Why do people pay for insurance? If they have the money to ensure protection in the case of damage or loss that isn’t guaranteed, why not save the money for when something actually happens?
In: 0
>ELI5: Why do people pay for insurance? If they have the money to ensure protection in the case of damage or loss that isn’t guaranteed, why not save the money for when something actually happens?
Insurance protects you precisely from damages you *couldn’t* possibly afford to pay.
When you buy insurance, you – in essence -buy **immunity from bankruptcy** (due to legal fees/liability payments/medical bills/<insert insurance type here>/etc. …).
it boils down to risk management.
You don’t know when something unexpected(ly bad) will happen, and you don’t know how bad it’s gonna be when it eventually happens.
so without insurance, you’re in a awkward situation where you can’t know if what you’ve saved is enough for a potential eventuality, and even if it is, there’s nothing stopping 2(or 3 or 10) bad things happening in short succession before you can save enough money to deal with the second.
insurance is worth it because instead of constantly worrying about a random event you can’t predict or control, you can pay a constant and predictable rate, which is obviously more consistent and thus can be planned around.
consistency is king, in all forms of business pretty much.
One simple example would be that it’s fixed costs.
I can plan for a 50€ reduction in monthly spending, I can’t plan for a 3000€ bill suddenly because something stupid happened.
Additionally to that, remember that an accident can cost a LOT of money. Imagine I hit another car, that’d be more than a thousand, multiple. I don’t want to plan for a “what if” scenario. Heck, if a person is damaged it can go up into the millions. I’m not going to be able to pay that amount of money.
That’s where the insurance comes into play.
One would have to check if it’s likely, and how impactful an accident would be. Would I get an insurance for a mobile phone? Nah, I barely have any issues with them.
Car? Absolutely, even if the chance is low, the damages can ruin me, as opposed to a phone cracking it’s screen.
Because depending on the nature of the insured event you may never be able to save enough to cover that situation.
Eg. Insuring your $3000 car for $50 a month gives you access to millions of dollars of cover in case of being sued if someone dies in that car crash. It also gives you a level of cover in case you were at fault and the other car needs repairs.
Saving for 60 months would give you the $3000 replacement value of your car, but it wouldn’t cover costs to other vehicles or property affected, being sued for being in the wrong etc.
I guess the point is that for a much smaller outlay of capital you are covered in reasonably large quantities for an array of different events, something you could never achieve just by saving. This is applicable to almost all insurance types.
Insurance is a fixed cost to protect against *catastrophic* loss
If you pay $100/month for car insurance you could save it and pay for your car if something bad happened, but you would be able to pay the $200k you’d be liable for if you caused an accident that sent multiple people to the hospital
Similarly home insurance protects you against the relatively low risk that your house may burn down, but if it does and you’re not insured then you’re homeless *and broke*
Insurance is there to cover low percentage events that *you cannot feasibly save for*
In a lot of countries insurance is mandatory for some things like driving or offering a professional service. That’s more to protect the people who might be affected by your mistake or negligence than it is for your own benefit.
You might have the money to take care of a situation if it arises but what if you don’t? The person who you crashed into or whose home you damaged doesn’t know if you have the money to put things right or not. So it’s a more fair system to mandate that people have insurance.
One factor that a lot of these answers don’t include is that, in many cases, insurance in MANDATORY. Most jurisdictions won’t allow you to operate a motor vehicle without liability insurance, because youv shouldn’t be able to drive your car into someone else’s car and not afford to pay for the damages.
Many rental agreements require tenant’s insurance. Medical professionals generally need proof of professional liability insurance before they can be resistance to practice.
Mortgage companies require it. Which makes sense, but if I had enough money to not have a mortgage I would have the insurance so I didn’t need to keep 1m sitting around just in case my house burns up. Also, liability and lawsuits are covered under most home insurance which can be expensive if you’ve ever had someone fall on your property or steal/break something expensive. Not many normal income people have large sums of $ hust sitting around and the very small cost of insurance provides peace of mind, just in case. My 3 yr old once plugged the toilet on the 3rd floor of our old house, it cost $88k to clean up and replace all the damage it cause, insurance covered 100% and they organised everyone to do it. It was a traumatic accident but in the end we were made whole again by the insurance.
Because it is for costs that are more than what you can afford.
Item: $5,000
Insurance: $20/mo
Let’s say you break it and need a new one. Assume no deductible or anything and the insurance pays the whole $5000. You would need to save 250 months to equal that $5000; so as long as it’s been under 20 years, the insurance is worth it.
Now, in the US it gets iffy with medical insurance, as prices are inflated as prices get haggled down and negotiated, but different insurances have different negotiated prices for different billed items (and if you don’t have insurance, you can tell the hospital and they may be able to drastically lower the bill).
There’s lots of good answers here but nobody touched on shared risk yet so let me take a shot.
Insurance is a shared risk initiative.
So take automobile insurance for example, if you needed decent coverage for yourself you’d likely calculate the average vehicle price where you live, your vehicle pay off and a rough estimate of medical bills. You’re looking at $50,000.00 at very least to self insure assuming you’d need to pay for the damages you potentially caused.
But perhaps an insurance company has found out that accidents happen (completely fabricated number here) once a year per 25 people.
So rather than every person needing to save $50,000.00 as a bond in case of an accident, an insurance company (which is essentially a risk management firm) can collect $50,000 per year from the statistical 25 people, which comes to $2k/yr or about $170/month per person.
It makes protecting yourself and others more attainable for the average person, and it frees up money on an individual level. So even if you could afford to put 50k aside, that money would be much better spent collecting interest, dividends, rents or be invested into a business venture
Latest Answers