Can we be safe? Really?? I wonder. I have noticed the Lac Megantic rail tragedy, the Calgary flood, the 777 crash in San Francisco that Sheryl Sandberg missed by a fluke, and the untimely deaths of James Gandolfini and several children left in overheated cars.
Events similar to these have happened before so to that extent they were foreseeable, but they were all unforeseeable as to specific people, specific places and specific time.
That is the nature of risk. There are not many things truly unforeseeable. In physics there is the thought that unless something is specifically prohibited, it will eventually happen.
It is the time, place and people uncertainty that creates our idea of risk. On an individual basis in a particular time and place things are unpredictable, even unforeseeable. In collective society, the same things are certain.
That certainty taken over all of society, and that uncertainty for an individual is the philosophical underpinning for insurance.
An example. There is a small but non-zero probability that my house may burn down. Similarly yours might or maybe that of any of the thousands of people we know or know of. Individually there is a small probability, but for a large group, it is certain.
For example, if the probability of a house burning is one in 10,000 then for a group of 7,000 people there is a 50-50 chance that a house will burn within a year. The risk relates to which one. Over a 5 year period there is only a 3% chance that all 7,000 will survive unscathed.
Here is why we have insurance.
One house burning down is not the same thing as each one burns 1/10,000 down. If it is your house, it either burned or did not. There is no gradation. So we say to ourselves, I don’t like the all or nothing nature of the outcome, even though it is improbable that I will have a loss. If it happens I lose large.
Suppose each of the 7,000 members of our society decide to share the risk. Fortunately, each house in our group is worth the same. $350,000. Each of us throws $50.00 into the pot and when a house burns down, the unfortunate takes out the money and rebuilds.
Here in the real world, your fire insurance is not $50 a year. There are reasons.
Regardless of whether we use a skilled intermediary like an insurance company, the point of it is the same. Individually we do not want the all or nothing risk of a loss. We know it is certain somewhere, and we are willing to pool resources. We accept the premium as being a controlled and affordable way to avoid the unaffordable, near random loss.
When you think about insurance do you first think about the premium or do you first think about the magnitude of the potential loss?
If you think about the premium and then avoid the insurance because the loss is so improbable, then you are not being fully rational. Good plans deal with all the facts.
By refusing the insurance you are choosing to believe that you have a way to manage the loss if it occurs and you can do so for less than the premium the insurer wants.
At this point, you need to consider that insurers know the odds. As in know precisely. You do not. Self insuring does not change the risk. It remains the same. Only the method of paying for it will change. A little now or a lot later.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.
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