Earthquake Insurance
My earthquake insurance policy is due for renewal. It was purchased via Policy Genius a little over a year before; it is for our Tucson home. As I looked at the premiums, I was tempted to not renew the policy. Tucson hasn’t had an earthquake since at least 1931.
After finding data suggesting that, even though there haven’t been any earthquakes, the likelihood of one with a greater magnitude than five in the next 50-years is near 20%, I changed my opinion. When I compare the annual cost of the policy, it is less than 0.05% of the value of my home.
We don’t have any earthquake insurance for our cabin in Idaho. There’s 73% of a chance that an earthquake will be greater than 5.0 on the Idaho coast in the next fifty years. But I rationalized my decision with “Well, this is just a small cabin”.
Our house in Tucson is built from adobe. It’s mostly a log-cabin; it appears to be more stable. And the majority of value, or even more value of that property, is the land and not the structure. I should probably also get insurance for the cabin in Idaho.
It is easy to assume that there won’t be an earthquake in Tucson because there hasn’t been one since 1931. I therefore shouldn’t buy earthquake insurance. This is a classic example of survivorship prejudice.
Survivorship Bias
The survival bias is a tendency to focus only on the successful to draw conclusions. It ignores the failures and focuses on the successes.
During World War II, the US military decided to add armor to areas of damage on aircraft returning to their bases. Abraham Wald, Columbia University professor, said this was a wrong conclusion. It is better to add more armor in the areas which were not hit as the planes didn’t return when they hit them.
The long-term performance of US mutual funds is another example of survivorship biased. In many cases, this long-term average does not include funds that were closed because they underperformed or failed and so they had to be shut down.
This week I came across another example of survivorship in an academic article. The performance of the US Stock Market relative to other countries may be an example survivorship bias. The title of the paper is “Is America a lucky survivor?”
The authors of this paper created a database that includes returns for 55 countries from 1920 to 2020. In 1920, the stock markets of most countries were not developed. Even the US had a very developed stock market. As a result, it was difficult to tell which country would perform best over the next century.