oblomov

I agree. Pace Nassim Taleb, this is where the Fat Tonys of the world take the Dr Johns to the cleaners.

Dr. John (he of the bag lunch and the actuarial degree) says "well, the reporter says that Seo actually planned on using the proceeds from one policy to purchase additional insurance on the other factory. So this must be the scenario, and we should take that as a given." Well, as I wrote above, even with that assumption, the article's math is still wrong.

Fat Tony (of the Brooklyn accent and custom suits) says "This Seo guy isn't covered nearly as much as he thinks he is. If the two earthquakes happen on the same day, he's screwed. Heck, they'd better not happen less than a month apart ... have you seen how long it takes an insurance company to get a policy written up? If he thinks he's gonna have that second policy the next day after the first earthquake, he's dreaming." And he's right. The reporter has misrepresented the solution in some fundamental way -- either it didn't play out like this, or it's purely a hypothetical deal.

So which error is more egregious? I dunno; both aspects of this article bothered me when I read it. Not only does the reporter almost certainly misrepresent the terms of the deal, but he doesn't even get the math right on the terms he presented.

You are missing something, but so is the article. Not only is the conclusion misleading as stated, but the math is incorrect as well.

Here's where the conclusion is unclear : it says "The cost ... was a mere $400,000." However, according to the article's math, that's the cost -per factory-. The policy for the entire company would cost $800,000.

However, that's not quite right either. In order to return $10M total, you'd only have to buy about $334,000 of insurance on each factory (I'm rounding the numbers for convenience). Since the example operates under the assumption that you can always use the proceeds from one policy to pay for the other -- ie, there's never a perfectly simultaneous event at both locations -- I'll take that as a given.

Let's say that Factory A gets hit first (California or Japan, it doesn't matter). We collect our insurance payment of $1,670,000 ($334,000 5) and spend the total amount on additional insurance for Factory B. When Factory B gets hit, we receive $8,350,000 ($1,670,000 5) from that supplementary purchase. So where does the missing $1,650,000 come from? Remember that we couldn't know which factory would be hit first, so we initially bought $334,000 policies on -both- factories ... and that policy is still in effect on Factory B. It returns $1,670,000, which brings our total to just over the $10M target (remember, I'm rounding for clarity). So the total that we need to spend on insurance is ($334,000 * 2 =) $668,000 per year.