Pascal's Wager and the Making of Prudent Decisions: Insurance

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Pascal's Wager and the Making of Prudent Decisions: Insurance

Larry Swedroe Aug 26, 2015

To Buy or Not to Buy Life Insurance

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 Insurance

The Impact of Adding Long-Term Care Insurance

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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