Why is insurance so...
Insurance is complicated because it’s hard to put a price on peace of mind
Insurance is (seemingly) expensive because paying for peace of mind seems perverse
Insurance is important because it removes barriers to transact, allows you to do stuff and gives you a sense of security
Insurance is a very special product. It’s the only product you buy you never wish to use. Unlike an iPhone or a company’s stock where you can touch it or measure the value of it, insurance is something you just kind of pay for and get seemingly nothing in return. In fact, you’d be glad if you never have to use it. So, you might ask yourself why is insurance so complicated, expensive and what makes it so important? Read on, reader.
Why is insurance so…complicated?!
Pricing an insurance policy, or underwriting it, is a very complicated science. Putting a price on the probability of a myriad of things happening based on your specific profile is not easy. Like the concept of interest rates when borrowing money, the riskier you are – say you’re a male, in his mid-20s, with a speeding ticket – the higher your auto insurance premium will be because the computers have calculated the likelihood of you getting in some sort of accident within the policy period is higher.
So, the insurance company will charge you more to take on that risk protect you.
This is the biggest risk to an insurance company: mis-pricing the risk. Actuaries get involved and come up with their best estimates to price certain risk factors like age, gender, health, driving record and countless other factors to be able to calculate the insurance premium. But even with all the computers and smartest actuaries, no one can tell the future and pricing will always be wrong, but the trick is getting it less wrong as much as possible.
So why is insurance so complicated? It’s simple really because the future is uncertain and there is no right answer.
Why is insurance so…expensive?!
Insurance is expensive because it feels like we’re just paying for nothing. It’s like a scam we’re willing to and sometime even required to pay for. The product itself is not something we can use or play with so it’s hard sometimes to rationalize why we’re paying for insurance in the first place.
But insurance is not expensive it just feels that way. What you’re paying for is peace of mind that in the event of something unexpected like a hurricane that destroys your home, a freak car accident or an unforeseen medical emergency, you’ll be protected. Now different insurers may price it higher or lower than other companies so don’t be afraid to shop around and find the best price for you. Because protecting you should be affordable.
Why is insurance so…important?!
It’s clear that insurance plays a crucial role in mitigating risk. Protecting yourself from the unexpected is not only smart but sometimes necessary to buy and do things. To buy a home, for example, mortgage companies require homeowners to have both homeowner’s insurance and sometimes mortgage insurance as well. To be able to drive legally, states require drivers to have auto insurance.
Insurance is important because it ensures that we’re protected but it also gives others confidence to be able to transact with us and incentivize good behavior.
Hopefully the words above shed some light into why insurance us such a confusing concept and provided some clarity as to why it is the way it is.