## Sunday, December 13, 2009

### An uncertain world and its asymmetrical payoffs

I read a silly post about critical illness. That person commented that there's no need to get critical illness coverage because the probability of claiming such things are very low, to the tune of 5% during their working life. A hospitalization and surgery plan (H&S) is enough. I disagree fully with the comment that having a low probability of claim means that there is no need to cover for it. I shall not comment on whether a H&S plan is sufficient.

The comments made me wonder if people are confused with the probability and the payoffs. The consequence of an event happening are often more important than the probability of occurrence.

Let's play a very sick game of russian roulette. Inside the chamber, there are 6 slots with only 1 live bullet. If you press the barrel against your temple and squeeze the trigger, you'll immediately be given \$5 million SGD if you survive. The probability of getting the bullet is 1/6 and you have 5/6 chance of getting the \$5 million SGD. Would you play?

I would not, unless there's no more meaning in my life. Though the probability of a payoff is good, the result of having a bullet running through my brain is so disastrous that the low probability is of no consequence to me. Probability works for past statistic over a large sample size, so if there are 600 alternate realities of you squeezing the trigger, approximately 500 such 'you' will get the \$5 million and approximately 100 of 'you' will be lying on the floor. Even then, it's approximately. But before it happens, there's no way to know if you're going to lie on the floor or be jumping for joy over your windfall.

It is often said that in the long term, the probability of stocks beating any kind of instrument is very high. Statistics are given, charts are shown. I heard of people using these long term investments as a nest egg for their retirement (it's happening in US now) and I wonder if these 'long term investors' ever thought what happens if in the long term, the investments don't work out. Will they be able to ride out the consequences?

I keep hearing this "In the past, 9 out of 10 times, blah blah blah happened, so you can be assured that blah blah blah will work out fine for you". My bullshit sensor will start to ring. My mind will start to wander - what happens if blah blah blah that is so highly likely to happen didn't actually happen.

I still think that in an uncertain world, the consequence of an event happening is more important that the probability of occurrence. Screw probability and its illusion of certainty under uncertainty.

#### 22 comments :

Createwealth8888 said...

http://createwealth8888.blogspot.com/2009/11/critical-illness-cover-pitfalls.html

Bro, can one claim against CI easily without subjecting to delay of claim? Any further delay, that CI guy/gal may be already dead?

Musicwhiz said...

You should definitely get covered for CI, and also for TPD. The consequences of not being covered are unimaginable. It's ok if you suffer, but imagine your loved ones suffering as well if they do not have enough \$\$ (as usually the man is the breadwinner in the family)?

On an off-topic note, Popular has proposed a 3-for-10 rights issue. Why do they need so much cash?

Cheers,
Musicwhiz

Hi LP

Moving into the realm of "Black Swans" and "Fooled by Randomness"?

Human beings are not good in estimating payoffs, probabilities and impacts of the various scenarios. Thus, intermediaries of all sorts come in to "educate" us about those choices.

Personally, I think we cannot safeguard against everything but we can think about what's important to us and take some simple precautions.

My philosophy towards financial freedom still remains to live within my means, to save and invest to grow and protect my means.

Besides the usual saving up, investing for long(er) term ;-P and buying adequate insurance, I try to take care of my health and to just watch myself when crossing the street or driving.

In life, you cannot be 100% prepared for everything, but just be prepared enough to handle the sh** that happens.

Be well and prosper!

la papillion said...

Hi bro8888,

Good article that you posted back there. I read it and found that it makes sense. There are two points that I want to contend with:

1. By CI late stages, I take it that you mean cancer. There are some other illness that is not cancer but is covered under CI plan e.g. heart attacks, strokes... There's a chance of recovery.

Besides, I'm also covered by an adequate H&S.

2. I do not have CPF due to the nature of my job. I think things are a little bit different.

Either way, the post is not really about the CI thingy :) Just wanted to talk about how bullshit probability is, haha

la papillion said...

Hi mw,

Popular 3 for 10 rights? Hmm, maybe they going to build a batman two property, after their robin one? lol

la papillion said...

Hi PG,

Yea, you've read it so you know :) Recently I re-read fooled by randomness again. That book never fails to excite some brain activity in me.

You take care :)

Jeremy Ow Tai Pang said...

Hi, LP,
Wonderful illustrations on the illusion of low probability events. I totally agree with you that preparing for the consequence of an event is more important than considering the probability of the event occuring. Since the event can anyway have a chance of occuring (though maybe a slim one), one should still place emphasis on preparing for the occurance of an event (especially in this case it is a drastic event of critical illnesses occuring). There are so many critical illnesses that can possibly hit anyone in their lifetime, so it still makes sense to be covered for the critical illnesses component. The only way for us not to cover for an event of low probability of occurance is unless we have found a way to block off even the possibility of the event occuring, in your illustrations of critical illnesses and russian roulette, this not possible as we cannot control 100% how our future health will turn out to be and also we cannot control the live bullet from not firing at oneself once it is loaded, so it is still logical to be prepared for such events that may still occur.

Createwealth8888 said...

Don't be too overly concerns about medical treatment if one don't mind Class C as it is still affordable and in worst case go for social-medical assistance. Last venue, write to the press for medical donations.

la papillion said...

Hi Jeremy,

Nah, I won't take credit for my illustrations. I probably took it from somewhere, though I'm not sure if it's from Nassim Taleb's Fooled by randomness.

You shld read his books. It gives a different insight to statistical inferences and deductions :)

la papillion said...

Bro8888,

The trappings of middle class will be even worse with means testing. Not sure how it works, but the principle is that for those who can afford it, you have to be pushed into higher class wards. Not a choice.

Createwealth8888 said...

One can still opt for lower class but with less subsidy.

Anonymous said...

Waaah, LP, I hope you are not talking about what I said about CI over at FinancialFreedom SG.

I remember I did say CI is important : )

W

la papillion said...

Hi W,

No lah, you're too sensitive :) I didn't even read about your comments on ffsg's blog.

Where where? show pls!

Lau said...

Hi LP,

Believe a certain insurer CEO said that about CI after leaving the company. :)

Just my opinion, CI insurance needs should not be based on probability! If it was, what is the ideal probability before it becomes necessary? ...

Insurance needs should be based on risk transfer needs. I.e. Can you bear the financial loss of the outcome of the event? In this case, CI.

A. You can self insure. Sufficient liquid cash and passive income on hand to insure against this. Fine, no need insurance.

B. You can transfer risk. Spouse and children can take care of me. You want to be selfish. Fine, no need insurance.

C. You can transfer to insurance company through loss of income plan and/or a standalone CI plan.

D. Unfortunately, unlike some risk, you can't avoid this risk. Like for example, you can avoid the risk of dying in a plane crash by never flying. Living a healthy lifestyle may minimize the risk but not eliminate it.

Just an example, if the probability of your house collapsing is 0.1%, do you still need home insurance? Again, if you got another home some where, fine. You got enough cash to buy another home, fine. Else, it would still be prudent to insure against this catastrophe as you cant bare the financial risk of being homeless if that 0.1% happens.

LP, would you like to exchange blog links?

Anonymous said...

This one lor ...

https://www.blogger.com/comment.g?blogID=2580989564838748562&postID=798565933187989797&isPopup=true

We had a brief sharing of CI thoughts : )

W

Createwealth8888 said...

Let me share too...

http://createwealth8888.blogspot.com/2009/12/critical-illness-insurance-pays-you-for.html

Hi LP

I read Taleb's "Ten Principles for a Black Swan Proof World" quite funny yet so true. How can bankers who brought the world to near brink and collapse, causing REAL unemployment and RECESSION get getting BONUSES?

Singapore Inc also privatises some of profit and socialises losses (think Temasek).

http://www.fooledbyrandomness.com/tenprinciples.pdf

Createwealth8888 said...

Sometime how we wish Heaven got eyes

Derek said...

Sounds complicated.

My rational is simple, as long as there is a chance that it might happen, I wanna prepare for it. So unless the chances of me getting CI is zero, I will need CI coverage.

Cheers!

la papillion said...

Hi guys,

Sorry for the late reply, I just came back from batam today.

Lau, will link you up to my blog :)

W, OH! I remember - you're the evil one, haha :)

Bro8888, thanks for sharing :) I agree fully with you. Settle the basic first, then if you can afford it, upgrade again. That's the way to approach it.

PG, great site! Thanks for letting me know :)

Derek, haha, the question is how pple want to cover CI. Not easy leh, so many permuations and products. Aiyo, really can be confusing.

bummy said...

LP, I am a firm believer of CI insurance and have tried convincing some of my friends to buy CI until my face turn blue, There are some really cheap CI term alternatives from Safra, Aviva or even NTUC union but sadly some rather spend their money on the latest handphone. Your fine example of russian roulette will hopefully help convince my friends

la papillion said...

Hi bummy,

Thanks for visiting :)

Well, perhaps they think it will not happen to them. The problem about insurance is that, when you don't need it, you have no incentive to buy, but when you need it, you can't buy anymore.

I hope your friends won't be a negative example - that will be dreadful.