Monday, December 29, 2014

4 Quadrants Relating to Insurance

If you are diagnosed with a disease and you know you have roughly six months to live, should you purchase life insurance?  If you have a home which has a 50% chance of being flooded in the next year, should you purchase home owner's insurance?

This is an interesting question.  From www.securitymagazine.com, we are going to discuss this issue from a risk frequency standpoint.

The above questions include high risk, high frequency situations.  The truth is that if you are almost certain something will occur, it is not a good idea to insure against it, as the insurer will charge extremely high premiums.

Likewise, a low risk, low frequency situation would be purchasing insurance to cover your the door know on a home.  The risk of losing the door know is extremely low and the likelihood of something happening to your door knob is extremely low, meaning that you do not need insurance.

Check out this chart (from www.securitymagazine.com):

High Risk High Risk, High Frequency High Risk, Low Frequency
Low Risk Low Risk, High Frequency Low Risk, Low Frequency
High Frequency Low Frequency


If something occurs often but has little risk, you do not want to insure against it.  A good example is purchasing insurance when playing blackjack.  The risk of losing the round is small compared to how often the dealer has blackjack so insurance is not a good buy (see www.casinopeople.com).

It turns out the situations you want to insure are high risk, low frequency situations.  The likelihood that you will prematurely die over the next ten years might be close to 2%, however the risk is huge if you have young children you are raising.  This is the type of event to insure.

Did this article give you some good information?  Did you know that about insurance?

This post was reposted from http://finlit.biz/life-insurance/4-quadrants-relating-to-insurance/, originally written on February 9th, 2013.

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