Arnold Kling

Don't Buy Insurance

Arnold Kling, Great Questions of Economics
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Insurance companies always make money in the end, as this Washington Post article on homeowners' insurance reminds me.

It's a game in which actually tapping into the insurance protection they think they've paid for may toss the insured out of the game, and many homeowners are finding out about the new rules the hard way.

As an economist giving advice on personal finance, I recommend buying the least insurance practical. Moreover, never make small claims.

For life insurance, buy only term insurance, and only if you have clear dependents. For health insurance, get only catastrophic coverage (high deductible, high limit). For car insurance, do not buy collision coverage, because making a claim will cost you more in future insurance rates than paying for repairs yourself. Never pay for an "extended warranty."

Daniel Kahneman, who shared this year's Nobel Prize in economics, found that people suffer from "loss aversion." What this suggests is that you will tend to pay too much to avoid a loss. Loss-averse behavior tends to take money out of your pockets and put it into the pockets of insurance companies.

Discussion Question. If you take out extended warranties on every product that you buy, the chances are that you will be able to use at least one of them. Should this reinforce your decision to buy extended warranties?

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