How to do the math on self insuring?
May 29, 2018 2:49 PM Subscribe
How would I work out how much to set aside for self insuring against the loss of an item which depreciates?
Let's say I have bought a new gadget. It seems like self insuring it against loss would be a better gamble than insuring the item itself through a company (unless I'm mistaken?).
I can reasonably expect to need to replace the gadget in a certain number of years. I might drop it down the toilet and need to replace it at any point in that period.
Basically I'm asking - how would I work out how much to set aside? Is it just amount per month = (cost of new item) / (total months before I expect to have to buy a new one)? Or more? Or less? Does my risk / clumsiness save the amount I'd need to save?
Let's say I have bought a new gadget. It seems like self insuring it against loss would be a better gamble than insuring the item itself through a company (unless I'm mistaken?).
I can reasonably expect to need to replace the gadget in a certain number of years. I might drop it down the toilet and need to replace it at any point in that period.
Basically I'm asking - how would I work out how much to set aside? Is it just amount per month = (cost of new item) / (total months before I expect to have to buy a new one)? Or more? Or less? Does my risk / clumsiness save the amount I'd need to save?
You're working with a few interrelated factors here. The depreciation you mention is something you're going to pay for one way or another. You could figure this out separately, and set it aside. For example, maybe every 5 years you buy a laptop for $1500, and sell your current one for $300. That represents an average monthly depreciation cost of $20/month (ignoring that depreciation starts higher and ends lower over its life).
So you could set aside $20/month for a laptop, and every 5 years put the $1200 towards a new laptop.
Now that you're paying for depreciation, you have a separate issue of loss/damage. This is trickier, for the reasons mentioned by praemunire. You can't spread the risk of laptop loss since you only have one laptop. But you can pool the risk across all your individual items. This could work well, but only up to a point. It would probably work great to self-insure against toilet drops, random breakage, and the occasional loss or theft. But it would all fall apart if you had a major event, like fire, flood, or something equally bad that you can't predict or afford to absorb with your savings.
posted by reeddavid at 3:08 PM on May 29, 2018
So you could set aside $20/month for a laptop, and every 5 years put the $1200 towards a new laptop.
Now that you're paying for depreciation, you have a separate issue of loss/damage. This is trickier, for the reasons mentioned by praemunire. You can't spread the risk of laptop loss since you only have one laptop. But you can pool the risk across all your individual items. This could work well, but only up to a point. It would probably work great to self-insure against toilet drops, random breakage, and the occasional loss or theft. But it would all fall apart if you had a major event, like fire, flood, or something equally bad that you can't predict or afford to absorb with your savings.
posted by reeddavid at 3:08 PM on May 29, 2018
If it's something you need to replace soon after something happens to it, you need means to replace it on day 1. $20/month won't help you if it's stolen on the way home from the store. This is what insurance is for, to spread the risk out to an expected avg claim rate.
posted by TheAdamist at 4:11 PM on May 29, 2018 [1 favorite]
posted by TheAdamist at 4:11 PM on May 29, 2018 [1 favorite]
How would I work out how much to set aside for self insuring against the loss of an item which depreciates?
As you're not sharing risk with a pool, you set aside (or maintain) a balance equal to the replacement value of the item.
Recalculate this annually (or as often as you like) and adjust accordingly.
Self-insured for damage to / theft of a car with a $20k replacement cost? Have $20k in assets set aside.
posted by zippy at 5:27 PM on May 29, 2018
As you're not sharing risk with a pool, you set aside (or maintain) a balance equal to the replacement value of the item.
Recalculate this annually (or as often as you like) and adjust accordingly.
Self-insured for damage to / theft of a car with a $20k replacement cost? Have $20k in assets set aside.
posted by zippy at 5:27 PM on May 29, 2018
If you know the future cost, there's no value to insurance. Insurance is intended to reduce risk - but you need to pay to avoid risk. Simplest example: You face a 1 in 1000 risk of a fire destroying your $100,000 home. That's an expected cost of $100 ($100,000/1000). But instead of saving $100,000, you pay $120/year in insurance.
If you know for sure you'll have to pay $1000 in 10 years for a new door, it's better to save $100/year than to pay $120 in door insurance for 10 years.
The larger the potential cost and the smaller the risk, the greater the value of insurance. Homeowners and health insurance: excellent idea. Insuring a $40 toaster: not so smart.
Theoretically, you shouldn't insure if 1) you have enough savings (or potential borrowings) to cover potential expenses, and 2) those expenses are small relative to your lifetime income. $1000 may seem like a lot, but for someone with a $100,000 annual income and $50,000 in assets, there's little point in insuring a refrigerator.
This also depends on how risk-averse you are and whether you know that your actual risk exceeds the insurance company's expectation of your risk. Would you bet on a coin flip if you'd get $120 if you won and lose $100 if you lost? If not, buy lots of insurance. Do you have an unusual risk factor, like a pet donkey who likes to kick fridges? If so, sign up. (In real life, though, that donkey kick would not be covered; that's how insurance companies screen out the high risk people.)
posted by Mr.Know-it-some at 6:54 PM on May 29, 2018
If you know for sure you'll have to pay $1000 in 10 years for a new door, it's better to save $100/year than to pay $120 in door insurance for 10 years.
The larger the potential cost and the smaller the risk, the greater the value of insurance. Homeowners and health insurance: excellent idea. Insuring a $40 toaster: not so smart.
Theoretically, you shouldn't insure if 1) you have enough savings (or potential borrowings) to cover potential expenses, and 2) those expenses are small relative to your lifetime income. $1000 may seem like a lot, but for someone with a $100,000 annual income and $50,000 in assets, there's little point in insuring a refrigerator.
This also depends on how risk-averse you are and whether you know that your actual risk exceeds the insurance company's expectation of your risk. Would you bet on a coin flip if you'd get $120 if you won and lose $100 if you lost? If not, buy lots of insurance. Do you have an unusual risk factor, like a pet donkey who likes to kick fridges? If so, sign up. (In real life, though, that donkey kick would not be covered; that's how insurance companies screen out the high risk people.)
posted by Mr.Know-it-some at 6:54 PM on May 29, 2018
I don't think of it as insurance; I think of it as budget for replacement stuff. I choose to have an Android phone, not a terribly expensive one, because I have a bring-you-own-phone carrier. No phone insurance, so it has to be in my budget to replace it.
After years of having laptops and never damaging them, I have killed 2 in one year. One was sitting in the living room when a pipe above it leaked. One fell because I wasn't as cautious as I should have been. But I try to have some leeway in my budget for stuff happening.
I budget for car, home improvement, travel; things are that pleasant but not required. I can keep my current car and increase the budget for maintenance. I can live with the current bathroom though it might be nice to update. I can travel in my state instead of taking a trip to Barcelona.
posted by theora55 at 7:09 PM on May 29, 2018
After years of having laptops and never damaging them, I have killed 2 in one year. One was sitting in the living room when a pipe above it leaked. One fell because I wasn't as cautious as I should have been. But I try to have some leeway in my budget for stuff happening.
I budget for car, home improvement, travel; things are that pleasant but not required. I can keep my current car and increase the budget for maintenance. I can live with the current bathroom though it might be nice to update. I can travel in my state instead of taking a trip to Barcelona.
posted by theora55 at 7:09 PM on May 29, 2018
You can't say you would need to set aside $500 to avoid insurance on a $500 item - what happens if that item breaks multiple times within the coverage period? $500 would not be enough. For example if you need a laptop for uni, you will keep buying new laptops as often as they break, you don't have the option of just going without one.
The most mathematically correct approach would be to assess the probability of loss for all the assets you own that aren't insured, and then figure out how much you would need to cover some percentage of outcomes using NCR permutations.
For example, say you run a data-center with 10 hard drives that cost $100 each, each hard drive has a failure rate of 1% per month (and for simplicity say that it can't fail within the month of new install) and you want to figure out what is a reasonable mount of money to hold to self insure yourself. The insurance company is charging $15 per hard drive to insure it for a year, knowing it has a 11% chance of failure over the course of a year, so that would be $150.
So you calculate the probability of number of failures within 1 year (120 individual chances of failure)
No failures (cost $0) = 30% chance
1 failure (cost $100) = 36% chance
2 failure (cost $200) = 22% chance
3 failures (cost $300) = 9% chance
4 failures (cost $400) = 3% chance
5 failures (cost $500) = 0.6% chance
6 failures (cost $600) = 0.1% chance
7 or more failures (cost $700 or more) = 0.02% chance
The "expected" cost of self insuring is around $120. The company is charging you $150, so clearly self insuring is the cheaper option.
However, how much do you need to keep in reserve? (your question)
You can see from the table - if you hold $300 in reserve, there is a 97% chance you will cover your costs for the year. If you hold $400 in reserve, there is a 99.3% chance you will cover your costs for the year.
If you don't have $300 in reserve, then you need insurance - otherwise you could have a significant chance (3%) where you will flat out not have enough money to replace the hard drives.
posted by xdvesper at 8:42 PM on May 29, 2018
The most mathematically correct approach would be to assess the probability of loss for all the assets you own that aren't insured, and then figure out how much you would need to cover some percentage of outcomes using NCR permutations.
For example, say you run a data-center with 10 hard drives that cost $100 each, each hard drive has a failure rate of 1% per month (and for simplicity say that it can't fail within the month of new install) and you want to figure out what is a reasonable mount of money to hold to self insure yourself. The insurance company is charging $15 per hard drive to insure it for a year, knowing it has a 11% chance of failure over the course of a year, so that would be $150.
So you calculate the probability of number of failures within 1 year (120 individual chances of failure)
No failures (cost $0) = 30% chance
1 failure (cost $100) = 36% chance
2 failure (cost $200) = 22% chance
3 failures (cost $300) = 9% chance
4 failures (cost $400) = 3% chance
5 failures (cost $500) = 0.6% chance
6 failures (cost $600) = 0.1% chance
7 or more failures (cost $700 or more) = 0.02% chance
The "expected" cost of self insuring is around $120. The company is charging you $150, so clearly self insuring is the cheaper option.
However, how much do you need to keep in reserve? (your question)
You can see from the table - if you hold $300 in reserve, there is a 97% chance you will cover your costs for the year. If you hold $400 in reserve, there is a 99.3% chance you will cover your costs for the year.
If you don't have $300 in reserve, then you need insurance - otherwise you could have a significant chance (3%) where you will flat out not have enough money to replace the hard drives.
posted by xdvesper at 8:42 PM on May 29, 2018
You can't say you would need to set aside $500 to avoid insurance on a $500 item - what happens if that item breaks multiple times within the coverage period? $500 would not be enough.
It's been a while since I've done this as these insurance offers are all scams, but, if I remember correctly, this kind of insurance is per item, not per time period. That is, if OP wants insurance on a replacement item to cover the next loss, he has to pay all over again. Hence, the "coverage period" for purposes of comparison is only from acquisition to replacement. A new period begins every time the item is replaced, so no multiple losses in any one "coverage period."
posted by praemunire at 9:27 PM on May 29, 2018
It's been a while since I've done this as these insurance offers are all scams, but, if I remember correctly, this kind of insurance is per item, not per time period. That is, if OP wants insurance on a replacement item to cover the next loss, he has to pay all over again. Hence, the "coverage period" for purposes of comparison is only from acquisition to replacement. A new period begins every time the item is replaced, so no multiple losses in any one "coverage period."
posted by praemunire at 9:27 PM on May 29, 2018
One easy way to insure electronic devices is to buy them using a credit card that has enhanced purchase protection. Most 'status' cards with annual fees have replacement insurance for purchases made with the card for a few years. They also frequently have warranty extensions.
Almost nobody uses these credit card features though because typically people just forget about it.
posted by srboisvert at 1:31 PM on May 30, 2018
Almost nobody uses these credit card features though because typically people just forget about it.
posted by srboisvert at 1:31 PM on May 30, 2018
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Self-insurance is a tricky concept because the whole idea of insurance is to spread risk over a pool. An insurer would know the risk over the whole pool of a claim having to be paid and would basically charge the risk times the pool value plus its margin (it's trickier than that, but that captures the general idea). You, on the other hand, can't spread the risk, because you're a pool of one. If you were to put away the premium a non-scammer insurer would charge you (i.e., not Best Buy), or even considerably more, it wouldn't do much to protect you in the event of an early loss, since the point is to be able to replace the item without additional cost. Really, you would need to have the entire value of the item saved (and then the cost to you is having it in liquid funds instead of less secure savings). Your other plan is a reasonable approach, but it's just saving in advance for a replacement, not really insurance.
posted by praemunire at 3:00 PM on May 29, 2018 [1 favorite]