Isn’t insurance, by its very nature, often not worth it?
While the title may seem bold, this is essentially the core argument.
The underlying premise is that the cost of any insurance policy is typically greater than the expected statistical costs incurred. This is a fundamental principle of how insurance companies operate and generate profit.
For example, if you pay $100 annually for car insurance, the insurance company anticipates that, on average, your costs will be less than $100 each year.
So, if we assume you won’t face catastrophic expenses (like a doctor being liable for a patient’s death), how can any insurance policy ever be statistically—meaning rationally—justifiable?
To clarify my point: for insurance policies that do not cover catastrophic events (such as lost luggage or missing a trip due to illness), how can they ever be considered statistically or rationally worthwhile?
On the other hand, I contend that insurance does make statistical sense in cases of catastrophic damage. Although the probability of such events may be very low (e.g., 0.001% annually), the financial repercussions can be effectively “infinite” if the costs exceed what you could feasibly pay out of pocket. In this case, 0.001% multiplied by an infinite cost equals infinity, rendering it statistically justifiable to have such insurance.
Your argument raises an interesting point about the nature of insurance as a financial product. While it’s true that insurance companies price their policies higher than the expected costs in order to make a profit, there are several angles to consider when evaluating whether insurance is statistically or rationally worth it, especially for non-catastrophic insurance.
Risk Management: Insurance can be viewed as a tool for risk management. By paying a relatively small amount (the premium) for protection against significant financial loss, individuals can stabilize their financial situation. This aspect of risk management is invaluable, as it provides peace of mind and allows people to plan their finances more effectively.
Shared Risk: Insurance operates on the principle of pooled resources. While you may pay more in premiums than you receive in claims in a given year, your premiums contribute to a collective pool that helps cover the costs for those who do incur losses. This shared risk model means that insurance can protect you from the unpredictable nature of life events.
Behavioral Economics: People often value certainty over uncertainty. An insurance policy, even when it may not statistically benefit you on paper, provides a sense of security. This psychological benefit can make insurance worth it in a rational sense, even if the math doesn’t support it for every individual. It can help mitigate anxiety and enable people to take on risks they might otherwise avoid.
Cost vs. Potential Loss: For many forms of insurance (e.g., health, auto, or home insurance), the potential financial impact of an unexpected event can be substantial. Even if the probability of a loss is low, the financial consequences can be dire. The cost of forgoing insurance in these cases may far outweigh the cost of the premiums paid over time.
Legal Requirements and Consequential Costs: Certain types of insurance, such as auto liability insurance, are legally required. Not having such insurance can result in severe legal and financial repercussions.
Long-Term vs. Short-Term Thinking: While it might seem that non-catastrophic policies are not worth it from a purely statistical perspective, consider long-term implications. Regularly paying for insurance can safeguard against compounded financial loss over time, particularly for frequent occurrences like accidents or minor health issues.
In conclusion, while your perspective highlights valid points about the mathematical underpinnings of insurance, the psychological, emotional, and practical aspects of risk management must also be considered. Insurance isn’t just about expected financial return; it’s about protecting oneself from uncertainty and potential future hardship.