The insurance company doesn’t operate free of expense. It has staff to pay, buildings to buy or rent in which to carry on its operations, equipment and supplies to pay for, and, in the case of insurers with a profit motive, owners to pay. The combination of premium dollars and investment returns must provide enough for all these expenses, in addition to paying claims. In this way, the process of providing insurance coverage has built-in friction that takes some of the premium dollar and consumes it before it can be paid to the poor guy whose car gets totaled by someone texting while driving.
It’s said that over our lifetime, we pay for our own losses. Year by year as our ongoing income provides the available funds for us to pay for premiums, most of us give our insurers at least as much as they’re likely to give us back.
Relatively few people will experience catastrophic losses that are covered by an insurance policy. Over time the rest of us will pay for all the claims on which we collect from our insurers.
So if we’re being paid for small, frequent claims (think of a health insurance policy with a $100 deductible), we’re trading dollars with the insurance company. (“Here’s my $800 premium this month. Oh, and thanks for the $200 for the dermatologist.”) But every dollar we get back from the insurer in the form of a claim payment has, over our lifetimes, likely cost us more, because the insurer has already taken out its overhead and profit.
This is why it makes sense to self-insure reasonable, controllable amounts of our insurable risks. Even though it may cost us more in a given year, over time, it’s more cost effective to cover what we can handle ourselves using our current income. It puts less of our money into the hands of the insurer to be burned up in their internal costs.