Max Scherzer and the Incentives to Self Insure

Over the winter, Max Scherzer turned down an offer from the Tigers that would have paid him $144 million over six years, and instead, decided to play out his final season in Detroit and then see kind of offers he will get as a free agent. Given pitcher attrition rates, Scherzer was certainly taking on a significant risk to pass up that kind of contract. Jeff Zimmerman’s research pegged Scherzer as having a 31% chance of landing on the disabled list at some point in 2014, and a significant injury likely would have forced Scherzer to forego pursuing any kind of long-term deal this winter. By turning down the offer, Scherzer appeared to have made a big bet on himself and his future health.

However, as Scherzer noted to Tom Verducci over the weekend, he actually hasn’t taken on nearly as much risk as we might have thought. Instead, he sold the risk to an insurance company for what was presumably a better rate than the one the Tigers offered. And I fully expect this to become a trend, with third-party insurance agencies stepping in to correct a market imbalance in Major League Baseball.

As I noted back in February, the outcomes on recent long-term extensions have skewed very heavily in the favor of Major League teams. There have been a handful of pre-free agent contracts where the player made out better than they would have had they not signed the deal, but most of the time, the players have ended up leaving money on the table. And often, quite a lot of it.

The argument in favor of these deals — and one that is trotted out every single time a player signs a team-friendly extension — is that the marginal utility of the first few million to a player dwarf the utility of all subsequent millions. By guaranteeing themselves $10 or $15 or $20 million in future income, the player no longer has to worry about finding a post-baseball career, and can live comfortably without fear of an injury or other factor derailing their career before they get to arbitration or free agency. This argument has merit, as the value of a dollar certainly has some diminishing returns once you get into the kinds of paychecks that Major League players make. The hundredth million isn’t worth the same as the first million.

But that argument fails to capture the nuances of the risk/return market, and ignores the fact that MLB teams themselves are not the only party willing to buy risk. The options for a player are simply not limited to taking a long-term deal from an MLB team or personally carrying all of their own risk until free agency. And as long as Major League teams are making offers to players that put too low of a price on the risk that the player is buying, players like Scherzer are going to be incentivized to look for secondary risk-purchasing markets. And that’s what insurance companies specialize in.

We might not think of it in these terms, but each of us sell personal risk to insurance companies every year. Auto insurance is required by law, but odds are, you probably have more than the minimum coverage on your vehicle, so you have willingly sold some of your risk of getting into a car accident for some percentage of your monthly income. The same is true with homeowner’s or rental insurance, health insurance, life insurance, and even pet insurance. As human beings, we generally have a desire for stability over the unknown, and we’re willing to trade some of our income to hedge against disaster events.

Large corporations fill the market with products that essentially transfer risk from an individual to an investor, and these companies are very good at pricing risk so that the aggregate of their premiums collected return a higher rate than the policy claims they pay out. From an investor perspective, there is little practical difference to selling someone insurance versus buying stock in a company or a fund; they are essentially looking for a return on their investment that outpaces market averages or brings a lower rate of risk for that same level of return. There are billions of dollars being invested every day, and everyone is after the same goal; the best possible return for a given level of risk.

Of late, Major League teams have been buying the risk of future injury or performance decline at severely discounted rates, and that kind of market inefficiency begs for competition. The prices that players have been selling their risk for have to look very appealing for risk-seeking investors, and third-party insurance companies are drawn to any market where risk and reward are not in balance.

Since Scherzer is the most recent player to publicly note that he self-insured, let’s look at how the risk-pricing calculations might work. Let’s create an outcome probability matrix based on Scherzer’s profile.

Outcome Occurance Percentage Expected Future Contract
Stays healthy, performs better than 2013 15% $200,000,000
Stays healthy, performs same as 2013 20% $190,000,000
Stays healthy, performs worse than 2013 25% $160,000,000
Stays healthy, performs much worse than 2013 10% $100,000,000
Minor Injury, performs well when healthy 10% $150,000,000
Minor injury, doesn’t perform as well 10% $80,000,000
Major injury, value tanks 10% $30,000,000
Weighted Average 100% $144,000,000

Since this is more of an object lesson than a break-down of what Scherzer should sell his risk for, these numbers are made-up, but I think they have some basis in reality. And, not coincidentally, the weighted average comes out to $144 million, the amount that Scherzer turned down from the Tigers; these are the kinds of outcomes you can get when you make up the numbers. We could say that perhaps the Tigers calculations looked something like this, even if they didn’t lay it out exactly this way.

This matrix gives Scherzer a 70% chance of staying healthy all season — with various outcomes relative to his 2013 performance within that range — and then a 30% chance of getting injured, with different levels of injuries and performances requiring differently sized discounts. I set his base level pay in the worst case scenario outcome at $30 million, as even if Scherzer’s elbow exploded tomorrow, there’d still be a long line of teams lining up to pay for his rehab as long as they got a few discounted years after he got back from surgery. Short of death, Scherzer isn’t really at any risk of not getting paid some significant amount of money this winter. The only question is how much he’s going to get paid.

So let’s say that Scherzer wanted to sell the risk of the negative outcomes occurring, guaranteeing himself a minimum payout of $100 million, with the insurance company agreeing to make up the difference between the $100 million and the amount he is guaranteed in his next deal. Based on this matrix, there’s a 10 percent chance that the insurance company would have to pay him $70 million, a 10% chance that the company would have to pay him $20 million, and an 80% chance that they wouldn’t have to pay anything. Thus, a $100 million guarantee would be a break-even proposition for the insurance company with a $9 million premium.

Of course, there’s no incentive for the insurance company to just break-even, as they’d need a significant return on their money in order to invest in Max Scherzer instead of just parking their money the market. At a 15% return on their money, they’d ask for $10.35 million. So, using our totally made up numbers, Scherzer could agree to pay just over $10 million out of the total value of his next contract and have no risk of earning less than $100 million. The policy would reduce his top-ending potential from $200 million down to $190 million, but as everyone always argues, what’s the practical difference between $190 and $200 million anyway? This way, Scherzer gets to test free agency, pick where he wants to spend the rest of his career, and have no concern that an injury is going to cost him the monstrous payout he’s in line for.

Obviously, the risk profile and future expected dollars are going to be different for every player, but policies like this are almost certainly cheaper than taking the kinds of long-term deals that MLB teams have been offering of late. Players who have not yet made enough money to support their family for the rest of their lives should be incentivized to sell a portion of their risk, but the prices MLB teams have been putting on that risk simply doesn’t reflect a balance between risk and return. MLB teams aren’t the only ones with money who want to buy risk. Until teams start making offers that are more aligned with the actual risks the players are selling, there’s going to be a market for third-party insurance companies to step in and take advantage of the inefficiency.

The market for buying and selling risk is very well established, and the prices that outside parties will pay to relieve a player of his risk-burden are likely much cheaper than the discounts MLB teams have been offering players in order to sign long-term contracts. A long-term deal with a team can come with some ancillary benefits beyond just guaranteed money — no-trade clauses being a big one — but the primary reason players have been taking these deals is to rid themselves of disaster risk. But you don’t have to sell six, seven, or eight years of future incomes at discounted prices to divest yourself of disaster risk, and neither should Major League players. If the teams themselves aren’t going to offer competitive prices for the risk carried by a player, then perhaps third-party insurance companies will correct the market for them.




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Dave is a co-founder of USSMariner.com and contributes to the Wall Street Journal.

71 Responses to “Max Scherzer and the Incentives to Self Insure”

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  1. Professor Ross Eforp says:

    I’m unclear how the minimum he ever makes is $30MM. I think that is probably pretty reasonable if he continues to be a major league baseball pitcher. There is a non-zero chance that he does not continue to be one, though.

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    • Dave Cameron says:

      Teams pay for rehabbing upside-starters all the time. Josh Johnson got $8 million from the Padres last winter. Ben Sheets and Rich Harden have each gotten $10 million deals on the hopes that they would finally stay healthy. Scherzer doesn’t have the injury track record that any of those guys do, and pretty much any non-fatal injury would be rehabbable.

      Even if he needs Tommy John surgery, you’re looking at a likely 2016 return. Would a team pay him $10 million to rehab next year in order to get two additional years at $10 million apiece, assuming he’ll get back to something close to Max Scherzer levels in those years? Absolutely.

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      • BenS says:

        While the chance of death or a non-rehabable injury (limb amputated) shouldn’t be higher than any other healthy adult man his age shouldn’t it be factored in to the calculation? Also discussing insurance can be kind of morbid.

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        • Dave Cameron says:

          If Max Scherzer dies, it doesn’t really matter whether he was signed to a $5 million contract or a $250 million contract; the entire deal goes away regardless. At that point, the only thing that matters is the size of the life insurance policy he’s taken out on himself.

          In terms of something like losing a limb, it’s almost certainly the same, but depends on how it happens. If he’s cutting down trees with a chainsaw and cuts off his own arm, he’s SOL. If he gets decapitated by Manny Machado’s flying bat, well, maybe he has a case for continuing to get paid. I’ll probably wait for a pitcher to actually lose a limb on the field before factoring that into the calculation, though.

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        • Alec says:

          There is almost no situation where Scherzer doesn’t make ~$30mm without dying. Brandon McCarthy was already injury prone, then nearly died from a baseball related injury and STILL got new contracts. While they weren’t for $30mm, he also was nowhere near the player Scherzer is. Erik Bedard makes millions every year simply on the off chance that he’s healthy enough to win a few games (anything beyond 3-5 starts consecutively with him has to be considered a bonus). Unless he retired, he could get contracts for at least 3 years.

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        • Alec says:

          To emphasize – if Max Scherzer tore his labrum tomorrow, do you think Billy Beane wouldn’t be willing to offer him something like $20mm over 3-4 years with per start bonuses? I sure as hell would want the Mariners to offer him something like $50mm over 5 years.

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        • Nathaniel Dawson says:

          Dave, how much would Dave Dravecky have had to pay to have his risk bought away?

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      • tz says:

        For purposes of estimating the insurance premium, this is absolutely correct.

        If we were being theoretically precise, of course, there would be a non-zero chance of a truly career-ending injury. But for rate-setting, this scenario would fall under the broader bucket of the “value tanks” scenario, where the average contract value falls around $30M.

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      • Simon says:

        Shoulders break too, although I suspect that the $30 million is a decent weighted average, given the chances of signing an additional longish term contract later on if he did suffer a TJ-style injury. He could get another $40-50 million in 2016 under that scenario, assuming he was healthy.

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  2. Thufir says:

    Great post

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  3. tz says:

    I think you’ve nailed the argument for a market for third-party insurance for contract values for pro athletes. Based on what I know about insurance, some details would probably be a bit different:

    1. The rate of return that an insurer would want for this coverage would probably be a good bit higher than 15% (say 30-40%) because of the volatility of the risk they’re taking on, as well as the high chance of estimation error in setting the price (they’d probably use an analysis very similar to your chart for a young market like this)

    2. Because Scherzer would be locking in the $100 million value, there would now be a “morale hazard” that he’d be less careful in preserving his ability to get the big contract. To control the risk of morale hazard, the insurer could add policy exclusions and/or pay less than 100% of the “lost” contract value (say 80%).

    3. The market will probably rely heavily on “hands-on” agents like Boras who would talk sense to their clients about the risk/reward tradeoff. Without this, I’m sure many players would downplay the risk to their future earnings, or even rationalize that the worst-case scenario is truly the “value tanks” scenario above (in reality of course, it would be “career-ending injury”)

    4. If we assume that owners begin to “pay” players for their risk through a lower discount rate, then (ironically) it may actually increase the demand for insurance like the above example. This comes from the larger amount of future earnings that would be at risk under the worst scenarios.

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    • Word police says:

      These are good points, but I think you unwittingly coined a great new term. I suppose a “morale hazard” is the risk that a player won’t have the enthusiasm to do the work to maintain high performance. That hazard was particularly high with Jesus Montero.

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    • Tucker says:

      I work for an agency in another sport where these policies are becoming more common as well. You are right on the money with the “markup” being more in the 30-40% range. Also, the policies usually must be paid in advance, there is no option to pay it out of your next contract. This fact alone makes these policies a hard pill to swallow for anyone not virtually set up for $100M+ payday, which is why I think they will not become more prevalent among pre-arb players unless the insurance companies adjust.

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    • Burly says:

      I think the “moral hazard” for a player like Scherzer, who turned down a $144M guarantee for the opportunity to make $200M, is essentially nil.

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  4. Jon Bon Jovi says:

    I think you implied that hypothetical Scherzer would agree to pay $10+ mil from his next contract. Wouldn’t the premium have to be paid before the 2014 season? So wouldn’t he be out an initial 10 million for the insurance policy before signing his next deal?

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    • tz says:

      Yes. Dave acknowledged that point where the $200M best-case scenario is now reduced to a net $190M. Insurance will reduce the best case scenarios by the cost of the premium, in exchange for improving the outcomes of the worst-case scenarios.

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    • Dave Cameron says:

      There’s no reason the premium would have to be prepaid. The player and insurance company could setup any kind of payment plan they wanted.

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      • Alec says:

        Exactly. The insurers would likely be fine with a plan that either pays them out of his next contract (likely a minimum dollar figure or %, giving them some upside in exchange for delaying their payment) or by reducing his payout by an agreed upon amount. That way, they’d give themselves upside, cost certainty, and the option to offer a reduced fee in exchange for an upfront payment should Scherzer prefer that.

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        • tz says:

          And with the premium being such a huge % of the current (lower) salary, they’d almost have to set it up that way.

          So in Dave’s example, every dollar from $100M to $100M+X (X being the premium) would go to the insurer once the contract terms are known.

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    • Anon21 says:

      Payment terms are always open to negotiation in a high-value situation like this one. He probably had to pay something up front, but the insurance company was probably happy to take a cut from his next contract as their primary form of payment.

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  5. Matthew says:

    Very good article, thanks! I do have a point/question, though.

    You essentially argue that teams are discounting players’ level of risk too much and that players should instead be self-insuring rather than accepting these steap discounts from the team. However, all the parties involved here have (or obviously should have) done a similar analysis — the Tigers, Scherzer (and agent), and the insurance company (or companies). The Tigers appear to have placed the weighted average of Scherzer at $144M. Assuming he acted rationally, in order for him to justify declining that offer his own calculation would have been higher than that number. And obviously the insurance company would have set their rates based on their own number.

    Doesn’t Scherzer’s decision whether or not to accept the $144M just come down to who he believes did a better job of predicting own risk/value. By extension, if teams are making out better in these extension than the players, isn’t the real issue that players/agents need to be a better job of calculating their own risk/value??

    If that is true, I could see it justified in that teams presumably have more resources (scouts, analytics, doctors, etc…) at their disposable than a player would. Perhaps a mega-agent like Boras has the means to beat the team’s valuation, but most smaller agents couldn’t possibly do so over the long-run, could they. Perhaps this explains why Boras player almost never sign extensions?? Or, if we accept that teams are “winning” these deals, it’s not that they have incorrect values on players, but that they just know that the players is undervaluing himself.

    Long story short, don’t players simply need to do a better job of determining their value?

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    • Matthew says:

      Sorry “tz,” wasn’t trying to steal your points about Boras — you just happened to post while I was typing.

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      • tz says:

        Matthew, you brought out another good question which I responded to below.

        And I don’t think we’ve broken any records on “simultaneous” posts here. I’ve seen some that are downright uncanny!

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    • Dave Cameron says:

      Mostly yes. I think the reality is that these super team-friendly long-term deals are kind of a new thing, and MLB teams aggressively exploiting players selling their risks too cheaply is a 12-24 month old problem, so there hasn’t really been time for agents/players/third parties to adjust and bring things into balance yet. As the evidence stacks up that the first round of these deals were overly team-friendly, agents and players will adjust, and prices for these deals will either go up or third-parties will come in to provide competition.

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      • Alec says:

        It’s entirely about who prices the risk correctly. That’s basically the entire business of insurance – they specialize in pricing risk. In a risk-pricing contest between MLB front offices and third party insurers, I’m betting on the insurers 100 times out of 100 (and this isn’t a knock on front offices, I wouldn’t ask an insurer to build a baseball team, but I’ll trust them to be good at their jobs).

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      • tz says:

        “Aggressively exploiting” may be a bit strong. The real driver for these is the extreme undervaluing of players during their years of control. These long-term deals are a (small) step towards players getting “fair” value in the earlier part of their careers.

        And I’m sure Boras can make a pitch to prospects that the one long-term pre-FA contract his clients got may have been the most player-friendly (Andrus)

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    • tz says:

      That’s what agents get paid the big bucks to do.

      Seriously, you’re absolutely right that players and their agents need to put the time in to figure out what contract they deserve and make the case for it. Boras and other big-name agents probably have more clout in convincing the players to trust their judgement on these types of decisions.

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  6. Alec says:

    This is fascinating, and makes so much sense that I’m kind of shocked that this has taken so long to emerge. I imagine if this becomes a major trend (to the point where young players no longer agree to team friendly deals at all), this strategy v. the service time manipulations teams go through will be a major issue in the next round of CBA negotiations

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  7. Los says:

    I work in insurance and I can tell you that long term, there will be no market for this type of product. For the rate of return that insurance companies will require for individualized policies, it will make much more financial sense for the players and teams to work things out with the team purchasing insurance after the players sign the contract.

    The only way that this market will exist is if the players union incentivized the Trouts and Harpers (and Polancos, and Singletons, and Longorias)of the world to reach free agency so that they raise the payroll threshhold.

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    • Alec says:

      Correct. Long term there will be no market (or very little market – I could see a high risk player getting a policy that covers some small payout in exchange for a massive percentage payout on the upside, but not much beyond that, and even then, it’s not substantively different than those players just agreeing to a Josh Johnson style contract) for this product, because teams will adjust their pricing models accordingly. There likely will be a short term market, since there current system is pricing risk incorrectly. Insurers will come in, reap the benefits, and should the teams adjust correctly, they’ll move on to the next irrational market.

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    • tz says:

      In the short-term though, there are some insurers offering this. The revenue potential drives the decision-making at enough insurers to make this attractive. And it may take a while for the players and their agents to push for lower premiums on this specialized coverage.

      The long-term success of the market may hinge upon how many big claims occur in the short-term. That would definitely trigger the insurers to pull back.

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    • munchtime says:

      Why does it matter who purchases the insurance – team or player? Regardless of who makes the payments, the risk of player-injury is the same.

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      • Los says:

        It matters because purchasing insurance is more costly for the player than the team.

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        • munchtime says:

          So why does the player have to pay a higher premium than the team does?

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        • Los says:

          Two reasons:

          1) The player and the team are insuring different things. The player is basically locking in future earnings and using the insurance as a hedge against injury and performance loss. The team is basically insuring only against cat losses.

          2) Players have no leverage and are probably not repeat customers. Teams can have one company underwrite all their risks.

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  8. ballfour says:

    Scott Boras will never steer you wrong.

    Oh.

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  9. Brian says:

    Great post, thanks. I’m interested to see what Scherzer will get if he’s healthy all year.

    He’ll be 30 next year, and he’s a much better FANTASY baseball pitcher than real life pitcher.

    His career high in innings came last year, at 214. His K/9 is off the charts but it’s not like he led the AL in ERA last year – in fact, he was 4th. A great season, but likely his best.

    I would never pay Scherzer $190M, and I think he was foolish to turn down $144M not because of the risk of injury, but because he’s not worth more.

    Cliff Lee at the same age got 5/120 before 2011, but had already won 100 games and gotten CYA votes three times and had three seasons in a row of 212+ IP. I think at that point in their careers that Lee > Scherzer. Adjust for inflation and…

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    • jpg says:

      This looks wrong on so many levels. Homer Bailey isn’t as good, doesn’t have a Cy Young and even wasn’t a FA yetgot 6/$105M. Cliff Lee is terrible example because it was no secret that he left a year or two and $40M+ on the table to pitch in Philly rather than the Yankees. And “…had already won 100 games…” and “…better FANTASY pitcher…” Seriously? The guy has been worth 11 wins in the last two years.

      The best comp is Greinke who got 6/$147M two years ago coming off 4.8 win season. Scherzer had a 6.5 win season last year and is on pace for another 6 win season. He’s gonna blow that $144M out of the sky if he stays healthy

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      • Brian says:

        Bailey got an absurd contract, and I think everyone who likes it even for a second was insane (which was most experts).

        Greinke is a good comp but had a longer track record of success than Scherzer and was a year younger and was the beneficiary of the Dodgers largesse.

        Even if you spot Scherzer the same circumstances as Greinke, that’s $147 million, no gain. Even if you spot Lee an additional $20 million or so that he left for a hometown discount, that’s still $120 million over 5, no gain.

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      • Brian says:

        Oh and just to be a little more specific:

        Greinke was 91-78, 114 ERA+, IP of 202, 229, 220, 171, and 212 prior to his contract. And he was 28.

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        • jpg says:

          Right, but you aren’t considering the skyrocketing inflation in player salaries. Salaries are rising, not staying flat. Whether you think it was ridiculous or not, the fact that Bailey got that deal from a mid-market team before hitting free agency should tell you all you need to know. Greinke has longer track record and is a little younger, that is true. What is also indisputable is that Scherzer has been the better pitcher for the last three or so years. By the the time Scherzer negotiates his new deal, the Greinke contract will be three years old. Honestly, do you not think the Yankees or possibly Boston aren’t going away that 6/$144M offer?

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        • jpg says:

          *blow away

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        • Brian says:

          I guess it’ll depend a lot on this year.

          $25M per year would be a lot for the age 31-36 seasons of a pitcher who has eclipsed 200 innings just once.

          If he replicates last season it looks like a better bet that someone will break the bank to give him 6/150 or more, but any setbacks and I’d be surprised.

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        • jpg says:

          The problem is that you’re making different arguments. First, you intimated that he wasn’t worth it because of performance related issues by saying he was a better “FANTASY” pitcher than a real life pitcher, which is, frankly, pretty ridiculous. The guy has accumulated close to 17 wins the last four years. The guy is a stud whose performance has improved as he’s entered his prime years. Then you cited his age which will probably limit the number of years to six or seven, but it won’t be much of a factor in terms of the AAV. Lastly, you mention a possible setback. Obviously, if he gets hurt that changes things but what “setback” can we reasonably forecast? He’s got two wins under his belt and ZIPS projects him to accumulate another 2.9 and finish basically at five wins total. If he does that, 7/$175M+ on the open market is a mortal lock. I wouldn’t be surprised if he got close to $200M.

          If you’re arguing that he won’t be worth the deal he eventually gets that’s not exactly a bold statement. Long term deals for pitchers are risky. Free agent deals for guys on the wrong side of 30 rarely ever work out. These facts are obvious. But if you’re saying his performance doesn’t merit that type of deal or that he’s simply overrated, your arguments haven’t been convincing.

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        • Brian says:

          You’re hung up on that fantasy comment, for what reason I don’t know considering how irrelevant it is to the points we’re discussing now.

          Scherzer has been good for 2.6, 4.6, 6.4 WAR the last three years and is projected to finish at 4.9 this year. That’s not a stud. Even if you gave him an average of 5 WAR (the actual average is 4.6 WAR and this season isn’t over yet), that’s inferior to Lee and Greinke.

          Lee posted WARs of 7.1, 6.5 and 7.0 prior to his big contract with Philadelphia.

          Greinke posted WARs of 4.8, 3.6 and 4.8, plus his Cy Young season of 9.1 the year prior to that.

          Those pitchers had established higher ceilings or higher floors, or both, than Scherzer.

          If you think someone is going to break the bank, fine. But if he signs for 6/150, that’s only a $6M gain over what was offered to him already.

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        • jpg says:

          I said that I expected him to get $175M+ and that $200M is in play. You’re the one who keeps saying $150M. There is no argument that Lee is better. I’ll even grant you a wash with Greinke. Hell lets say he is better too. The key thing is that Lee’s deal will be four years before Scherzer gets his deal. Greinke’s came three years earlier. The inflation in salaries trumps all of that. Bottom line is you said he was a fool for passing up the $144M. Your words. He’s going to crush that number barring injury. Easily. My words.

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        • Nick says:

          Thanks for giving me the ability to not get “hung up” on your other points. You don’t mention the free market value of wins during the times the pitchers were signed and you fail to include relevant information about projected MLB revenue streams. Dave Cameron and the writers T Fangraphs cover these things exhaustively, so I’m going to get “hung up” on the data that informs that guess. But,hey, I guess you can anchor down the lower part of the distribution when we guess free agent contract values.

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  10. He has money already says:

    Another thing that people aren’t picking up on or discussing is that Scherzer already has had several years of >1 million compensation in baseball. If he has a “modest” lifestyle for an athlete, he is already set for life. Thus, he is more likely to accept more risk than if he were in Trout’s position before he signed his contract.

    I’d probably just take the money and run if I were Scherzer but everybody is different.

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    • tz says:

      Great point. Probably why many players haven’t done these types of deals in the past.

      For the agents, on the other hand, the PV of future player earnings has all the utility in the world. So, expect a 795-page research report from Mr. Boras to his clients on why they need to lock in their future value.

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  11. vivalajeter says:

    I’d love to see the actual terms of the contract, and I wonder if it will ever come out. I know Dave is just giving an example, but he says that maybe the insurance company would make up the difference between $100MM, and the contract that he ultimately signs for (assuming it was under $100MM). Let’s assume that he fits into the “Minor injury, doesn’t perform as well” category for $80MM. Max will be making $100MM no matter what, so what’s to prevent him from signing a team friendly deal for $40MM? Either way, he makes his $100MM – but he screws the insurance company while giving his team a better shot at winning.

    Will this be based on a lifetime contract, or simply based on whatever he signs for this offseason? What if he gets a long-term option from one team, but a 2 year, $60MM contract from another team. Can he take the second option, and get a $40MM payout? I’m sure the answer is no – but that’s part of why I’m curious to see how it was set up, and how the sides prevent themselves from getting hosed.

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    • tz says:

      That’s a great example of why insurance companies don’t pay 100 cents on the dollar for the loss that they cover.

      Let’s say the insurer only covers 75% of the shortfall. Then if Scherzer signs the team-friendly $40M contract, he would get $60M x .75 = $45M from the insurer for an $85M total payout. If he signed for full market value in this scenario ($80M), the insurance payout would be $15M and he’d get a total of $95M. That $10M difference should be enough incentive for Scherzer to not “take one for the team”

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    • AF says:

      The insurance company could protect itself by (1) insuring against injury rather than poor performance, so there’s no payout at all unless there is a serious injury; (2) making payments based on six years of salary or the total value of the contract, whichever is greater, so that taking a shorter-term contract for more money per year (or a longer-term contract for less money per year) would not trigger a payout from the company; and possibly (3) making payments based on the highest offer, rather than actual salary.

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  12. AF says:

    This is an interesting article, but it is different from the insurance contract Scherzer actually signed, according to the reports. He didn’t buy insurance for an under-$100M contract. He bought insurance for an injury. My guess would be that the policy covers his 2015 salary if he ends 2014 on the DL or spends X number of days on the DL in 2014, and after that he is on his own. The maximum payout is probably closer to $20M than $70M.

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    • tz says:

      If it’s for an injury, then (a) you’re right about the likely payout and (b) the premium would be much less, probably something Scherzer could afford to pay right now.

      And given the risk (no matter how remote) of getting a career-ending injury, this kind of coverage makes sense. More like a “catastrophic” coverage vs. the “comprehensive” coverage in Dave’s example.

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    • AF says:

      Actually, based on the report it sounds like the policy is for more than $20M. My mistake. Still, the policy does seem to be based on injury rather than poor performance (ie, no payout if he is not significantly injured regardless of contract amount).

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  13. BMarkham says:

    Perhaps Scherzer just doesn’t want to play in Detroit. He’s from St Louis bu the Cards are in not in a position to sign him. 6 years/144 million is a good offer a year away from FA, at least it certainly wasn’t a lowball offer. The main way teams are going to be able to blow that offer out of the water is by increasing years and that’s pretty risky for a pitcher in his 30′s.

    Maybe something like 7 years/180 million? That’s an extra $36 million so I guess that classifies as blowing it out of the water but almost all the extra money came from an extra year rather than bumping up the AAV.

    Scherzer has been a good pitcher since 2009, and from that year to now he is 10th in WAR among pitchers (22.3 over 1048 IP). The guys ahead of him in that time period are almost all pitchers with big contracts. First to ninth goes Verlander, Hernandez, Lee, Kershaw, Greinke, Sabbathia, Lester, Wainwright, and Halliday. Of note Bailey is only at 11 WAR in that time period in 850 IP.

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    • Costanza says:

      FWIW, players seem to value years/total dollars more than AAV.

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      • pft says:

        Exactly. The only guarantees in life are guaranteed contracts. On 1 year deals you can have a great AAV this year and make nothing next year. With a guaranteed contract you get whatever it is you signed for, which may be less in year 1, but no worries on future years income covered by the contract.

        Scherzer is taking a risk passing on the 144 million. Insurance mitigates it some, but he could end up getting much less with a sub-par year or an injury

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      • BMarkham says:

        I agree, but teams are reluctant to go as long with pitchers as they do position players. Pujols, Fielder, Votto, Arod (twice), Cano all have got 10 year deals, whereas even Kershaw had to settle for 7 guaranteed years entering his age 26 season as the best pitcher in baseball. Scherzer can only hope to match that 7 years.

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  14. pft says:

    But the agents don’t get a commission for the insurance pay out so most will not recommend their players go the insurance route and forego the extension. Of course, most players early in their careers can not afford the premiums

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  15. pft says:

    I think salaries have reached the point that players no longer feel the need to get the best deal, but prefer to lock in the money on the table. The injury nexus being what it is I can understand. I do think players who are willing to leave the most money on the table tend to have less confidence and this may show in their future performance. It would be interesting to look at players performance after signing a big extension and seeing if there is a drop off in performance relative to expectations and compare them to players who went the year by year route before free agency

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  16. MikeS says:

    I realize that these are all good, mathematically sound arguments. But somehow anybody saying no to $144M baffles me. At some point, it just becomes a game where you want a high score and not about financial security. I think Scherzer and many other athletes are well beyond that point. People like Longoria clearly cared more about the actual money and not making more than everybody else, and he occasionally gets lambasted for taking a big discount.

    I’m not saying ball players are overpayed. They get what the market gets them and none of the owners are taking out loans to make payroll. Just that when you pass up nine figures, you can’t say you actually need more than that. Maybe you want more and that’s fine. at that point it really is not about the money, it really is about “respect.”

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    • $$$ says:

      As Dave noted, the benefit in selling the risk in this case is not about making more than the $144 Million that the Tigers offered, it is about going into this season without the risk of losing a nine figure contract AND being able to choose where he plays after this year. It stands to reason, he will not be playing for the Tigers next year.

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  17. Chris says:

    Morale hazard is a commonly used term in the industry. I’ve worked in insurance for 11.5 years and I guarantee there is an insurer that is likely to take about any kind of specialized policy, so long as it carries the appropriate premium. There are many companies that take this kind of risk, but Berkshire Hathaway loves this kind of policy. They should use this example in my “Foundations of Risk Management and Insurance” class.

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    • tz says:

      Chris, would it be safe to say that the rates for these “specialty risks” would be calculated in a fashion similar to Dave’s example (i.e. not too granular, and lots of educated guesses)?

      I’ve worked on the life insurance side, where we’ve had the benefit of years upon years of data for setting rates, which is a whole different story.

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      • Chris says:

        Good question. I’m not an underwriter, but I’ve heard a lot about these athlete insurance policies, whether it be a college basketball player that opts to stay another year or any of the numerous pro players that has taken out a policy. I would guess Dave is pretty spot on with his example, since it is all about assessing risk, determining probability of loss, the potential scope of loss and figuring out an appropriate premium. There has to be a wealth of data available out there about sports injuries.

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  18. Los says:

    One nit to pick, Scherzer is not “self-insuring” since risk is being transferred to the insurance company.

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  19. Contract Length says:

    Dave- How does the length of his next contract factor in this equation?

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  20. Jim Price says:

    What I don’t quite get here is that this does not seem anything like a team-friendly offer from Detroit. The Tigers in this case would be taking just as much risk if not more than Scherzer. I think the history of 6yr contracts to pitchers past 30 yrs of age are not that favorable to the team. The real story here is that Scherzer seems extremely confident he can repeat 2013 otherwise how is he going to get offers better than 6/$144?

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  21. Charlie says:

    How does this plan compare/differ from the new Fantex offerings with players (i.e. Vernon Davis)? Essentially, they are selling their risk by selling stock in themselves?

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