What We’re Talking About When We Talk About Risk

Jonathan Crystal
Jonathan Crystal
CFO, Crystal & Company

Why is it so challenging to talk to our clients about the cost-benefit of various insurance and risk transfer decisions? I came across an info-graphic recently that explains a lot about the difficulties people have in making insurance decisions. The graph illustrates perceptions of probability, and suggests that the problem we have has to do with the level of precision we use in language.

Consider that three phrases on the info-graphic intended to communicate extremely low probability (“almost no chance”, “highly unlikely,” and “chances are slight”) are perceived by the majority of people as representing a 1-in-5 chance (20% or greater) of actually occurring. Likewise, three phrases intended to communicate extremely high probability (“very good chance”, “highly likely,” and “almost certainly”) are perceived by most as representing no better than a 4-in-5 chance (80% or less).

When people consider “very unlikely” to be something that won’t happen 95% of the time, how are we supposed to talk about events that won’t happen 99.99% of the time?
And that’s often the case when we are talking about matters of insurance. A policy that costs $1,000 per year in premium for $1,000,000 in coverage costs 10 basis points of the limit (0.01% = 1 basis point). For that rate to be sustainable, a total loss cannot happen 99.9% of the time.
This explains what we hear all the time in regards to certain claim scenarios. Regardless of whether it’s a liability or property issue, the attitude is the same: “That’s impossible” or “That’s never happened” or “I can’t see that ever happening.” So while premium rates reflect an extremely low level of improbability, too many people still can’t imagine a situation in which they’ll need to make a claim. 

This aspect of innumeracy is not surprising to behavioral economists, who study the systematic hiccups in human decision-making. Our brains evolved to make probability assessments that are much simpler and more intuitive than the ones we’re asked to make in modern life. As a result, we often rely on various “heuristics,” or shortcuts, that make choosing easier (if not more efficient or wise). 
Bottom Line: When language fails us, maybe pictures can do the job.

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