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‘Optimism bias’ and our reluctance to buy insurance

Life happens: insurance is designed to protect us from major calamities

Many of us have, one might say, a supreme confidence in our invincibility in the face of calamity. It is called optimism bias, as in “bad luck events happen to other people, but not to us”.

Optimism bias exists across the human global spectrum – transcending gender, ethnicity, nationality and age, occurring statistically in around 80 per cent of any population. Specifically, we believe fully that we are in control, overestimating probability of positive events, and underestimating the chance of negative situations: vehicle accidents, hurricanes, job loss and debilitating illness.

Secondly, optimism bias tends to make us equivocate about the future.

Why should we when the present is so great, nothing bad is happening, no obstacles to the perfect life stand in the way? Plus, planning for negative events is such a stressful, draining thought process; we’ve all been there, so no one should be faulted for “putting it off for another day”.

Thirdly, an individual’s optimistic perception of control gives rise to a complacent thought process relative to our ability to purchase risk protection as “while, I really don’t want to buy it now, or not sure that I need property/health/life/business succession planning or other catastrophic insurance, but I’m thinking about getting around to it – one of these days.”

Optimism in itself is a wonderful thing, especially in personal and work-related relationships, but it can be in detrimental conflict with proven facts that are relied upon to generate contingency plans.

So, optimism bias can explain much of the procrastination that follows – until the urgent reality of no protection hits home (figuratively) as an impending catastrophic event looms on the horizon.

Dear Readers, there is a reason that insurance companies have moratoriums on increasing limits on an existing policy or issuing new property policies, say, if an impending hurricane is a couple of weeks (or less) away.

Cost and value. It isn’t so much the cost although that certainly is a factor for many households, or because the individual or family never has had – as yet – to file a claim (a big yet until the next hurricane, for instance).

It is more about the feeling that there is little value for money spent – until and when absolute disaster strikes. Then, if insurance does exist, it is a comfort during a terribly stressful time for a family.

Reader comments about cost of insurance have stated such; “I’ve paid these premiums all these years, never had a claim but the insurance people have my money.”

Two things to think about regarding property insurance.

1. Add up all the premiums that you have remitted over the years, let’s say an average of $5,000 a year, for a home replacement value of $600,000 – $800,000.

Note: This is a theoretical illustration, you will need to use your home and your premium values, but the questions are the same.

a. Ten years – $50,000

b. Twenty years – $100,000

c. Thirty years – $150,000

d. Forty years – $200,000 and so on

2. Now, the second, you decide to “go bare” – no insurance.

Could you save enough to replace your whole house for $200,000?

One-half of your house for $200,000?

One-quarter of your home for $200,000?

If the answer is no, you could not, what would you do?

We cannot predict actual events, only compute the probability and try to contingency plan. The insurance component provides a buffer against disaster.

Risk exists always and can occur in just about anything: personal, business, government, trade, country.

Cybersecurity risks, unheard of years ago, are at an all-time high. The depth of risk prevention required is massive. In March 2021, a global/US insurance company, CNA Financial paid, $40 million in ransom after a cyberattack. If it can happen to them………..

Insurance companies quantify and manage risk starting with two basic approaches.

Risk control

• Avoidance is not placing an individual, family or business at risk in the first place

• Reduction manages costs of exposure with loss prevention programmes.

Risk financing

• Retention, even though a risk may be apparent or not understood at all, nothing is done.

• Transfer of risk means that when you walk into an insurance office – or conduct Zoom interview – you (and your business) have made the decisions to transfer risk

That’s not all they do.

Stay tuned for June Insurance Week.

Disclosure: the author has no relationship with any insurance company, local or global, nor is she employed in, receiving commissions or gratuities from, or selling/buying insurance policies, securities, and the like.

Held Captive: A History of International Insurance in Bermuda by Catherine R. Duffy, AIG, Bermuda Country Head, pages 4-5.

Although, tiny and remote, Bermuda has always been significant. It was one of the earliest ports of a global network and a foundation stone in what was to become the British Empire. Bermuda had an importance, at first strategic and latterly financial, out of all proportion to its size.

1784. Bermudians first recognised the potential of marine insurance business and thereupon established the Bermuda Marine Assurance Company, issuing its first policy on December 28, 1784 to cover a shipment of cargo from Bermuda to Philadelphia. The sum insured was £400 at a premium rate of 2.5% with a refund of 2% if no claims were filed.

Bermuda began its first Postal Service to enable the efficient transaction of international commerce.

The Bermuda Gazette was published for the first time.

Marine cargo business became quite lucrative with the exporting of Bermuda produce to the United States and Canada and it encouraged large UK insurance companies to appoint general agents in Bermuda.

1815. Hamilton was made the capital in place of St George’s. Mr. NT Butterfield became the first contact person for the Phoenix Assurance Company between Bermuda and London.

1902. Harnett and Richardson (now a member of the Freisenbruch-Meyer Group) became underwriting agents for Guardian Royal Exchange Assurance Co Ltd as the British sought further lucrative partnerships in the Bermuda market.

1903. A group of eight Bermudians, who understood the necessity of a domestic insurer for fire and cargo insurance, incorporated The Bermuda Fire & Marine Insurance Company.

Henry Tucker was born. He would become a leading force in changing for ever the landscape of international business in Bermuda.

Reference sources

“The Optimism Bias”, Current Biology, Volume 21, Issue 23, December 6, 2011, Tali Sharot

Simplicable, John Spacey, Singapore, https://simplicable.com/new/business-risk

Fundamentals of Risk and Insurance, Emmett J. Vaughan, Therese M. Vaughan

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Published May 29, 2021 at 8:00 am (Updated May 31, 2021 at 8:14 am)

‘Optimism bias’ and our reluctance to buy insurance

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