Saturday, May 30, 2015

Regret theory in practice

I am on holiday in Italy until - well - today - when I go to Germany for work.

I rented a car.

Supplemental insurance for the car - which reduces excess from 2000 Euros to zero - was 14 Euro per day (for nine days). The car is automatically insured beyond a 2000 Euro excess.

I did about twenty seconds thinking and elected (against my wife's wishes) not to take supplementary insurance.

The logic:

(a). I pay about $800 a year for a $40,000 car in Australia. It gets driven a lot. That works out at under $3 per day - and it covers considerably more than the supplemental insurance - which makes the supplemental insurance look expensive.

(b). Against this I would be driving about 5x average - somewhat offsetting this - and on the opposite side of the road. Thought of that way the insurance is not massively mis-priced.

I figured there was less than a 10 percent chance of a dingle - but more than a 5% chance. The insurance looked expensive. I am a hedge fund manager and paid to take rational bets. So I declined the insurance.

You guessed it - I had a dingle.

The 2000 Euros is financially irrelevant to me. [It is way less than I risk, personally, every day in the stock market.]

But I am surprisingly, irrationally unhappy about not taking the insurance.

It is widely observed that people (likely including my clients) are irrationally affected by small losses.

But they pay me to be rational. And I insist on being so - but it is harder than it looks.



webko wuite said...

Hi John, thanks for sharing your thought, but if you were truly rational you would not be long Herbalife.

Glenn said...

$800 or $8000? (You can delete this comment if you'd like.)

jestyn said...

Next time, go online to buy the supplemental insurqnce separately from the car hire.

50 gbp per year buys you worldwide coverage for multiple rentals

point 3.

webko wuite said...

Hi John, thanks for your sharing your thoughts. I would have abstained from the insurance too under those conditions, but I believe that you would not be long Herbalife if you were truly rational.

Anonymous said...

Why not fight loss aversion with gambler's fallacy: this dingle clearly protects you from further problems for the next ten holidays.

Anonymous said...

There is no such thing as rational, only a sliding scale of irrationality. Most of us are wildly irrational, but mostly in our blind spots.

Anonymous said...

You may find your credit card will cover the difference if you used it to pay for the rental cost. If not find a new credit card when you get back to Oz.

James B. Shearer said...

So your credit card doesn't automatically provide some sort of coverage? In the US many do.

dlr said...

You're right, it is harder than it looks, and rational probably isn't a good word to use here, either. If loss aversion is difficult to change than it is just as rational to pay to mitigate it as it is to pay to mitigate uncomfortable temperatures. Rational should not mean making some symmetric assumption about utility that doesn't fit the facts on the ground. Rational-you should take into account actual-you as best as possible. On the other hand, there are a lot of cheaper and more creative ways to mitigate loss aversion than paying for it, assuming you are not economically benefitting from the volatility protection (i.e. you have enough wealth and liquidity). Unnecessarily extreme version: set up a separate brokerage account that owns only a basket of insurance companies and insurance company debt. Invest small "premiums" into it every month covering all your self insurance and every so often glance at the P&L. If you mentally include enough self insurance, there should be regular enough payouts that you feel more like an insurance company yourself than a gambling failure when losses strikes.

Incidentally, the math you did was probably unnecessary. Almost all insurance is "unfairly" priced to people who don't economically benefit from the volatility protection and are not adversely selected risks.

Doug said...

I'm surprised your credit card doesn't automatically provide supplemental insurance? In the US, almost every credit card now carries this as a standard benefit. I know things are different internationally, but, if you travel a lot, American Express has all sorts of travel benefits (that go way above and beyond rental car insurance).

BTW, kudos for making the rational decision. Insurance protects against catastrophes, and, as you noted EUR2000 is far from a financial catastrophe for you.

Jean said...

WIth your background as an insurance analyst i'm surprised by the way you frame this. Isn't the only rational time to buy insurance when an adverse event could wipe you out? The math that you lay out on top is the exact math that the insurance company has already done and concluded that it's profitable business for them and unprofitable for you.

David Andolfatto said...

How you feel ex post is irrelevant unless it leads to a change in your future behavior. Will it?

Nawp Dolittle said...

But you're on holiday and the emotional pain is real. And as you say, it isn't really about the money in this case. And your wife gets to tell you "I told you so". In hindsight, wouldn't paying the 126 euros be the rational choice?

Anonymous said...

Hey John,

I presume you already know/have checked this ... but just in case ... almost every Australian credit card (and I presume you bought your tickets with one), includes travel insurance that would cover your rental car.


Mark B. Spiegel said...

You should also factor in the increased risk of driving in an unfamiliar country on the opposite side of the road.

David said...

Thanks John,

The other factor is that there is a kind of counter party risk in dealing with an insurance company, as compared to insuring directly you own car.

I have heard of many examples of unscrupulous rental companies always finding a scratch or two and billing the client 500-2000 to have them fixed.

As the client has not proof the scratches were not done while they had the car they cop it.

This is my reason for always taking the extra insurance with rentals....just so there is no arguments at the end of the deal.


dfi said...

you know if you travel a lot for work and have ongoing travel insurance this will often cover this type of event (read the fine print though)

Unknown said...

So next time are you making the same decision to forgo insurance? Or are you going to include in your calculation the horrible feeling of losing and therefore buy it?

I also rationally decided to not get insurance on a hire car. Some road rage thug kicked and dinged my car up, broke off the windscreen wiper etc. and I got left with the bill.

Jinning Zhao said...

An actuary would suggest you taking the insurance.

Unknown said...

I think the supplemental insurance is a huge rip off. I rented a car last weekend in Miami and Hertz offered three different plans and cast them in language which was clearly intended to scare you into taking coverage. I had already spoken to American Express and my auto insurance carrier and got the impression that I was basically covered (outside of my deductible perhaps.)

I know it's not the point of the article in terms of small losses and regrets but by thinking about it as a "deductible" it makes your very rational choice feel better - you took the "$0 premium/ $2000 deductible" versus the "$X day/$0 deductible" plan.

Some people are very comfortable with risk, others are basically allergic to it.

BHill said...

Good post and thanks for sharing. Glad it was only a dingle and you are ok. You must be getting an earful from the wife ;-)

Anonymous said...

Hi John,

It's early in the morning here but:

If you estimate the probability of a dingle to be between 5 and 10%, let's say 7,5%, then it seems rationally better to take the insurance.
On average you would have an accident 1 on 13.33 times. During this 13.33 times you would have paid 9*14*13.33 = 1680 euro. Paying the excess yourself would cost you on average 2000 euro each 13.33 times.

Where's the fault in this logic?

Nick said...

If you rented with a credit card it may cover you. Also a 5% probability of a crash is far too high. It's wildly profitable for the rental co so hardly anyone is actually making use of it. See the guardian link above for a non ripoff product that probably still makes money!

Dmitry said...

a little of the *happy* opposite story to offset the feeling.

Three years ago I elected to go for a vacation via an agency package. Pretty much the first time in like 10 years and possibly last ever in my life (as usual, that package was noticeably worse then I could've done myself with minimal effort). I was extremely tired and in a hurry to "get to the beach", so went the weak way.

However, package included a rather expensive travel insurance. And guess what? Big 100mph bike crash. (Before you worry, it's totally okay now.)
So I've got that insurance to cover hundreds of thousands worth of medical bills.

Unsurprisingly, I often describe this a winning a lottery. Despite the objectively sad nature of said lottery. ))

Rationally analyzing these feelings I elected to never again purchase "casual" insurancies, as to not feel the irrational happines when anything happens.
Now I guess it's the damned-either-way thing, huh.


dearieme said...

1. It was Italy.

2. They drive on the wrong side of the road there.

3. It was Italy.

Buboe said...

a couple of comments from a professional in this area.
Under deductible insurance is rotten business from a profitability perspective for insurers - but this is driven by large commissions, so it's probably not a good buy for punters.
Several others have commented that travel insurance will probably pick this up - given your amount of travel, I assume there is a corporate travel policy in the organisation. This may well pick up private travel also.
Credit card travel insurance is worth exactly what you pay for it. These sort of policies are an Ombudsman's nightmare.
On a side note, it's likely that your rental company would expect you to pay the excess for both at-fault and not at fault damage. (Damage whilst parked, impacts where a third party is at fault.)Somethimes these payments might be refunded if there is a settlement from third party insurer, but it's not likely...

Anonymous said...

I think it's a lot easier to get comfortable with this when you rent cars frequently. While travelling regularly (weekly) for business a few years back, I did the maths on how may days I'd need to rent without taking the top up insurance, accident free, in order to have covered the excess that I'd be forced to pay if I did have an accident. It turned out that that time frame was 6 months. 18 months later, still accident free, I ceased travelling as frequently, but it's never since been an emotional decision to make.

Unknown said...

€14/ day for 9 days? €126 altogether? To protect yourself from a €2000 loss in the event of an accident?

If your rate your chances of an accident as less than one in sixteen (I should hope so - the real risk is probably less than one in a hundred), then you are better off financially without any insurance (assuming you are in position to front €2000 in the event you get unlucky). Supplemental insurance is a terrible deal.

Frozen in the North said...

I think what you are discussing is more a problem of the Australian insurance market. In North America I get coverage (when I rent) from either my car insurance company or from my credit card. Dinged a car in Netherlands and in the US, up front cost was $2,000 but two weeks later got a check from my credit card company for the whole amount.

Actually, we used our points to rent a car in Mexico last easter, insurance cost was more than the cost of a normal rental (we often rent there...) Just goes to show -- your analysis was not wrong, you were studying the wrong variables (the uncompetitive car insurance market in Australia...)

Richard said...

Sorry! I have been having a "there but for the grace of god" reaction to your post.

My wife and I are just back in Mallorca (where we live) having spent a week in Ronda (Andalusia). We hired a car at Malaga airport and like a mad fool I agreed to the offer for an upgrade to a BMW 730B for an extra €20 a day - who wouldn't? (Apparently it was "happy hour", which I understood that Avis was sick of their high end cars sitting in the garage).

I was confronted by the same option to insure the €2,000 excess, did the math, and made the same decision as you did. I sagely assured my wife that the risk had been "over priced".

Enter the second player in this drama. The Garmin. (My wife couldn't figure out how to get the BMW's own navigation system of German so we used our own.)

We were exploring some of the white villages around Ronda and found ourselves in a back streets of a village called Benaoján which the Garmin assured us was the best route to the next village. The BMW 730B is a rather wide car. The back streets of Benaoján are remarkably narrow. As I crawled along a lane, the walls of which could be touched by the fingers of out stretched hands, all I could think of was now how I was going to fund the €2,000.

Like all great comedies, there was an audience of bemused locals who came out to watch our progress. The moment of potential tragedy came when I turned a corner in an attempt to escape and the back right wheel dropped suddenly, and there was loud clunk. My credit card went "ching" in my wallet. The sweat was visible while I searched for the expected damage and my wife sat in smug vindication.

I still don't know what made the "clunk" but it left no visible mark, and I regained what passes for a two way street in Benaoján with no further excitement.

The connection between these events and my skill in tactical financial risk management is loose, but it was a sobering experience.

Maybe it is time to do a portfolio review.

Anonymous said...

Supplemental rental insurance is notorious for high adverse selection.

Only the renter knows if the car is going to be driven long distances, recklessly, or perhaps through a wildlife park or to a gentlemen's club.

Personally, I contribute to the adverse selection problem. If I am driving airport to hotel conference and back to airport, I skip the insurance. However, if I am going 'adventuring' I take the supplemental insurance.

The supplemental insurance is also useful if you get a minor ding and don't want to waste time or stress haggling over the repair value of said ding.

rafaminos said...

I am with anonymous on the calculation front.

not sure the insurance is expensive (depends on where you stand on the 5-10% probability)
@ 5% => no insurance (cost expectation = 100), @10% insurance => insurance (cost expectation = 200)
btw, I did the same computation 5 years ago while in corsica for car rental. breakeven implied proability for insurance was @ 5% and I took the insurance (no dingle though)

rafaminos said...

my prevous comment is wrong.

I assumed the payment in case of dingle was 2000 although it is a maximum. make it say 1000 (in expectation) and the insurance is not wortwhile even @ 10% probability

Anonymous said...

As an actuary I can tell you that you did make the right decision. Car insurance is a very competitive product and if you are paying the same premium as a large group of people chances are it is expensive.

Anonymous said...

You are stupid at best. You agree to your wife on such things and earn brownie points. This gives you freedom and peace of mind to actually apply the probability in life where it matters.

Anonymous said...

Driving in Italy is more different than driving on the other side. In some areas (Amalfi coast) roads are so tight that you cannot find any car without scratches. The way of driving is totally different. Same in Germany: On the Autobahn you have to deal with Speeds higher than 140 mph. So, Parameters used for calculation / speculation were not complete.

Anonymous said...

Recent interview with John:

Likes a lot of Telecom names....

Anonymous said...

>Supplemental rental insurance is notorious for high adverse selection

If that is the case, why do they sell it so hard?

If they really want me to have some skin in the game why don't they offer me the same excess as my own car insurance, ie GBP200? Instead they typically have GBP1000 and GBP500.

The reason I want zero excess is that it changes the terms of the deal in two important ways. First, I don't have to spend time checking and documenting the car. Second, if there is damage, the rental company decides when and how the damage is repaired. Then I think it is better that they carry the cost for it.

dede said...

I fully agree with Anonymous : "Driving in Italy is more different than driving on the other side"
You got the analysis wrong in the first place. I remember the first time (as an 18 years old) I drove with my Dad in Marseilles (South of France, much easier than Italy) and me switching on my blinker to change lane, he yelled : "never use the blinker in Marseilles : they will know you want to change lane and they will accelerate!"

No luck for you though, I am never consistent on the car-rental insurance either: should always get the cheapest one to avoid real financial pain but sometimes get the expensive one to avoid the hassle (and I loved it once when I was about to look at old scratches and they asked me why would I care because I was insured for any new ones anyway)

TomTom said...

The aspect that you did not price in which is very high - is the price of having your wife say "I told you so", and reminding you of it at every opportunity for the rest of your life.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.