I'm curious how this math works. In my (quite likely incomplete) mental model of insurance, there are only a few terms: premiums, payouts, profits. It would seem that they have to balance. So if you pool risk, you are summing the payouts. Those payouts are covered by the sum of premiums. Any profit is the sum of premiums minus the sum of payouts.
Profits = Premiums - Payouts
Is this right so far?
Because then it seems that the expected value of insurance to the customer is the negated value of the expected profit of the insurer. Put another way: if the expected value of insurance is not negative, shouldn't the insurer raise premiums or exit the business?
Again, I know next to nothing about insurance and I'm asking to learn.
The point of insurance is to smooth risk, not to pool it. Pooling risk is not the point of insurance as a product; it's the mechanism by which that product (risk smoothing) becomes feasible as a business model.
> Look up the term "actuarially fair".
There's really no need to condescend by telling me to look up basic terminology; I am quite well-versed in this topic.
I didn't bring up moral hazard in this post, because it actually isn't necessary to explain why insurance has a negative expected value (which is equivalent to the statement that premiums are always non-zero[0]). It sounds like you're confusing a few different concepts here.
[0] Moral hazard is generally addressed by deductibles, not by premiums.
On an infinite timescale it may not add up but it surely can on any practical one, right?
from an individual perspective, insurance means you don't have to worry about unexpected expenses from things beyond your control (ie, peace of mind).
Now, the mechanism by which this is achieved may be described as a pool in that it's a single company with a pool of money that everyone pays into and the input into that pool necessarily must be greater than the output.
But from the "customers" perspective, insurance is peace of mind. ie, it smooths their total risk over time.
You will always have to worry about unexpected expenses, because insurance companies are never going to insure everything that could possibly happen, even if you get a good policy that doesn't dick you around on claims.
If you are expecting insurance to protect you from not knowing the risks, then you are taking a much bigger risk than not having insurance at all, because of the complacency that the belief you're insured engenders.
What I'm looking for is the ELI5 for what insurance really is about (especially from the POV of insurers) given that, if I understand correctly, 'chimeracoder is disputing the insurance-as-everyone-pooling-money model.
people and business purchase insurance to cover unexpected loss, ie, "peace of mind".
Maybe insurance companies are evil scumbags, but that's STILL the reason why people PURCHASE insurance.
But everyone seems to forget that there's a huge part of that pool taken by the things sitting in the insurance office's chairs.