23 Sep The Chance of Loss vs. the Consequences of Loss
Perhaps one of the most unglamorous but most important components of a solid financial profile is insurance. If your investments represent what you stand to gain, think of insurance as what you stand to lose.
Many of us, whether we have great wealth or not, think of insurance in the wrong way. We tend to measure the value of insurance in terms of the likelihood of a bad event. Think of a young person contemplating health insurance. They think, “I’m healthy, I’m in good shape. I don’t need health insurance.”
While it’s easy for people to spend money on a benefit they can see or use or own, it is more difficult to part with money for something that, by design, they will most likely not need. In fact, you buy insurance, hoping you will never use it. It makes sense that insurance works best when it is mandatory, like auto or homeowner’s insurance.
The risk management firm Mechelsen Private Client makes a useful distinction between the “chance of a loss,” and the “consequences of a loss.”
We tend to think more about the chance of a loss, which – let’s admit – is generally low for most things we buy insurance for. We are probably going to get through this week, probably the whole year, without getting into an accident driving to work, or breaking a collarbone, or accidentally setting the house on fire. Thinking about the chance of a loss is relatively comfortable. “Everything will be fine,” you tell yourself. And it usually is.
We tend to think less in terms of the consequences of a loss, and understandably so. What would be the cost of a catastrophic injury or an accidental death? Such scenarios are difficult to imagine because they seem so unlikely. Even if we did think about the consequences of a worst-case scenario, few of us really know what the costs will be.
Mechelsen’s research came up with some sobering figures from actual jury verdicts and court settlements of liability cases.
– The victim of a boating accident was awarded $34.9 million.
– Property owner was ordered to pay $30.7 million to family of a boy who drowned in his pond.
– Victim receives $5 million after car accident results in brain damage.
– Another victim of car accident, left paralyzed, receives $20 million.
– Victim of a golf-cart accident awarded $2.1 million.
– High school athlete injured by a javelin is awarded $2.1 million.
None of these people were stuntmen, race car drivers, or firemen, nor were they doing anything particularly risky or dangerous. Dangerous jobs are about the “chance” of loss.
These people were ordinary folks doing routine things that we all do every day, driving home, playing golf, taking a swim on a hot day. They had some terrible luck and happened into a worst-case scenario which the courts determined were worth millions in compensation. That is the consequence of loss, and its price is always very high.
Preparing for the possibility of such events might be unpleasant and even unnecessary, but the right amount and the right type of insurance should be part of any sound financial plan. With some luck, you’ll never need it.