Part 1: Unnecessary coverage
At ONE we are bringing experience and a fresh mindset together to rethink insurance at it’s core.
At ONE, we don’t believe in selling coverage our clients don’t need. We offer flexible deductibles given our clients control over the level of coverage to suit their individual risk tolerance. If you are willing to cover your daily mishaps yourself you’ll enjoy attractive premium reductions, if you prefer no deductible that’s fine too. The important thing is that you understand the risks you are facing, develop a view on your risk tolerance and keep a critical mind when you are offered to buy insurance cover.
I recently came across an insightful study about our perception of risks thatmade me wonder about my decision process when buying insurance. I consider myself a reasonable person making rational purchase decisions but after reading the study I wasn’t so sure anymore.
“What is the purpose of insurance and what risks are really worth insuring?”, I wondered.
The study analyses the common misconception of risks by the public. It explains how psychological effects can significantly distort the perception of common risks and how the gap between perceived and real probability of an adverse event may lead to irrational decision making and unsuitable protection. See Risikowahrnehmung & Risikorealität by Profs. Horst Müller-Peters (TH Köln) and Dr. Nadine Gatzert (FAU Erlangen-Nürnberg) for the full text and put your risk perception Selbsttest to the test (both in German only).
Coming back to my question of purpose: I define Insurance as a means to provide (financial) compensation in the event of a loss. It lies in its nature that in general you don’t get anything in return for your money. So, one may conclude that insurance is disappointing and useless. Of course it isn’t, but it doesn’t always makes sense.
Insurance is a great thing in the event of a large loss
Insurance is a great thing in the event of a large loss. It can provide you that peace of mind necessary to live a carefree life. But as with the proverbial free lunch, insurance comes with a cost and it is a good idea to put some thought into what and how much protection you really need. I advise people to hedge against those risks that can cause substantial financial loss. The definition of“substantial” depends on the individual situation and there is no “one size fits all”.
For most people losing their home to flood or fire that represents a real threat. Equally, high value or hard to replace items: say your car or your diamond engagement ring are probably worth insuring (unless of course the guy’s a real jerk and you’re just looking for a reason to drop him anyways).
Insurance cannot compensate you for the emotional loss of losing irreplaceable things like your health, a loved one, or your ability to make a living but it can ease the financial consequences associated with such a loss. And insurance can protect you from claims (think an accident with a body injury) that have the potential to destroy the very basis of your existence.
These large risks with the potential to generate significant financial damage are the ones worth insuring.
Insurance industry has lost its way
So, one would assume that these risks were the focus of the insurance industry, however that’s not entirely the case. I get flooded with offers to protect from petty damages. When purchasing any type of ticket, even for the movies, I actively have to exclude cancellation protection. If I buy a new TV I am offered 5 years warranty extension (it’s probably outdated in 18 months) before moving on to purchase. And my credit card company hasn’t given up trying to lure me into credit balance insurance (in case of unemployment), travel insurance (if my luggage gets lost) or card cancellation service (if my card gets lost or stolen). Typically, these are small amounts that don’t hurt but they do add up to the whole sum.
I agree, being without your smartphone is a scary threat for some of us (much like the amputation of a primary limb, right?) but is it really such a life-threatening situation that you need really need a mobile phone insurance? Didn’t we say the other day, the new model was much cooler and we’re looking for a reason to upgrade. I am not saying these types of insurance aren’t justified at all but from an economical perspective they are a bad deal for most of the people (not for people who sell them of course).
As outlined in the aforementioned study we tend to misjudge the actual risks and thus focus on perceived frequent and small damages instead of the large and less frequent ones. We therefore spend a lot of money on small risks that would have been better invested in protection from those risks that can putour standard of living at jeopardy.