“When you say ROI, do you mean return on investment or risk of inaction?”

-Paul Gillin

How an individual views risk is a fascinating topic because the framing of the risk itself can lead you to make very different decisions.

The first time I came across this idea was in an Alberta edition of IMPACT magazine (fitness, performance, and sports) over 10 years ago. There was an ultra-marathon writer who wrote an opinion piece on the risks of running. He was frustrated with being told that long distance running was risky because it increases your chances of injury. It’s an argument that we’ve all heard, and it is used to justify taking the safe bet and not pushing the physical limits of our bodies. But his argument was that he heard this most often from non-runners who were also for the most part inactive. He said although he knows he’s at increased risk of injury, these people were heading towards a high chance of cardiovascular disease as they aged and THIS risk was unacceptable to him.

This same re-framing can be approached at the employment level. Are you accepting a larger risk by specializing in one service with one employer for 100% of your income, or starting your own business/consulting practice that serve many different clients? Alan Moore, co-founder of XYPN, discusses the shift he made in viewing employment risk when he realized that his backup plan was to get a regular job if his business failed, something that is usually viewed as Plan A. Even Elon Musk said he lived off of hot dogs and oranges for a month to come up with his baseline of $30/month income needed to feed himself and live on his friends sofa, to give himself confidence that he could earn that income doing anything before deciding to start businesses to solve what he considers humanity’s most pressing issues.

Even our purchases reflect risk in our decision making. Does buying an SUV with 4 wheel drive reduce driving risk as much as a single defensive driving course and winter tires? Absolutely not, but that’s not what we tell ourselves when we purchase a $60k vehicle.

The point that I’m trying to make here is not that we should all partake in extreme physical activities, start businesses, or avoid buying SUVs. It’s that we need to question whether a perceived risk is actually real or if it’s being used to justify our emotional decisions. If it’s the latter, avoiding this risk can cause another offsetting risk that we didn’t anticipate.

Risk is inherent in life, and creating avoidance behavior doesn’t actually protect us. It’s part of why playground equipment design is going back to a “risky-play” model, because protecting our young children from all slips and falls doesn’t allow them to develop skills required to make appropriate judgement calls.

Risk as it relates to investments and insurance is something we should all give some thought to as we work through our finances. I dislike the type of risk investment question that asks “Can you handle a 30% drop in your investments?”. I hate this question, because no one wants to lose money that they’ve invested for the future. Unless the subsequent conversation deals with the risk of inflation over time and under performance of conservative investments, then people might not really understand the choice between the two risks and tailor their investments to match their psychology.  

Insurance risk is another hot-topic for me. Mostly because otherwise rational individuals become a confused bundle of emotions and fears when they select products. So we end up with people on either end of a spectrum; massively under-insured because they don’t know any better or massively over-insured because they allowed their emotions to get the best of them.

Several years ago I distributed a simple spreadsheet around my workplace to help people calculate the appropriate level of dental benefits to buy into, and what amount they should keep in a health spending account to tax shelter the out of pocket difference. What resulted was a steady stream of traffic in my office where person after person realized that they had been paying $3000/yr for premiums that gave them a $2000/yr benefit. They would have been better pocketing the money (or better yet investing it!) and paying for dental visits directly. It’s not that dental or supplementary health insurance is a bad idea, but no one checked the value or even asked what that alternative was. Fortunately being an engineer gave me credibility to be able to navigate excel and basic math, but there was a lot of disbelief in the results at first.

It then occurred to me that some of my co-workers who were completely competent handling multi-million dollar budgets, risk analysis, and economics at work – didn’t apply any of this to their personal lives. They were managing health risks emotionally and unquestioningly and were losing out on the ability to put themselves into a more secure financial position as a result.

Personally, I have always opted out of these supplementary programs and have slept great at night because I “what if” myself to death (and I live in Canada – universal healthcare :)). It’s the same reason I have a reasonably high deductible on my house insurance that is appropriate to my means and risk tolerance.

I have long suspected that my risk tolerance to insurance products isn’t appropriate for many people. It wasn’t until I embraced the intersection of my two career paths that an obvious solution came to me.

What engineers do really well is learn to assess process risk in a consistent, methodical manner. It’s incredibly important that you don’t end up with dramatically different designs based on the individuals sitting in the room. This process is called a PHA – Process Hazard Assessment and is probably the least interesting 80 hours that you will never get back.

When I discuss insurance with people, I use the PHA framework to take my personal views and their personal fears out of the picture. It goes a little something like this:

Hazard – You die

Cause – Car accident, heart attack

Consequence (no safeguards in place) – Family slowly starves to death

Likelihood – Medium

Severity – High

Risk Ranking – High

Safeguards – Wealthy extended family, existing net worth, job skills and income of spouse

Risk Ranking (after safeguards) – Medium

Actions – Purchase life insurance for difference between FI # and current net worth

Risk Ranking (after actions implemented) – Low

You run through a standard list of hazards that may include: death, disability, job loss, health crises. Then you list all of the causes that could result in the hazard. Each cause is evaluated as a separate line item because its probability changes depending on your personal situation.

It comes with a risk assessment matrix that spits out the Risk Ranking depending upon the Severity of Consequence and Likelihood of the event actually happening. The beauty of it is that it still allows for flexibility based on individuals risk tolerance and it provides a documented risk analysis of your personal insurance needs. It should be revisited every 5 years to update your current networth progress and current health and circumstantial conditions.

There is however one rule that needs to be adhered to, and that is that you can’t assume independent concurrent failures (hazards). That puts you into what is called a “double jeopardy” situation and it’s impossible to manage for this risk in any economically viable way. Double jeopardy is sneaky though, and will creep in if you let it. For example, you could potentially say that the death of a spouse will cause a severe mental break in the other spouse who will then never be able to go back to work. Or that your child gets cancer at the same time that you lose your job. Your safeguards start unravelling at this point and you need to be fully insured for everything all of the time at a cost that you likely can’t afford.

Once people start adding double and triple jeopardy failure situations into their insurance, you know they’re about to head on an irrational tangent. At this point, we might as well all stock up on canned goods and befriend our local veterinarians and mechanics, because shit will hit the fan during the zombie apocalypse and money won’t help you at all by then. Ahem, I digress…

Where I’m going is that risk should be managed in our lives, not avoided at all costs. It also goes to follow that attempting to manage risk has its own tradeoffs that need to be considered carefully. Once you have a rationally analyzed your risks and options, then you are in a much better position to seek out insurance products and know whether the advice you’re receiving is appropriate for you.


Note: Bonus points to anyone who gets the connection between Dyson Spheres and risk aversion 🙂