Risk is all around us and, as articulated “10 Ways We Get the Odds Wrong,” our common misperceptions of risk often get in the way of making good decisions.
Risk is the foundation of our decisions about insurance. We buy insurance to protect us from the financial impact of the unknown (and sometimes, as in the anomalous case of health insurance, the known). The intersection of two factors – our risk literacy and our risk tolerance – largely influences our decisions about whether and how much insurance to purchase to cover our potential financial exposure to any given risk or set of risks.
Risk literacy refers to our ability (or inability, as is so often the case), to understand our real risks. (Check out Gerd Gigerenzer’s short TED talk on risk literacy for a good summary of the pitfalls of risk illiteracy.)
Examples of our inability to assess our risks abound. We tend not to worry about risks caused by bad habits built up over time (those french fries at lunch every day, perhaps), but instead fear the very rare disease that our friend was just diagnosed with, and so on.
And even if we are good at statistics and do have a good understanding of our probability for bad events, we each have a different level of tolerance for different types of risks. I happen to have a very low risk tolerance – or a high risk aversion – for many types of risks. My husband, on the other hand, tends to be at the other end of the scale …for the very same risks. We both understand that the risks have the same probability of occurring, but we have completely different comfort (or discomfort!) levels with respect to them. When we want to save money on insurance, guess who makes the decisions?!
Risk literacy and personal risk tolerance are deeply interrelated. For example, my relatively solid understanding of health risk data might actually help increase my risk tolerance when it comes to buying health insurance, but I may also be unduly influenced by the salience of several friends battling cancer. And even if I do correctly understand my risks, my low tolerance for risk may lead me to insure a little more than is strictly warranted by my risks, just for peace of mind.
As Gigerenzer points out, we can – and should – become more risk literate. That’s a piece of the equation we in the industry can influence. Getting better risk data to consumers in a way they can understand it, only helps them make better, more informed decisions about insurance. Personal risk tolerance aside, if we can help consumers better understand their individual risks, we should be able to help them make their insurance decisions based more on what is probable than what is possible.