Summary: Insurance pools your risk of a possible large, future expense with others, allowing you to reduce your exposure to the large expense in return for making smaller, known payments. However, the expected value of insurance is always negative, and it can be extremely negative - in some cases, it is a hugely expensive way of purchasing a little peace of mind. And often this peace of mind shouldn't be needed (e.g. replacing gadgets) or insurance is not the best way to achieve it (building up a large savings fund is often far better).

Generally, it makes financial sense to pay others for insurance only for very large potential costs that vastly exceed your savings (e.g. your house burning down) or if you are at a significantly higher risk than average but your premiums are not proportionally higher.

Conventional advice is that most Australians are underinsured. In reality, most Australians will waste tens of thousands of dollars over their lifetime on insurance. In this post, I will provide guidance on working out the few exceptions where paying for insurance may be worthwhile.

Gain: ~$2,500 / year. I pay for no insurance other than two exceptions:
- $185/yr value-for-money "Extras" health insurance that costs less than the dental and optical expenses I would otherwise pay.
- Travel insurance only for the high-risk exceptions like medical costs in the United States.


Details:

1. Understand how insurance works and why enlightened consumers - who self-insure and only purchase insurance in exceptional cases where it's really worthwhile - are guaranteed to be better off 

See the below articles:

> Mr Money Mustache - Insurance: A Tax on People who are Bad at Math?


2. Some additional things to consider about insurance

- Overall, the insurance industry is a gigantic rip-off to the tune of tens of billions a year just within Australia (profits of the insurance industry + most operating costs + wastage on lawyers, etc).

- Insurance is also the biggest laziness tax of all. Those who bother to understand it and self-insure wherever it makes sense are thousands of dollars a year better off than the average consumer who sticks with conventional advice (e.g. pay for all types of insurance you can afford) and default options they don't opt-out of (e.g. paying for life, disability and income protection insurance via superannuation).

- Those who aren't lazy also find and purchase the best value-for-money insurance for the exceptions that are worthwhile. For example, I almost never purchase travel insurance but do so for the high-risk exceptions like medical costs in the United States or when the value-for-money considerations justify it (a 3 month trip through Africa). Also, if worthwhile travel insurance can be had for free via using a credit card, I'll expend the effort to do so.

- For those who build up significant savings that are wisely invested and accessible when needed, only the few types of insurance against catastrophic financial losses (e.g. your house burning down) need to be considered. All other types of insurance for non-catastrophic expenses (e.g. pet insurance, funeral insurance) should never even be considered.

- Even consumer advocate organisations, who have to be very cautious about general advice about insurance not being worthwhile, clearly warn that some types of insurance are almost never justified. Such as: lender's mortgage insurance, credit protection insurance, funeral insurance and most extended warranties. The list is actually much bigger (there are dozens of types of insurance that are virtually never worthwhile), but the fact that a mainstream organisation mentions even a few types is indicative of the problem.
See: Choice - Do you need insurance for that?

- Remember, an enlightened, diligent consumer is one who makes their own, informed, judicious decisions on what's really worthwhile. So while I have never taken out an extended warranty on any other product, I did recently pay $150 for a 3 year extended warranty on a washing machine - taking the guaranteed cover to 5 years. This is an exception as we just had a child, are using cloth nappies, and suddenly doing a hell of a lot more washing than the average household. Based on extensive research, the extended warranty was judged to be a better alternative to spending at least as much purchasing a more expensive machine that still has a considerable failure risk and have a minimum $150 callout fee for repair.

- Many types of insurance can be taken up temporarily only when needed and then dropped again. For example, dental repair can be expensive but you can take out sufficient "Extras" health insurance cover, serve the waiting period (often promotions will reduce this), get your dental work done, and then drop your cover or reduce it to a minimum.

- Ensure you appreciate the factors that will determine whether each type of insurance is worthwhile for you. Such as: your risk tolerance; dependents; safety net provided by family, friends and government; the real extent of uncertainty involved (e.g. size of the future, possible expense) and whether there are other things you can do to mitigate it.

Make sure you understand the insightful comments (e.g. Bill June 8, 2011, 10:22am) on articles like: Mr Money Mustache - Insurance: A Tax on People who are Bad at Math?


Further Info:

Mr Money Mustache
> Insurance: A Tax on People who are Bad at Math?

The Age
> CommInsure Exposed
> Devils are in the detail in super life insurance

Choice
> Do you need insurance for that?