Why Get Insurance?

We spend over $4.5 trillion U.S. a year on insurance premiums, which works out to over 6% of worldwide GDP, so the insurance business is a huge one indeed. With all this money spent though, people do give insurance quite a bit of thought, but perhaps not as much as they should.

It certainly can be helpful to have at least a good idea of the basics of insurance, beyond just thinking about looking to protect oneself from future risks. That’s certainly the main goal of it, but we really need to understand the value here in certain cases anyway to decide whether we should insure, and if so, how much insurance we should buy.

Insurance companies will sell you insurance for just about anything, save for some pretty bizarre requests such as Stanley Kubrik looking for insurance against space aliens being discovered before the release of his film 2001: A Space Odyssey, which he was unable to get.

The problem with this request is that it was impossible to ascertain what the risk really was that they would be taking, but generally even some off the wall requests such as insuring the legs of celebrities are successfully appraised and underwritten.

So that’s what insurance companies do, they calculate the risk that they are taking and they price the premiums such that it becomes probable that they make a profit from the deal. So people who do business with them are paying a premium for this coverage, and premium means more than just the cost of the policy, it means a premium over the actual expected value, much like taking out a loan involves a premium over the cost of what is bought from the proceeds of the loan.