Which insurances should you buy?
An insurance salesman will tell you that you need to be insured for everything. But is that reasonable?
In Switzerland, there are a few mandatory insurances:
- Liability insurance if you’re a renter
- Car insurance if your own a car
- Health insurance if you own a body
But what about other insurances? Are they worth considering? Here are some principles that will help you decide.
How insurances work
Let’s start by outlining how an insurance works. An insurance assesses risk and risk is nothing else than frequency times consequences.
The frequency is measured in number of cases per year and the consequences are measured in Swiss francs. So let us take the example of a car insurance. And let’s simplify by assuming that the only damage the insurance covers is total damage. In other words: if the car is totalled, you get the value of the car but it’s just a scratch, you get nothing.
The consequence is the value of the car (let’s assume 20,000). The frequency can only be derived from experience. Assuming 10,000 accidents involving a totalled car per year and 10 millions car on the roads (completely made up numbers), that’s a frequency of 10,000 / 10 millions = 0.001 per year.
The risk is therefore 0.001 x 20,000 = 20 francs per year, which dramatically underestimate the actual risk, but remember that we only considered total damages. Let’s stick with that 20 francs figure for now. So can you expect to pay 20 francs in car insurance for total damages? Well, if you would only pay 20 francs, the insurance would on average earn nothing, because its revenue exactly cover its liabilities.
In addition to the 20 francs risk per driver, the insurance company must pay administrative and infrastructure costs and… make a profit. For instance, health insurance providers spent an average of 166 francs per policyholder on administration in 2017.
Insurances are usually a bad deal
The bottom line is that the price of the insurance is much larger than the risk, because of administrative costs and profit making.
What does that mean? It means that, on average, you pay more in insurance fees than the probable cost of the damage being insured. The key word here is « on average ». Because if you are a terrible driver, or just unlucky, and crash your car every year, you will obviously pay less in insurance fees than what it would cost to buy a new car every year. On the opposite side of the spectrum, some people pay an insurance premium every year for 50 years without ever filing a claim.
Never buy insurance?
Does that mean that you should never get insured for anything ever? Absolutely not.
Imagine that health insurance was optional. Since you’re young and healthy, and since you don’t want to overpay, you decide against subscribing that health insurance. Six months later: bad luck, you’re diagnosed with cancer. The treatment cost 500,000 francs a year (I’m not kidding, those are realistic numbers). Do you have 500,000 francs waiting to be spent? I’m going to assume that you don’t.
You could take a loan and pay that debt back at 12% interest for the rest of your life, like in the US. Or you will refuse treatment and die much sooner than expected.
The fact that you’re overpaying for the risk doesn’t mean that you shouldn’t buy the insurance.
There are two relevant questions when it comes to insurances:
- Can I afford the maximum consequences? If yes, move to the next question. If no, buy the insurance.
- Am I way more likely than the average person to have that happen to me? If yes, consider buying the insurance. If no, don’t buy it.
Phone insurance, worth it?
Let’s make this concrete: phone insurance. Can you afford the maximum consequence (the cost of a new phone, 800 francs)? In other words, do you have 800 francs somewhere ready to be spent to buy a new phone in case you break you current one?
If the answer is yes (and the answer should be yes, because there should be more than 800 francs in your emergency fund), then ask yourself: am I more likely to lose or break my phone than the average person?
If you’ve broken each and every phone you’ve ever own, then the answer is yes, and phone insurance might be a good deal for you. But if you’re not clumsier than the average person, there is no reason why you should buy phone insurance. You can instead act as your own insurer.
The best way to save on insurances is to only those worth your money. That is: those against consequences you can’t afford or those against hazards that you’re more susceptible to.