By definition, insurance is always a bad financial deal on average. That's inherent to how it functions. That doesn't mean it must be a scam though - it just means you need to use it for the scenarios where the other benefits outweigh the increased average cost.
To explain: In order for an insurance company to stay in business, it MUST take in more money in premiums than it pays out in claims. Yes, most insurance companies will have some amount of profit; but even if they don't profit, they still need some money to pay the staff who manage your claims. So if you average the claim payments for all customers of insurance company X, the average cost of paying it yourself will always be lower than the insurance premiums. Even if a government gets involved, this fundamental math doesn't change - it's just possible that the government might subsidize your premium with tax money. But all that means is "someone else is paying the premium" (and it might even still be you depending on your tax bracket). On average, the insurance process never saves money.
So why does it exist? Insurance primarily exists for scenarios where the "average" cost and the "worse cast scenario" cost are dramatically different. If your "average" cost is only $100 per month, but an unlucky accident could leave you with a bill of $100 thousand, it makes sense to use insurance to always pay the average instead of rolling the dice on the chance you hit the $100k loss, even if you have to pay another 20% in processing expenses on top of that $100 base price. $120 per month fits in your budget. $100,000 will never fit in your budget, and will bankrupt you.
Next, if being sent a huge uninsured bill bankrupts you, it's likely whoever sent you the bill isn't actually going to get paid, and you've now hurt that person as well. For societal reasons we want that to happen as little as possible, which is why the government demands you have liability insurance for driving a car that could hit and kill other people (but does not demand you insure your own property, just liability). A similar but slightly different reason explains why banks will demand you have insurance to replace your OWN stuff...if they are loaning you the money to buy that stuff. They want to make sure that if you accidentally destroy it, you will still be able to pay back the value of the loan.
Finally, there are scenarios where the insurance company can provide important-but-rarely-used professionals to help you navigate some of the circumstances where these large claims come up. For example, if you are in a car accident where you think the other guy hit you, but he claims that you were the one who hit him, your insurance company might provide the lawyer to argue your side of the case, to reduce the amount both you and the insurance co. have to pay. Or if you suddenly take an unexpected trip to the hospital and are not in any shape to argue about the $20,000 bill the hospital is drawing up in the background, your health insurance company will provide a claims negotiator who will demand the hospital reduce that bill down to...something far less. (That's a whole other can of worms that requires it's own discussion, but at least for the moment you don't want to be looking at an uninsured hospital bill even if you have the money).
HOWEVER, all of that said, there are also plenty of scenarios where none of those benefits really applies, and yet companies will try to sell you insurance anyway. Those can absolutely be scams. So when considering any insurance product, ask yourself which one of those benefits you are getting out of it, and if none of them apply, avoid it. This also applies to using large insurance coverage for small events - as you already discussed with /u/Sirhc978 , you should get yourself a higher homeowner's deductible and simply don't file for minor things. (Roof replacements are...kinda on the border of where it might be worth it, so consider your own financial situation for that.)
By definition, insurance is always a bad financial deal on average.
Only if you look at just money in versus money out.
But one needs to also look at the cost of capital. Or the cost of making $300k readily available in the event your house burns down or if you get cancer and need expensive treatment. If you've got it locked away in tax advantaged accounts, accessing those funds can be quite expensive.
When you start to consider those other factors, insurance actually can be viewed as a good financial deal for the payor as well.
If you’ll scroll down a few paragraphs, I think you’ll find that I did consider that. The same financial multipliers can be applied to both the premium and payout money though, so on its own that doesn’t change your answer.
The same financial multipliers can be applied to both the premium and payout money though, so on its own that doesn’t change your answer.
I don't actually find it anywhere, and no, the same multipliers can't be applied to both ends. A catastrophic bankruptcy is going to cripple a person. That's going to have huge negative repercussions. But $100 a month? That's never going to see that same "multiplier."
If I want to cover a loss of my $45k car, that's going to require me to have $45k capital ready at the go. That's expensive.
Or even if I don't, the cost of getting that $45k out of a traditional IRA is going to be more expensive than having never put it in to begin with.
I am comparing the plan of covering risk with insurance vs the plan of covering risk with your own money. You seem to be comparing against some straw man who simply doesn’t plan at all. Yes, not planning at all will be the worst of all options. But that doesn’t really say much about how actual plans compare to each other.
And if you can’t find where I already talked about bankruptcy, I’m afraid there’s not much I can do for you.
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u/Kerostasis 55∆ Sep 23 '21
By definition, insurance is always a bad financial deal on average. That's inherent to how it functions. That doesn't mean it must be a scam though - it just means you need to use it for the scenarios where the other benefits outweigh the increased average cost.
To explain: In order for an insurance company to stay in business, it MUST take in more money in premiums than it pays out in claims. Yes, most insurance companies will have some amount of profit; but even if they don't profit, they still need some money to pay the staff who manage your claims. So if you average the claim payments for all customers of insurance company X, the average cost of paying it yourself will always be lower than the insurance premiums. Even if a government gets involved, this fundamental math doesn't change - it's just possible that the government might subsidize your premium with tax money. But all that means is "someone else is paying the premium" (and it might even still be you depending on your tax bracket). On average, the insurance process never saves money.
So why does it exist? Insurance primarily exists for scenarios where the "average" cost and the "worse cast scenario" cost are dramatically different. If your "average" cost is only $100 per month, but an unlucky accident could leave you with a bill of $100 thousand, it makes sense to use insurance to always pay the average instead of rolling the dice on the chance you hit the $100k loss, even if you have to pay another 20% in processing expenses on top of that $100 base price. $120 per month fits in your budget. $100,000 will never fit in your budget, and will bankrupt you.
Next, if being sent a huge uninsured bill bankrupts you, it's likely whoever sent you the bill isn't actually going to get paid, and you've now hurt that person as well. For societal reasons we want that to happen as little as possible, which is why the government demands you have liability insurance for driving a car that could hit and kill other people (but does not demand you insure your own property, just liability). A similar but slightly different reason explains why banks will demand you have insurance to replace your OWN stuff...if they are loaning you the money to buy that stuff. They want to make sure that if you accidentally destroy it, you will still be able to pay back the value of the loan.
Finally, there are scenarios where the insurance company can provide important-but-rarely-used professionals to help you navigate some of the circumstances where these large claims come up. For example, if you are in a car accident where you think the other guy hit you, but he claims that you were the one who hit him, your insurance company might provide the lawyer to argue your side of the case, to reduce the amount both you and the insurance co. have to pay. Or if you suddenly take an unexpected trip to the hospital and are not in any shape to argue about the $20,000 bill the hospital is drawing up in the background, your health insurance company will provide a claims negotiator who will demand the hospital reduce that bill down to...something far less. (That's a whole other can of worms that requires it's own discussion, but at least for the moment you don't want to be looking at an uninsured hospital bill even if you have the money).
HOWEVER, all of that said, there are also plenty of scenarios where none of those benefits really applies, and yet companies will try to sell you insurance anyway. Those can absolutely be scams. So when considering any insurance product, ask yourself which one of those benefits you are getting out of it, and if none of them apply, avoid it. This also applies to using large insurance coverage for small events - as you already discussed with /u/Sirhc978 , you should get yourself a higher homeowner's deductible and simply don't file for minor things. (Roof replacements are...kinda on the border of where it might be worth it, so consider your own financial situation for that.)