Why Insurance is Never a Good Deal

And 4 Times When You Should Pay for It Anyway

When you purchase a computer, should you buy insurance in case it breaks? Or should you purchase travel insurance for a trip? What about car insurance, health insurance, homeowner’s insurance, or life insurance? You can save a lot of money over a lifetime by answering these difficult questions well.

Building destroyed by Hurricane Irma on St. Maarten island

Properly understood, insurance is always a bad deal. But there are 4 times when you should get it anyway. Let me explain.

Why Insurance is Always a Bad Deal

To understand why insurance is always a bad deal, look at it from the perspective of the insurer.

The insurer’s goal is to make money. Any well-crafted insurance policy is designed to take in more money from the group of individuals who purchase the insurance policy than the insurer will have to pay out in claims. Insurance is a “bad deal” in the sense that the expected value of the average payout is less than the average amount people pay for the coverage.

As a rule, insurance is always designed to be a bad deal both for the group of people, as a whole, who purchase the insurance as well as for the average member of that group.

4 Times When You Should Pay for Insurance Anyway

Despite it being the case that insurance is always designed to be a bad deal in the sense described above, there are, nevertheless, 4 times when it makes sense for a given individual to purchase the insurance anyway.

  1. You are More Likely than Average to Suffer an Accident.

    When you are more prone to accidents than the average member of the insured group, insurance can be a good deal—even a great deal. In this case you are riding on the coattails of the less-accident-prone. They are, effectively, subsidizing your expected payout from claims.

    Take, for instance, AppleCare+ insurance for the iPhone X. It costs $199 both for the accident-prone and for the non-accident-prone. If you have a history of breaking your phone, getting the insurance is a better deal for you than it is for someone much less likely to break his or her phone. Given that the iPhone X costs $1,000, paying $200 for insurance is a good deal if your odds of breaking it are greater than 20%.

    An even better example is when a person with a preexisting medical condition can purchase health insurance for the same price as more healthy members of his or her insured group. Such is often the case when purchasing health insurance through one’s company. The less healthy one is, the better the deal the health insurance is. That’s because you’re paying the same insurance premium as everyone else but you expect to receive more than most people in the way of insurance claim payouts.

  1. You Cannot Easily Afford the Loss.

    When I purchase a $20 box fan from Amazon, I skip the optional insurance. That’s because (1) I know the insurance is a bad deal for the average person and (2) I can easily afford to buy a new box fan. I’m better off pocketing the insurance money and just buying a new box fan if mine breaks.

    The calculus changes, however, for purchases that one cannot easily afford to replace. Take, for instance, a home.

    I still know that homeowner’s insurance is a bad deal for the insured group as a whole and for the average insured member. And I don’t think my home more likely to suffer an accident than other homes.

    Yet, I carry homeowner’s insurance. Why? Because no amount of “pocketing the insurance money” will enable me to replace the house should it be destroyed.

    Unlike in the case of the box fan, I take what I know is, technically, a bad deal (negative expected value) because in this case I cannot replace the insured object in the event of a complete loss.

    [UPDATE: Readers have asked what I think of life insurance. I put life insurance in this category. Most people cannot easily afford the loss (that their dependents would experience) of years of future income.]

    Do you ever wonder if you should you get car rental insurance? Read my thoughts here: How to Save Money on Rental Car Insurance.
  1. It Can Help Your Business.

    In some cases, carrying insurance can provide a greater return on investment than not carrying it. When that is the case, it makes financial sense to carry it.

    Imagine, for instance, you run a house-cleaning service. You may not be required to carry insurance. But you find that certain prospective clients won’t hire you unless you carry insurance in the event you break something while cleaning.

    In that case, you should run the numbers to see if you stand to make more profit by purchasing insurance with the expectation of being able to land more clients.

  1. You are Required by Law.

    Some insurance is simply required by law. In that case, you should carry it.

    Take, for instance, car insurance in Colorado. According to the Colorado DMV, all drivers must carry liability coverage for several items, including a minimum of $25,000 in coverage per person for bodily injury.

Conclusion

Insurance is designed to be a bad deal for the group of people, as a whole, who take out the insurance policy as well as for the average member of that group.

Nevertheless, you should purchase insurance when required by law, when it helps your business, when you cannot easily replace what you are insuring, and/or when you are more likely than the average member of the group to suffer an accident.

For any type of insurance you are considering, I know of 2 ways to help tip the odds in your favor in order to make the insurance a better deal for you. If you’d like me to send them to you, fill out the following form, and I’ll email them to you straight away:

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Question: What types of insurance do you skip and why? You can leave a comment by clicking here.

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2 thoughts on “Why Insurance is Never a Good Deal

  1. I’m really glad you wrote this article. I got beat up in a private Facebook group on a post asking if someone should buy travel insurance for their first time abroad. I advised strongly against it for the reasons you explain in your post, but the insurance industry has quite a large footprint and apparently has brainwashed most people…even on a Facebook group for travel hackers.