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?
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The point of insurance is to protect yourself from sudden, unpredictable, huge costs that have a low probability of happening.
Consider car insurance. If you crash your into somebody else’s car, the total damage may be, say, $100.000.
So, instead of risking having to pay $100.000, you pay insurance $1000 per year and contribute to the pool of money that is used when somebody crashes a car. The benefit is that now instead of having to pay $100.000, you paid several thousand, and the insurance covers $100.000. The downside is that you may end up paying insurance, but never actually crashing the car and thus never needing the money. But that risk is far more acceptable than the risk of getting into a situation where you have to fork out $100.000.
$1000 per year is a manageable cost. $100.000 all at once will ruin your life, so you’re insuring yourself against that.
If you wanted to avoid paying $1000 insurance and save these $1000 instead, it would take you 100 years to save up enough money to cover that $100.000 cost.
These estimates are generous. My son was in a single car accident. 56k for the life flight. 18k for the ambulance, 280k for the hospital bill before surgery… Etc.
If you hit somebody in an expensive car that could run you over a 100k.
3k doesn’t scare me, 300k hell yeah.
In the strictest sense, you should only insure against damage/loss that you can’t afford to pay yourself. For example, those ‘extended warranties’ on consumer devices are largely a scam – on average, consumers pay more for the warranty than they’d pay if they just replaced the device.
With that in mind, insurance also comes with other benefits in many cases.
Consider your the non-collision portion of your vehicle insurance. Even if you weren’t legally required to carry it, it would still be a good idea. If you do get in an accident with another vehicle, the legal consequences are borne by the insurance company rather than you. Outsourcing this potentially unlimited liability that few people have the legal acumen to navigate to a large corporation is a huge benefit. The same could be said for the portions of your homeowner’s insurance that protect you from someone slipping on your walkway.
Health insurance is another example. The price of care for an insurer is significantly less than the out-of-pocket cost you’d pay as a private individual due to their large negotiating power.
A fair bit of the answer depends on which particular insurances you’re referring to.
There are the catastrophic cases:
Vehicle liability for example covers the potentially enormous cost of ongoing treatment for an injury caused to yourself or others. That’s not realistically an amount even most prudent savers would ever have stocked away early in their life, and even late life it could be ruinous to your future.
Personally I have life insurance to make sure my family is adequately provided for if something tragic happens to me. Im the bit breadwinner for the family my a significant margin, and the amount to cover my house, my children’s food, clothes, education, utilities, etc for the next 15-20 years is not something I can reasonably save up for relatively early in life.
For less catastrophic but still sizeable items:
Many people lack the financial discipline to have emergency funds available to cover major vehicle replacement or repair. The insurance is acting as that emergency fund without being available to blow elsewhere. These may be the situations you’re thinking of. This also applies to much smaller but still relatively indispensable items like a smartphone. Personally I opt out of these and can accept the risk of doing so but it’s a good idea for people more reckless with their spending.
You don’t actually know the full extent of losses. Forexampke travel insurance often includes $500,000 in medivac as medical evacuation can run into the $100’s of thousands.
When something happens it can require more money than one can save.
The insurance can average out the bad luck throught the population.
Another thing to consider is what insurance allows you to do that you otherwise wouldn’t.
Say you run a business but insurance doesn’t exist so you need to set aside money every month and keep it as a contingency fund.
That money is sitting doing nothing until something goes wrong – that’s a chunk of money that could be spent growing your business by hiring new people, buying better equipment, advertising, etc.
> If they have the money to ensure protection in the case of damage or loss that isn’t guaranteed
Say you and 9,999 other people drive cars. Statistically every year one of you is going to get in an accident that’s going to cost $1,000,000. It would then make sense for each of you put $100 into a pot at the beginning of the year, so the pot contains $1,000,000. Then that pot of money can be paid out when the accident occurs.
The thinking here is that most people can afford to pay $100 a year, but very few people can afford an unexpected one-time expense of $1,000,000.
It changes it from an intolerable risk (“a car accident could bankrupt me”) to a more tolerable one (“I pay $100 a year and I’m mostly protected from the financial consequences of car accidents.”)
(I’m leaving aside the fact that most places legally require a certain level of insurance to drive.)
let’s say I have a widget that costs 100$ and I can afford to put aside 1$ a year for it. That means that only after 100 years of saving I would be able to handle a catastrophe.
Now let’s say that I have a group of 20 friends, and we’re somehow guaranteed by an all-knowing oracle that only one of our widgets is ever going to break. We can each put aside 1$ a year and we’ll have the emergency fund “ready” in 5 years.
Insurance companies deal with such large numbers that they’re basically “guaranteed” everything will work out according to probability:
If a widget has a 5% chance of breaking, then our group of 20 friends can assume only 1 will break, but it’s not guaranteed (we could have 2, or even 3 break). If an insurance company works with 20,000 “friends” (customers), then it could be that more than 1,000 will break, but it’ll never be *drastically* more…
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