Sharing risk
Insurance spreads risk across many people. Each pays a premium; the insurer uses the pool to pay the few who suffer losses.
Key terms
| Term | Meaning |
|---|---|
| Premium | what you pay (monthly or yearly) |
| Deductible | what you pay out of pocket before coverage starts |
| Coverage limit | the most the insurer will pay |
| Claim | your request for payment |
| Policy | the contract |
Deductible trade-off
Higher deductible → lower premium (you take on more risk).
Example: Car insurance
| Deductible | Annual premium |
|---|---|
| $500 | $1,800 |
| $1,000 | $1,620 |
Savings: $180/year. If you make a claim, you pay $500 more. If claims are rare, the higher deductible may save money.
How a claim works
Example: $3,200 of damage, $500 deductible.
- You pay $500.
- Insurance pays $2,700.
Common types of insurance in Canada
| Type | Covers | Notes |
|---|---|---|
| Auto | damage, injuries, liability | mandatory in every province |
| Home / tenant | property, belongings, liability | required by mortgage lenders |
| Life | income for dependants if you die | term or permanent |
| Health and dental | costs not covered by provincial health plans | often through employers |
| Travel | medical costs outside your province or Canada | strongly recommended abroad |
| Disability | income if you can’t work |
Insurance and expected value
Insurers set premiums above the expected payout to cover costs and profit, so insurance usually has a negative expected value for buyers. It’s still valuable because it protects against large losses you couldn’t afford.
Example: P(house fire this year) = 0.002; damage $300,000.
Expected loss = 0.002 × 300,000 = $600. A premium of $1,000 is "worth it" for protection from a $300,000 disaster.
Risk management strategies
| Strategy | Example |
|---|---|
| Avoid | don’t do a risky activity |
| Reduce | smoke detectors, safe driving, locks |
| Transfer | buy insurance |
| Accept | self-insure small risks (e.g., skip a phone warranty) |
Risk management means choosing the right mix.
Factors that affect premiums
- Age and driving record (auto)
- Location (crime, weather)
- Value of what’s insured
- Claims history
- Deductible chosen
Worked examples
Example 1: Damage $1,800, deductible $1,000. Insurance pays? $800.
Example 2: P(loss) = 0.01, loss = $20,000. Expected loss? $200.
Example 3: Which strategy is installing a smoke detector? Reduce.
Common mistakes
- Choosing a deductible you couldn’t afford in an emergency.
- Underinsuring valuable property.
- Insuring small, affordable losses at high cost.
Try it yourself
- Damage $4,500, deductible $750. Insurance pays?
- Premiums: $1,400 with $500 deductible or $1,250 with $1,000 deductible. Annual savings?
- Expected loss: P = 0.05, loss $2,000?
- Name the four risk management strategies.
Answers: 1) $3,750 2) $150 3) $100 4) avoid, reduce, transfer, accept
Quick recap
- Insurance transfers risk for a premium.
- A higher deductible lowers premiums.
- Use risk management: avoid, reduce, transfer or accept.