To Insure Or Not Insure

To insure or not to insure is one of those age-old questions. In fact, even before the invention of money, communities of farmers promised to help each other out in case of any disaster. 

In the time of ancient Babylonia, merchants sold loans which included a premium. When the ship that was bought with the loan would go under, the merchant was freed from the obligation to repay the loan. The oldest form of travel insurance in the world!

The idea behind insurance is simple and attractive. The probability of being hit with misfortune is very small, but the impact on your life is huge. A natural disaster could literally wipe out everything you have. Insurance allows people to work together and transform this small probability, high impact misfortune into a high probability, small impact event: the payment of an insurance premium. 

The risk is spread over thousands of people, reducing the potential burden on everyone. When misfortune does hit, they are compensated. 

Insurance companies make money from two sources. First, they try to collect more premiums than they pay out in claims. However, many insurance companies spend an equal amount on administration and claims as they collect in premiums. 

Second, because there is a significant period between the collection of premiums and the payment of claims, insurance companies sit on a large pile of money. This money is meant for future claims, but in the meantime, they invest it and reap the return.

Insurance is popular because it appeals to human nature. First of all, it reduces uncertainty, something which most of us dislike. Second, it significantly reduces loss to a fraction of the previous potential loss. Third, it allows us to look at a time horizon that we can easily oversee and understand, typically a year.

How do you decide if you should take insurance or not? 

Here are my top five tips.
Tip 1: Always take the long term view. The insurance premium for every trip and every smartphone probably seems quite reasonable. But if you add up the insurance premiums for all the trips and smartphone in your life, you are very likely overpaying. 

Tip 2: If you wouldn’t be able to recover from the incident, insurance is a good idea. Only take insurance for those incidents that would leave you financially destroyed. This means fire insurance for your house makes sense, but insurance on your TV or washing machine does not.

Tip 3: Always understand what is included and excluded. Does the insurance for your house also cover a flood or earthquake, or only fire? Some medical insurance only grants a limited pay out. This is contrary to the basic idea of insurance, namely to help you out in those instances in which you cannot afford by yourself.

Tip 4: Be skeptical about who is selling you insurance. Always question them thoroughly about their credentials and the product itself. They might omit certain limitations or exclusions and exaggerate risks. People selling insurance get paid on a commission basis, which means they have a vested interest to sell you insurance and might even have a financial preference for a certain insurer.

Tip 5: Make sure you don’t over insure. Your medical insurance probably also covers your broken leg abroad, which means you are mostly paying double if you take additional travel insurance.

Of course, some insurance is mandatory by law (for example car insurance). Which insurance you should take ultimately depends on your individual financial situation. 

Author: -Mark Reijman is co-founder and managing director of Compare Hero