EP10 - Credit & Insurance

How credit and insurance use quant models. Learn about credit scoring, probability of default, insurance as options, telematics, and how your risk is priced using math.

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It's a scam! A total scam!

What is? The electric bill?

My Car Insurance! They raised my rate by 20%! I didn't even crash!

They said "Algorithm Adjustment based on Credit Profile."

What does my Credit Score have to do with my driving?!

Insurance and Credit are boring, bureaucratic scams designed to milk normal people!

Boring?

Shez, Insurance is the oldest **Quant Trading** market in history.

And Credit? That's just **Bond Trading**.

What are you talking about? I'm just a person. I haven't registered for my own CUSIP number and you can't buy any shares of me.

But to an insurance and credit card company, you already a **Ticker Symbol** they've been trading for years.

And right now, your volatility has been trending up.

**SHEZ (Ticker: SHZ):** Price $500. Yield 15%. Risk: HIGH.

**KURUMI (Ticker: KRU):** Price $1000. Yield 3%. Risk: LOW.

When a bank gives you a credit card, they are **Buying a Bond**. They lend you money (Principal). You pay them coupons (Interest).

Okay, that makes sense. It's a loan.

But unlike a US Treasury Bond, you might **Default**. You might run away.

Your "Credit Score" (650) isn't a grade.

It's a **Probability of Default (PD)**.

**Probability** (Will she bail?) × **Exposure** (How much did she spend?) × **Loss** (Can we repossess her Xbox?).

So... the Interest Rate is just the Risk Premium?

Yes. **Risk-Based Pricing**.

If you are a risky asset (High PD), I need a higher yield (25% APR) to compensate for the chance that you go to zero.

That sounds cold.

It's efficient. Without this math, banks wouldn't lend to strangers. They'd only lend to friends. The algorithm allows trust to scale globally.

Okay, fine. Credit is a Bond.

But Insurance? I pay them to protect me! That's a service!

No. You are buying a **Put Option** on yourself.

You own the Asset (Car). Value: $30,000.

You are afraid the value will drop to $0 (Crash).

I (The Insurer) sell you a Put Option.

"If value drops to zero, I will buy the wreck for $30,000."

And the cost of the option is the Premium?

Exactly. And how do we price an option?

...Black-Scholes? **Volatility**?

**YOU** are the Volatility.

If you drive fast, brake hard, and text while driving... your **Implied Volatility (IV)** is 100%.

High Volatility = Expensive Option.

So they raised my rate because they think I'm volatile?

But I haven't crashed!

You haven't crashed *yet*. But your **Cluster** has.

My cluster?

**Statistical Correlation**. People with lower credit scores tend to take more risks in life. Including driving.

The model groups you with them. It's **Guilt by Association**.

That's profiling! That's unfair! I'm a good driver!

The model doesn't know *you*. It only knows your *Features*.

Unless... you give it better data.

**Telematics**.

The spy dongle?

Without this, the Insurer is guessing based on your age and zip code. Low resolution.

With this, they have **Tick Data**. They can measure your actual volatility in real-time.

So if I drive like a grandma, the algorithm sees it?

Yes. You move from the "High Risk" cluster to the "Low Risk" cluster.

You replace **Correlation** (Zip Code) with **Causation** (Actual Driving).

It's creepy, it's like I'm being stalked.

It makes your insurance **Cheaper** and **Fairer**.

True Quants hate "Pooling." We hate subsidizing bad drivers.

We want **Individualized Pricing**.

So Actuaries... the insurance math guys...

Were the original Quants. They were doing Data Science in the 1700s with mortality tables.

Wall Street just copied their homework and applied it to stocks.

Look at this. "Probability of Death for Female, Age 25."

They have calculated the exact odds of your death. To the decimal point.

Stop. Stop. I haven't made plans for death yet.

It's **Reality**. Life is a terminal illness with a variable timeframe. Insurance is just a hedge against the timing risk.

I feel like I'm walking around with a price tag on my head.

You are. We all are.

Every time you swipe a card, you are shorting a bond.

Every time you drive, you are exercising an option.

You are a **Proprietary Trader** of your own life.

So if I want to lower my premium...

Lower your Volatility.

Improve your Credit Score (Lower Default Risk). Drive smoothly (Lower Physical Risk).

I need a better **Sharpe Ratio** for my existence.

Quant isn't just about stocks. It's about quantifying the uncertainty of the human condition.

Wait... if I'm an asset class, someone could be doing insider trading on me?

Yes. I could break your fingers and legs on purpose then file an insurance claim. That is **insurance fraud**.

DON'T!