We purchase insurance to alleviate the occurrence of catastrophic events that would cost an inordinate amount to overcome. For example, my Pancreatic cancer operation, including chemo-therapy and radiation cost roughly $120,000. At some future time, I will address why this should not cost this much. I could have paid for it from my savings but it would have reduced the amount I had put aside to supplement my retirement. Most people do not have this amount of cash available without selling or mortgaging their home and if you have no home or assets to mortgage or sell you may be forced to borrow. If you have no job, you will not be able to obtain a loan so insurance comes to the rescue, only if you still pay the premiums.
Not everyone will require Pancreatic cancer therapy or will undergo such costly methods of correction and mathematicians, particularly those skilled in statistics can make reasonable assumptions, based on statistical data to predict how many people will actually need Pancreatic therapy or most any other therapies where sufficient statistics exist. It is how insurance companies predict life expectancy when they sell life insurance. Everyone is going to die and statistical analysis tell the insurance companies expectancies for various classes of individuals. After all, they are in the business to make money and there have not been very many bankruptcies in the insurance industry and when there were, the government stepped in and bailed them out because they are a government protected monopoly, just like the banks.
Let’s say 30,000 policies are sold to cover catastrophic healthcare costs. All of these policies contain a deductible clause that negates the coverage of individual claims under a certain amount to avoid nuisance claims. Medicare has the same effect by covering nearly all claims but paying only 80%. If you are not covered by Medicare and fall into a specific dependency category you may qualify to receive a government subsidy through Medicaid another scheme that insures the medical profession and the insurance companies who pay them will not have to provide a service without being compensated.
Let’s estimate that the cost of these 30,000 policies, with a $6,000 deductible cost $12,000 per year and cover a family of four. That means the insurance company is collecting $360 million per year from its participants. This would pay for 3000 Pancreatic cancer operations, but of the 120,000-people covered it is highly unlikely there would be that many and statistics of just how many each year for this cohort is reasonably well known. Therefore, the insurance company knows, with a reasonable degree of accuracy just how much it will have to pay out of the $360 million it takes in. Some of the difference is taken up in administrative cost and what remains is profit. Let’s say it amounts to an actual cost to each participant of $1,000 per year. Instead of returning this amount back to the policy holders, the insurance company invests or loans this money at interest. After 12 years the company has a nest egg of the equivalent of 1 years’ worth of premiums and growing.
The medical cost example is just the tip of the iceberg, home insurance is ever worse in that, at least in my community, very few houses experience a total loss in any given year and in many years, there have been none. It is why insurance companies can offer you term life policies at such low rates, because the payout versus the premium income is in an area where statistics are the most accurate and voluminous. Insurance companies compete only on the amount of greed they are willing to forego.
The insurance industry exists only because of the economic system that has been adopted by every society in recorded history. It is totally unnecessary and why is described in my book The Real Economy because an alternate economic system, I also describe, would make it redundant. Not only would you be able to pay for whatever it was that you needed, you would be able to pledge future income if you had not saved enough to cover an unexpected cost.