Hot Take: Insurance is Overpriced

I’ve been getting more organized this year by converting incomplete drafts into finished blog posts. Given the stock market crash Q1 of this year, here is a timely piece from October 2019.

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In any industry, insurance is overpriced. How do we know? Because insurance is known as a great business to be in (ask Warren Buffett). Whether or not they realize it, people have difficulty pricing the value of protecting against huge loss. As a result, they tend to overpay. Insurance gets dismissed as just another bill to pay.

With regard to cars, houses, and medical (until recently), insurance is a legal requirement. Such demand probably maintains or drives the price of insurance higher.

What if people were required to buy insurance for their stock investments? Some believe put insurance to be chronically overpriced. If people had to buy then the IV would presumably be even higher, which would be edge to the sellers. Why isn’t this the case? Only people with dispensable income (savings to invest) get involved in the stock market in the first place. This amounts to a relatively small proportion of people compared to the proportion of those with cars, homes, or medical needs.

I assume that the “smart money” such as pension funds, hedge funds, and institutional fund owners are those who predominantly buy put protection to keep the IV inflated. What a boon to business it would be if it ever came to pass that everyone had to buy!

Maybe it’s not such a bad idea to be like the “smart money” and buy the protection anyway.

Some strongly argue for this NOT to be the case. And if you have the extra money to lose, which synthetically takes the form of trading small, having lots of cash on the sidelines, and/or being relatively deleveraged, then it’s probably best not to buy the insurance at all and collect interest on those payments rather than seeing them go down the drain in the first place.