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The couple knows that the odds of either one of them dying in the near future are probably less than 100:1. Thus, they know that if they purchase life insurance, the great likelihood is that they’ll be transferring assets from their pockets into the pockets of the insurance company. What should they do?
Pascal provides the answer: the consequences of leaving a spouse and child with insufficient assets to provide the desired quality of life are unthinkable. Thus, even though the odds seem to suggest that the couple shouldn’t purchase insurance, the prudent decision is to do so.
Again, per the argument in Pascal’s Wager, we see that the consequences of our decisions should dominate the probability of outcomes. A similar example relates to long-term care insurance.
|Long-Term Care Scenarios||Odds the Portfolio Will Have Sufficient Assets (%)|
|No long-term care insurance, no need for care:||94|
|Have long-term care insurance, no need for care:||91|
|Have long-term care insurance coverage for 20 years, need care for 5 years from age 85-90:||83|
|No long-term care insurance, need care from age 85-90:||74|
On the other hand, if long-term care is needed, and no insurance is purchased, the odds of running out of money increase by 20 percentage points. The odds of success fall from 94% to 74%. That’s almost seven times the 3 percentage point increase in likelihood of failure caused by the purchase of insurance. It seems clear that the purchase of the insurance is the prudent decision.
The same lesson also applies to decisions to buy other types of insurance, be it disability, flood, earthquake, or personal liability (specifically umbrella policies, which are relatively inexpensive).
Next week, we’ll look a few more examples in which Pascal’s Wager can be applied to financial decisions.
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Money Market Funds