Is it worth it to buy insurance?
Mathematically no. Practically though, it’s a necessity. Any of us might be able to survive a small loss without insurance- a huge loss, not so likely.
That is why insurance companies make huge profits- sometimes. There are times when they go broke.
As you likely know, insurance companies operate their business much like a casino but in reverse. You pay, but you hope you don’t need to collect.
As a bettor, you hope that the bet you place will win. The casino knows that over a cycle with many, many bettors they will win more than they will lose because odds (probability) are on their side.
You might still win. But the odds are you will lose. In roulette for example as mentioned in a previous article, there are 38 spots here in the US.
18 are red, 18 are black and 2 are green. The payoff for $1 if the rolling ball lands on your number (if you only picked one) is $ 36-, your total return is your own bet ($1) back plus $35 more. They call that a 35 for 1 bet. It should pay you $38 if odds were fair. Your bet back plus $37 more. If it did that the casino wouldn’t make money.
Insurance bets you won’t have a particular calamity and you bet you might. They figure they probably won’t have to pay you. They hope that if they do, that they will have collected more from you than they will have to pay out.
You too, hope they won’t have to pay you- no one wants to have an accident. But you buy insurance because you don’t want to be personally responsible to pay if an event, like a car crash, happens.
They figure out the likelihood of you dying for instance. You pay a life insurance premium in every year. They keep it.
If you die that year they pay your beneficiary. The likelihood is that with many, many people doing the same thing that they WILL have to pay something to someone.
But the odds, if calculated correctly by the insurance company, says they will collect more money than they will have to pay out- enough to cover all expenses and still make a profit.
As you age or if you have some condition that makes your death more likely, they calculate your premium payment and the amount they take in over time to cover the increased risk.
This is true with health insurance, car insurance, life insurance, all insurance where a company is at risk.
There is a good book on the subject “Against the Gods- the remarkable story of risk” here:
If that risk- reward ever stops being true, say, due to changes in the laws requiring a bigger payout, or a payout more often, they will change the amount you have to pay to cover that cost. If they cannot, they will stop selling insurance in that area and go elsewhere where terms are more favorable.
This is one if the major issues right now covering Obama care costs.
Some companies are getting out of the business leaving us all fewer and fewer choices. Costs keep rising. Arguments about coverage keep increasing.
Insurance companies buy insurance too! It’s called reinsurance. They approach other insurance companies and pay for coverage in case they greatly misjudge their risk. That spreads that risk over a greater number of companies and increases the chance of a particular company’s survival in case of a calamity.
Some insurance such as flood insurance carries no risk at all to the insurance company. Anything not covered by FEMA, is paid by all of us taxpayers. See here.
It’s illegal in California to drive a car without car insurance, and though chances are you won’t have a claim, must banks require you insure your home if they loan you funds to buy it.
As mentioned in a previous article the coming great California earthquake will in all probability require funds far in excess of what is collected for us to buy earthquake insurance.
Fights and litigation will go on for years just as it did in New York and New Jersey after Hurricane Sandy.