purchase. I'm not using it in the making claims sense. I am using it in the constantly covering my risks sense. It's purchasing not having to worry. It helps us neurotic types sleep :).

pdavi21
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Re: Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 6:16 pm

sawhorse wrote:
Tue Dec 04, 2018 5:54 pm
Update: I saw your edit. It's very clearly written from a position of inexperience. Your statements are simply not true, and if you actually had to use a lot of healthcare, you would know.
Not true...but experience in Health Insurance is a very regrettable skill I have, and I have seen many scenarios in which the bill was over 10x or even 100x for an insured patient than for not insured. You can see them on the News too, occasionally. And it has happened to me about 10x where the insured cost was higher (including coverage).

patrick
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Re: Why Is Insurance Worth It (Analytically)?

Post by patrick » Tue Dec 04, 2018 6:18 pm

The traditional concept of risk adjusted returns doesn't easily apply to insurance because it measures risk by volatility of asset prices. When insurance covers major losses, the insurance reduces the risk of very bad results, which is probably the more important kind of risk to consider.

If we are talking about a travel insurance policy that will pay out $500 in case of lost luggage, self-insuring works well. But could you easily self insure for something that could cost $500,000 or more, such as a medical bill or a judgment against you? There are alternatives such as filing for bankruptcy which might work to some extent, but as you already see they won't work too well if you have lots of taxable investments.

Employer sponsored health insurance has additional benefits as already noted. In addition to avoiding taxes on the income, the employer also often pays a large portion of the costs. This can make the health insurance a net benefit even at a fairly low payout rate.

In my case health insurance has definitely been worth it lately. My employer pays more than half of the cost of insurance, and considering the tax benefit I'm paying less than a third of the cost. So far this year I have paid $2,596 in premiums and the plan has paid out $5,750 ... and some people have much higher medical expenses than that!

grog
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Re: Why Is Insurance Worth It (Analytically)?

Post by grog » Tue Dec 04, 2018 6:23 pm

pdavi21 wrote:
Tue Dec 04, 2018 4:27 pm
I don't see what I am missing.
Why do people have such a strong belief to promote a product with a statistically negative return (and negative risk) that isn't even 100% reliable on paying out in the event of a claim anyway?
You are only considering the first moment, not the second and higher moments.

sawhorse
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Re: Why Is Insurance Worth It (Analytically)?

Post by sawhorse » Tue Dec 04, 2018 6:30 pm

pdavi21 wrote:
Tue Dec 04, 2018 6:16 pm
sawhorse wrote:
Tue Dec 04, 2018 5:54 pm
Update: I saw your edit. It's very clearly written from a position of inexperience. Your statements are simply not true, and if you actually had to use a lot of healthcare, you would know.
Not true...but experience in Health Insurance is a very regrettable skill I have, and I have seen many scenarios in which the bill was over 10x or even 100x for an insured patient than for not insured. You can see them on the News too, occasionally. And it has happened to me about 10x where the insured cost was higher (including coverage).
I have only seen the reverse situation, and I would be very surprised if an insurance company would negotiate a rate 100x or even 10x that charged to an uninsured patient. It's nonsensical.

Nate79
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Re: Why Is Insurance Worth It (Analytically)?

Post by Nate79 » Tue Dec 04, 2018 6:36 pm

This is not the first time this subject has been discussed and unfortunately the entire premise as in the past is built on ignorance.

megabad
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Re: Why Is Insurance Worth It (Analytically)?

Post by megabad » Tue Dec 04, 2018 7:03 pm

pdavi21 wrote:
Tue Dec 04, 2018 6:01 pm
The same way one person cannot "insure" themselves would apply to a pool because the risk of default, while significantly reduced, is not zero.
Additionally, bonding and collateral are forms of insurance in which collateral is held by the payee. If you call yourself your own payee, then your assets are your collateral.
Linguistically, I think I agree with you, but functionally, I agree with nisiprius. But running down this rabbit hole further, you have basically indicated that there is a cost to "self-insuring" effectively (collateral). The effectiveness of your insurance will be directly related to the collateral available for it compared to the risk exposure. A large insurance pool will theoretically reduce the amount of collateral required to achieve the same statistical insurance effectiveness for each individual participant.

This means that a large insurance company can theoretically provide a cheaper "cost" for insurance than a small pool could for the same risk protection which would imply that it may actually be financially beneficial to purchase health insurance from a large company instead of self insuring.

To be more consistent with your apparent original premise--"Insurance is not worth it"--it seems that the proposal should be to not purchase a policy from a company AND to not self insure at all. If you "self-insure" as you defined above, you are by definition using a less efficient method of insurance (smaller pool) and have potentially made the case for large pool insurance policies.

In other words, either insurance is worth it or not. But if it is worth it, than theoretically large pool insurance is more cost effective than "self insuring". If not, than do neither and work under the assumption that no catastrophic event will happen (which is statistically likely but certainly not guaranteed).

123
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Re: Why Is Insurance Worth It (Analytically)?

Post by 123 » Tue Dec 04, 2018 7:11 pm

pdavi21 wrote:
Tue Dec 04, 2018 4:27 pm
...I have the legal minimum for car insurance and nothing else....
If you were a resident of California you can post a cash deposit of $35,000 (i don't think it bears interest) with the DMV in lieu of having car insuance. Over the long haul many individuals will find that the cost of car insurance will be less than the lost opportunity cost of the $35,000 deposit. Of course the deposit only covers liability to others and does not preclude judgements or claims that exceed the deposit. In addition the DMV does not provide any legal services to defend you in court in the event of litigation from other parties.
The closest helping hand is at the end of your own arm.

MandyT
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Re: Why Is Insurance Worth It (Analytically)?

Post by MandyT » Tue Dec 04, 2018 7:37 pm

pdavi21 wrote:
Tue Dec 04, 2018 4:27 pm
I don't see what I am missing.
Why do people have such a strong belief to promote a product with a statistically negative return (and negative risk) that isn't even 100% reliable on paying out in the event of a claim anyway?
My opinion is that the question can essentially be answered in one word: utility.

Would you rather win $10 or have a 50-50 chance of winning $21? Would you rather win $1,000,000 or have a 50-50 chance of winning $2,100,000? If your answers are different, it's because your utility function is not linear. For most people (and companies), the value of each additional positive or negative dollar is not constant and can vary based on practical (and psychological/behavioral) considerations. For example, you might prefer to pay $110 rather than take a 1% chance of losing $10,000, if it would save you from worrying about the possible loss and the regret if the loss comes to pass.

Utility is one way to explain why it can be logical for the insurance company to sell insurance and for us to buy it (different utility functions). Bogleheads can get so locked in to avoiding unnecessary costs that I think some have a blind spot about insurance. Many of the arguments in this thread are sensible but may or may not persuade someone who is convinced that "if they're selling it, it must be bad for me to buy it".

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Kenkat
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Re: Why Is Insurance Worth It (Analytically)?

Post by Kenkat » Tue Dec 04, 2018 8:08 pm

1. Health Insurance - can you afford a catastrophic cancer diagnosis where medical expenses might run upwards of a million dollars? Are you willing to forgo care for one of your children or declare bankruptcy and wipe out most of your assets?

2. Property Insurance - are you able to absorb a complete loss of your home and all of it’s contents?

3. Supplemental Car Insurance (above legal minimum) - do you have $100k or more to cover a bad accident with an expensive car or injuries to another party?

4. Umbrella Liability - again, are you willing to risk losing all your assets due to a lawsuit where you are found personally liable?

Life / Disabiliy Insurance - does your spouse have enough money to continue to provide for the family without your income? Are you willing to have to pull your kids out of their school, away from friends and move to a smaller house or apartment if you are disabled (or your spouse does this if you are dead)?

If you have few assets, then maybe you have little to lose but if you want to grow substantial wealth, in my opinion you want to protect that - typically at a pretty low cost.

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Re: Why Is Insurance Worth It (Analytically)?

Post by Daryl » Tue Dec 04, 2018 8:12 pm

Phineas J. Whoopee wrote:
Tue Dec 04, 2018 5:41 pm
I feel it has a second, perhaps more important aspect. If, by my actions or inactions, I injure somebody, or even just damage their property, the responsible thing, the right thing, is for me to compensate them, although money can never completely compensate for an injury or a death.

Therefore, I view insurance as a way to protect myself from adverse events, and as a way to protect my fellow human beings from me.
+1

A fair bit of the insurance that I purchase is for the benefit for third parties. I have a very small car; however, 3,000 lbs @ 65 mph can still do a lot of damage depending what I hit! Should I survive the accident, I hope that I can be an advocate for any victims and their families, working with them to help them recover / replace what was lost (to the extent possible).

I work for an insurance company. We often have an underwriting loss (premiums don't cover claims!)

Scrapr
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Re: Why Is Insurance Worth It (Analytically)?

Post by Scrapr » Tue Dec 04, 2018 8:16 pm

Artful Dodger wrote:
Tue Dec 04, 2018 5:27 pm
scimitar wrote:
Tue Dec 04, 2018 4:46 pm
Always remember that the entire raison d'être of an insurance company is to NOT pay you. To paraphrase the Simpsons' version of Bill Gates, they didn't get rich by writing checks.
The purpose of an insurance company is to pool risk, so many people can pay a small premium to cover a large loss when it occurs.

To the OP. We had three claims in the 80s and 90s (premature birth, meningitis, and a complicated pneumonia) that would have far exceeded my savings at the time, and would probably clock in between $750K to $1.25M in today's cost. So yes, it's worth it (analytically)!
we have had quite a run of (bad) luck the last 5-7 years. First i had 3 hospitizations & 2 surgeries of a week each. Then Mrs scrapr has contracted C. Radiation, chemo & surgery. One year later it's back & we are back in the treatment mode. She also had a run of 94 days en suite at the hospital during our boys birth. I don't know if there is a lifetime cap. I think there used to be at about 1 million. It would not surprise me if this 2nd round of C puts us close to 1 million


You can pry the Health Insurance out of my cold dead hands :mrgreen:

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Re: Why Is Insurance Worth It (Analytically)?

Post by delamer » Tue Dec 04, 2018 8:29 pm

It is interesting that you post this as a theoretical question, rather than providing a real-life situation that you have considered.

Say you don’t have homeowner’s insurance (yes, I remember you from the other thread). And your home sustains severe damage in a fire — $200,000 damage including rebuilding and replacing furnishings, clothing, etc.

Do you have liquid assets to cover that expense? What would be the tax consequences of selling assets in order to come up with $200,000? How much would it cost to house you and your family while your house is being rebuilt? How long would it take you to rebuild your assets?

Without giving more than 2 minutes thought, I can think of 4 people that I know who have been temporarily driven out of their homes by fire damage. But they were all smart enough to have insurance.

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Phineas J. Whoopee
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Re: Why Is Insurance Worth It (Analytically)?

Post by Phineas J. Whoopee » Tue Dec 04, 2018 10:15 pm

Daryl wrote:
Tue Dec 04, 2018 8:12 pm
Phineas J. Whoopee wrote:
Tue Dec 04, 2018 5:41 pm
I feel it has a second, perhaps more important aspect. If, by my actions or inactions, I injure somebody, or even just damage their property, the responsible thing, the right thing, is for me to compensate them, although money can never completely compensate for an injury or a death.

Therefore, I view insurance as a way to protect myself from adverse events, and as a way to protect my fellow human beings from me.
+1

A fair bit of the insurance that I purchase is for the benefit for third parties. I have a very small car; however, 3,000 lbs @ 65 mph can still do a lot of damage depending what I hit! Should I survive the accident, I hope that I can be an advocate for any victims and their families, working with them to help them recover / replace what was lost (to the extent possible).

I work for an insurance company. We often have an underwriting loss (premiums don't cover claims!)
Thank you for agreement, but I believe the underlined part is the normal, expected situation.

Insurance companies take in premiums and as part of prudent and highly-regulated management invest their assets. They don't keep stacks of hundred dollar bills moldering in physical vaults.

PJW

pdavi21
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Re: Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 10:58 pm

sawhorse wrote:
Tue Dec 04, 2018 6:30 pm
pdavi21 wrote:
Tue Dec 04, 2018 6:16 pm
sawhorse wrote:
Tue Dec 04, 2018 5:54 pm
Update: I saw your edit. It's very clearly written from a position of inexperience. Your statements are simply not true, and if you actually had to use a lot of healthcare, you would know.
Not true...but experience in Health Insurance is a very regrettable skill I have, and I have seen many scenarios in which the bill was over 10x or even 100x for an insured patient than for not insured. You can see them on the News too, occasionally. And it has happened to me about 10x where the insured cost was higher (including coverage).
I have only seen the reverse situation, and I would be very surprised if an insurance company would negotiate a rate 100x or even 10x that charged to an uninsured patient. It's nonsensical.
It's for poor people to have access to newer procedures. I'm not sure about the business case, but a good example is Martin Shkreili and his AIDS drug price hike. Uninsured patients paid a nominal amount, while Medicaid patients paid 200, and insured paid 700 (their portion of it).

EDIT: I don't have data on whether contract price or insured price is cheaper in most cases. However, it has been common for me, and I have been made aware of many stories of friends, family, and strangers. Additionally, out of Network providers do not have contract pricing, and the majority of providers are out of Network for most insured.

EDIT: I was once charged 3000 for an out of network service because my insurer paid 5000 of an 8000 bill. The cost for uninsured was 100-200 (quoted directly to me prior).

Katietsu
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Re: Why Is Insurance Worth It (Analytically)?

Post by Katietsu » Tue Dec 04, 2018 11:39 pm

pdavi21 wrote:
Tue Dec 04, 2018 10:58 pm
sawhorse wrote:
Tue Dec 04, 2018 6:30 pm
pdavi21 wrote:
Tue Dec 04, 2018 6:16 pm
sawhorse wrote:
Tue Dec 04, 2018 5:54 pm
Update: I saw your edit. It's very clearly written from a position of inexperience. Your statements are simply not true, and if you actually had to use a lot of healthcare, you would know.
Not true...but experience in Health Insurance is a very regrettable skill I have, and I have seen many scenarios in which the bill was over 10x or even 100x for an insured patient than for not insured. You can see them on the News too, occasionally. And it has happened to me about 10x where the insured cost was higher (including coverage).
I have only seen the reverse situation, and I would be very surprised if an insurance company would negotiate a rate 100x or even 10x that charged to an uninsured patient. It's nonsensical.
It's for poor people to have access to newer procedures. I'm not sure about the business case, but a good example is Martin Shkreili and his AIDS drug price hike. Uninsured patients paid a nominal ammount, while Medicaid patients paid 200 and insured paid 700 (their portion of it).

EDIT: I don't have data on whether contract price or insured price is cheaper in most cases. However, it has been common for me, and I have been made aware of many stories of friends, family, and strangers. Additionally, out of Network providers do not have contract pricing, and the majority of providers are out of Network for most insured.

EDIT: I was once charged 3000 for an out of network service because my insurer paid 5000 of an 8000 bill. The cost for uninsured was 100-200.
Are the prices you are quoting for the uninsured, restricted to low income individuals who qualify for subsidized care? I do have experience at obtaining drugs, MRI’s etc for low income individuals. But those very low rates are only available after completing an application and providing proof of low income. I think it is misleading to suggest that the uninsured middle income family can typically obtain hospital care for less than negotiated insurance rates.

pdavi21
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Re: Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 11:43 pm

megabad wrote:
Tue Dec 04, 2018 7:03 pm
pdavi21 wrote:
Tue Dec 04, 2018 6:01 pm
The same way one person cannot "insure" themselves would apply to a pool because the risk of default, while significantly reduced, is not zero.
Additionally, bonding and collateral are forms of insurance in which collateral is held by the payee. If you call yourself your own payee, then your assets are your collateral.
Linguistically, I think I agree with you, but functionally, I agree with nisiprius. But running down this rabbit hole further, you have basically indicated that there is a cost to "self-insuring" effectively (collateral). The effectiveness of your insurance will be directly related to the collateral available for it compared to the risk exposure. A large insurance pool will theoretically reduce the amount of collateral required to achieve the same statistical insurance effectiveness for each individual participant.

This means that a large insurance company can theoretically provide a cheaper "cost" for insurance than a small pool could for the same risk protection which would imply that it may actually be financially beneficial to purchase health insurance from a large company instead of self insuring.

To be more consistent with your apparent original premise--"Insurance is not worth it"--it seems that the proposal should be to not purchase a policy from a company AND to not self insure at all. If you "self-insure" as you defined above, you are by definition using a less efficient method of insurance (smaller pool) and have potentially made the case for large pool insurance policies.

In other words, either insurance is worth it or not. But if it is worth it, than theoretically large pool insurance is more cost effective than "self insuring". If not, than do neither and work under the assumption that no catastrophic event will happen (which is statistically likely but certainly not guaranteed).
What if all my relatives and myself forego insurance and save the premiums as additional contributions into our Asset Allocations with the understanding that we can loan money to each other? Is it functionally similar to insurance then?

pdavi21
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Re: Why Is Insurance Worth It (Analytically)?

Post by pdavi21 » Tue Dec 04, 2018 11:45 pm

Katietsu wrote:
Tue Dec 04, 2018 11:39 pm
pdavi21 wrote:
Tue Dec 04, 2018 10:58 pm
sawhorse wrote:
Tue Dec 04, 2018 6:30 pm
pdavi21 wrote:
Tue Dec 04, 2018 6:16 pm
sawhorse wrote:
Tue Dec 04, 2018 5:54 pm
Update: I saw your edit. It's very clearly written from a position of inexperience. Your statements are simply not true, and if you actually had to use a lot of healthcare, you would know.
Not true...but experience in Health Insurance is a very regrettable skill I have, and I have seen many scenarios in which the bill was over 10x or even 100x for an insured patient than for not insured. You can see them on the News too, occasionally. And it has happened to me about 10x where the insured cost was higher (including coverage).
I have only seen the reverse situation, and I would be very surprised if an insurance company would negotiate a rate 100x or even 10x that charged to an uninsured patient. It's nonsensical.
It's for poor people to have access to newer procedures. I'm not sure about the business case, but a good example is Martin Shkreili and his AIDS drug price hike. Uninsured patients paid a nominal ammount, while Medicaid patients paid 200 and insured paid 700 (their portion of it).

EDIT: I don't have data on whether contract price or insured price is cheaper in most cases. However, it has been common for me, and I have been made aware of many stories of friends, family, and strangers. Additionally, out of Network providers do not have contract pricing, and the majority of providers are out of Network for most insured.

EDIT: I was once charged 3000 for an out of network service because my insurer paid 5000 of an 8000 bill. The cost for uninsured was 100-200.
Are the prices you are quoting for the uninsured, restricted to low income individuals who qualify for subsidized care? I do have experience at obtaining drugs, MRI’s etc for low income individuals. But those very low rates are only available after completing an application and providing proof of low income. I think it is misleading to suggest that the uninsured middle income family can typically obtain hospital care for less than negotiated insurance rates.
No. They were just for uninsured. It didn't matter if you qualified for ACA subsidies or not. These scenarios are during the ACA. Not sure if they were happening before or not.

grog
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Re: Why Is Insurance Worth It (Analytically)?

Post by grog » Wed Dec 05, 2018 12:15 am

pdavi21 wrote:
Tue Dec 04, 2018 11:43 pm
What if all my relatives and myself forego insurance and save the premiums as additional contributions into our Asset Allocations with the understanding that we can loan money to each other? Is it functionally similar to insurance then?
And you're worried about the insurance company defaulting?

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Watty
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Re: Why Is Insurance Worth It (Analytically)?

Post by Watty » Wed Dec 05, 2018 12:28 am

Four things have not been mentioned(unless I missed it)

1) A reasonable case can be made for having a very high deductible.

2) If you have a mortage or a car loan then insurance will be required.

3) Your car/home/umbrella insurance also includes the cost of any legal defense. Legal bills can not only be high but if you can't pay for them you will be hard pressed to find a lawyer.

4) Without medical insurance you may be able to get emergency care without too many questions but for many if not most other things you may be expected to pay before receiving care.

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