Thursday, April 2, 2015

The expected value of losing a key

Late model cars these days come with a keyless fob that is really an active communicator with not only the door but also the ignition. Get close to the car and the doors unlock. Get close to the ignition and you can either start the car from the fob or from a button on the dash panel.

All swell stuff.

Until you get to price v value, and the expected value of  losing the key. Fobs like this can set you back $300 to $400, and some are more. One might ask--I certainly do--"can I opt out if I don't find that value exceeds price?" Answer, of course, is no. If you want the car, you have to pay for someone else's value.

Is that Agile? I'm the customer and I can't influence directly price and value

Now comes the expected value of the loss. I've had key fobs of one kind or another for 20 years; I've never lost one, but others in my family have lost one or two over the years. Thus, in my situation there have been two incidents; but how many opportunities?

Incidents/opportunities is the likelihood of the risk. 20 years is about 7000 days, and certainly the car is driven almost every day, and on the days it is driven, there are multiple stops where the key is taken out of the ignition and temporarily stored. But, let's make it simple:

Probability of losing a fob: 2 / 7000, a vanishingly small number.
Expected value: $400 * 2 / 7000; essentially $0 for all practical purposes.

Now comes transferring the risk of the loss to someone else. As project managers accustomed to the risk register concept, we would think of transferring the expected value out of our domain and into someone else's. Of course, in this case, in theory anyway, there is no practical expected value to transfer

Nonetheless, an industry has sprung up to insure fobs. With such small probability, and such an affordable loss even if it happens, you would think the industry would charge a very low premium in line with its likely losses, and a low premium to attract people away from self-insuring the loss.

But no, one offer I recently ran across was for nearly $300 to insure a $400 key! Is that company making money?

Hello! Either I am the exception and most people lose their fob so the premium has to be high, or this insurance plan is a gold mine for the underwriter: cost is almost $0; price is $300. The price all but drops to the bottom line!

Price in excess of expected value is what drives the insurance industry. Does it drive your risk register?

My rule: don't buy insurance for a loss you can afford, and if you do consider insurance, consider the expected value only.

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