Title : Insurance is Its Just Gambling Essentially
Link : Insurance is Its Just Gambling Essentially
Insurance is Its Just Gambling Essentially
I've seen quite a few news articles lately that blindly repeat assertions from the insurance industry about how people in Australia are underinsured. The implication seems to be that if you aren't fully insured against every possible eventuality, then you don't have enough. This irritates me, because people rarely talk about the true nature of insurance. Insurance is gambling.
Insurance isn't just 'like' gambling, is is gambling. In particular, it's a very particular type of gambling where you are betting that something bad will happen to you and the insurance company is betting that it won't. Replace the word 'premium' with 'wager' and it all becomes pretty obvious. Now, one truism about gambling is that on average the house always wins. If the odds weren't stacked in the favour of the house, there would be no house. And last time I checked insurance companies were pleasantly profitable.
Now, betting that something bad will happen can be very useful, as it provides a form of hedging, or smoothing, of the statistical variance of life. If something really bad happens, at least you win your bet with the insurance company and this can help you out of trouble. The other side of the equation, though, is that for as long as you avoid major misfortune, you're losing bet after bet with the insurance companies. This in turn puts you financially behind, which makes you more vulnerable to financial setbacks, which in turn makes it more necessary than ever to retain insurance. Perfect! (for the insurance companies, that is)
So, in the face of all this propaganda about underinsurance, what is the right amount of insurance to get? In my opinion, the answer is: as little as possible. In particular, you should only insure against events whose financial impact would be ruinous to you, and even then the insurance should be sufficient only to avoid said ruin. Basically, if you can afford to take the hit of a potential misfortune, you probably shouldn't be insuring against it. For this reason, insurance with a high excess/deductible/franchise is generally a good idea. In return for significantly lower premiums, you can insure only against catastrophic events. Say you have house insurance with a $2000 premium. For small mishaps, you're effectively not covered. Too bad. But if your house gets hit by a cyclone, the insurance covers all but the first little bit of the damage. You won't be ruined.
Insurance is valuable when you are facing potential uncapped liabilities, such as with third-party car insurance (who knows what you may hit?) or with health, especially in countries with a weak social safety net such as the USA. Taking out some insurance to make sure that your not faced with multi-million dollar bills (say, if you hit a truck full of Ferraris) makes good sense.
There's something that a lot of big companies do that is called self-insurance. That makes it sound scary, but individuals can do it too: self-insurance is just a fancy word for saving for a rainy day. With all the money you save on insurance premiums, you can build up a big buffer that you can draw upon whenever things go wrong. Statistically, you'll come out ahead this way. Of course, you need to have the discipline to actually save the money you would have spent on premiums for this to work. Also, if you have a particularly bad run of luck, self-insuring may well leave you worse off than if you had insurance. But that's the nature of gambling: sometimes you win big, but more often than not you don't. As long as you've insured against the big things as mentioned above, even a run bad luck won't come close to ruining you.
There are a couple of exceptions to the principle of minimising your insurance cover. The first is that it may make sense to take out insurance if you know something material that the house doesn't, or that it doesn't take into consideration, as that may tilt the odds in your favour. Consider the case of car insurance: if you happen to know you're a particularly bad driver, but for some reason your demographic profile shows you to be low-risk, you may come out ahead in the long term by taking out comprehensive car insurance.
The second exception is if the odds are warped in your favour by government regulation. This is particularly prevalent in the area of health insurance. In Switzerland, for example, health insurers are obliged to provide basic cover to all comers, and are not allowed to adjust the premiums for higher-risk members. Hence, if you have a health issue, taking out insurance is a bet you're nearly guaranteed to win. In Australia, people above a certain income threshold pay additional tax if they do not have health insurance. This has the effect of making the premiums less expensive (as they are subsidised by the removal of the tax penalty) and so again renders the insurance good value.
Insurance companies have a strong ally in selling their product: fear. Just as traditional gambling uses aspiration as its pitch, insurance panders to all our fears of things going wrong. Remember, just because they're "there for you when times are tough" does not mean that they're the good guys. For each type of insurance, think about whether your fear is rational. If it isn't, keep your money in your pocket.
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