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Insurance is Essentially a Scam

2017-01-31

Scam seems like a very strong word. Is this really true or just a big exaggeration? Actually, it is true. The fact of the matter is that, on average, you're better of saving your money than paying insurance premium.

How can this be true though? Aren't we getting something in exchange for paying the insurance. That's how all trade works right, you give something up which you value less, in return for something which you value more. A net gain.

But here's the thing, when you're paying insurance, all you're doing is giving money, in exchange for money. That is, you aren't trading one thing for something else which you value differently. You get the same thing back as you gave up.

Some people are quick to point out that what you're actually trading is risk. You give up the risk of having to pay a lot of money all of a sudden at some point in the future in exchange for a smaller fixed payment every single month. And this thinking isn't wrong, but it's also not quite right.

The reason is that we naturally have a very strong biases called loss and risk aversion, and because of this we buy insurance for things like computers and smartphones, even though these aren't actually very expensive items. If you can afford to buy one – you can afford to buy an other one. And you will soon anyway because they get outdated quickly.

The very same thing is true for more expensive things like cars and even houses. If you can afford to buy one, you can afford the tiny tiny risk that it'll burn down. However, you can actually buy a house even though you can't really afford it through easy credit. If you're in that situation, you do need insurance (but selling the house would be better).

Also, on the off chance that your house burns down without insurance, you can always rent. Owning a house isn't nearly as good a deal as people often think, when you take everything into account.

But what's the downside?

So far, we've mostly talked about how we don't really need as much insurance as we often buy. But why not get insurance? It's insurance. It does protect us from bad risk. Maybe we don't need it but it's not a bad thing to have, right?

Well, having a thousand t-shirts isn't really a bad thing – T-shirts are useful. But if you don't need that many t-shirts then buying them is a waste of money. Buying insurance is worse than that because you don't even get your money's worth.

Imagine you own an insurance company. Your customers pay you 100 000 dollars every year, and every year some of those customers have accidents. How much money could you give those unfortunate people and still keep your business running?

You can't give them any more than 100 000 – that's all you've got. But you also have to pay your empoyees, and pay for offices etc. You also want to make some profit, that's why you own the company. So maybe you give them 90 000 dollars.

As you can see, the insurance company must give less money back than it takes in in payment. That's why you can only lose money by buying insurance, and why it is indeed a scam.

However, you must not neglect to save money yourself! If you don't get insurance, you absolutely should save money into your own "insurance fund" to be able to pay for unexpected costs in the future. But how much should you save?

To save 10% of your income is very common advice, and it's good advice. There's nothing wrong with saving more if you can, but you should never save less than 10% of your income.

An other thing you can do is actually call the insurance company, ask them how much it will cost, but, don't buy the insurance, save the money yourself. With your own "insurance fund" you won't lose any of the money to employees, offices or someone elses profit.

What if something happens tomorrow?

If you haven't already been saving money, throwing your insurences away might not be the best idea. You need to transition gradually. You've developed a lifestyle where you always use up all your money, and now it's time to change that.

It will be though at first, because you'll have to keep paying the insurance while you also save money for your own "insurance fund". But it's worth it, because as you save more and more money, you can get rid of your smallest insurances (for electronics for instance), or at least not get any new ones.

As you build up your "insurance fund" you can neglect more and more of your insurances as you feel comfortably covered by the amount you've saved.

Freedom

An other thing which is really hard to completely grasp until you do this yourself is the massive amount of freedom, options and peace of mind having saved your own money gives you.

As you save more and more money, you realise that you can make different choices in your life and that will make you feel so much better – even if you don't actually do anything differently.

Simply knowing, that if you lose your jobb, you'll be just fine, can make you into a completely different person. In fact, you may even safely quit your jobb and search for a better one without having to worry too much about money.

If you're having a child you can take time off for that, or even to sail around the world if that's something you'd like to do. But the most powerful thing of all is simply knowing that you could – even if you never do – your life will be much better.