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The Rational Approach To Buying Insurance - The Money Habit

https://www.themoneyhabit.org/the-rational-approach-to-buying-insurance/

themoneyhabit.org

The Rational Approach To Buying Insurance - The Money Habit
Ever get stuck in the details of an insurance offer? With a thousand different kinds of health insurance and warranty offers for all kinds of products out there, here's a rational framework from our guest poster, Stuart, on how to decide what insurance to buy.

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Insurance Is A Bet

Generally, insurance is understood as a bet. We pay a premium and are secure about some uncertain future costs which may be substantial for us.

If we check the calculations of our monthly insurance payments, it would seem we are losing money, and this bet is only profitable for the insurance companies.

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The Insurance Calculation

The calculation for insurance runs like this: The company is profitable when the cost of premiums that we pay is greater than the future claim that we may ask for (having a certain probability).

Cost of Premium > (Cost of claim) x (Probability of claim)

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Reasons We Buy Insurance

  1. We believe that the probability of us experiencing the event that we are insured against is high.
  2. The claim that we may get in event of something happening is substantial with the cost of premium being on the lower side (basically a bargain).
  3. To offset substantial costs by paying less. This is when we know it's a bad deal, but the potential risk can be catastrophic and severe, so we are happy to pay more to avoid a probable calamity later.

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