Friday, March 09, 2007

Why buy insurance?

I guess I say no to extended warranties or purchase protection cover for two main reasons. The first reason is a gut feeling that all extended warranties are a rip off. My second reason is a bit more thought out and rleates to why we need insurance at all. As I see it insurance is purely a financial proposition based on risk. In crude terms the average payout of an insurance policy equals the actual payout that would occur in the event of a claim times the probability that that that claim will occur. What is more if the insurance company has any idea what they are doing then the expected average payout will always be less than the premium the company charges you. Excessive sales margins just make the picture worse. Any company foolish enough to offer insure you for a premium less than the average expected payout is unlikely to remain in business long enough to re-imburse your claim. Insurance is in effect a gamble where the odds are always stacked against you. Not much different in some ways from a casino.

Of course the reason we take out insurance is not to make a profit but to give us reassurance that we can recover from a catastrophic financial loss. The key word here is catastrophic. If the potential loss is small enough that I can cover it out of my own resources then there is no point insuring against that risk. My mobile phone falls into that category. I can afford to replace a €300 phone. I can even afford to pay for a few thousand euro worth of malicious calls in the event of some micreant getting their hands on my phone. It wouldn't be pleasant and I would certainly grumble but my family would still eat, have a roof over our heads, go on holiday and so on. This is not the case with my house. If my house burned down it would be difficult for us to pull together the financial resources to re-build it and neither could we survive without a roof over our heads. Therefore I do not buy insurance for my mobile phone (except perhaps as part of general house contents cover) but I do most certainly buy insurance for my house.

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