Why life insurance isn’t a gamble, even if it never pays out

Colin Lalley 1600


Colin Lalley

Colin Lalley

Insurance Expert

Colin Lalley is the Associate Director of SEO Content at Policygenius in New York City. His writing on insurance and personal finance has appeared on Betterment, Inc, Credit Sesame, and the Council for Disability Awareness.

Published March 31, 2017|5 min read

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Did you know insurance and gambling have a shared history?It’s true. Lloyd’s of London has its roots in people wagering whether or not ships would arrive at port. Now it’s one of the biggest insurance businesses in the world.And many people continue to think of insurance as a gamble – a wager between between the insurer and the insured, with whoever pays out the most over the term of the policy being the loser.While insurance may have grown out of gambling, drawing deeper connections between the two is dangerous, especially when thinking about how insurance factors into our daily lives. If you put money into a card game and come out with nothing, you’re a loser. If you put money into an insurance policy and come out with nothing, that actually means you made out pretty well!

Skepticism about the value of insurance runs sky-high. A lot of this has to do with basic human psychology – specifically, loss aversion. Put simply, people are weird. Put a little more complicated, loss aversion says that we’re more concerned about losses than we are with gains. We’re more upset about losing five dollars than we are happy about finding five dollars.Is it irrational? Sure. But it’s also a powerful impulse. It demonstrates why so many people don’t want to "lose" money paying for life insurance despite the peace of mind it provides—and it clouds the reality that not having life insurance is a bigger risk than it never paying out.

First, a chart

In order to illustrate the point, here are the possibilities when it comes to life insurance and your luck.

Let’s go through it quickly:

  • Box 1 represents an idealized world – you don’t pay for insurance, but that’s okay because you don’t need it. You get to keep all that money to yourself.

  • Box 2 is the second best situation — you spend some money on insurance, but never use it. In the context of life insurance, this means you outlived your coverage. Congrats!

  • Box 3 is the situation where you, unfortunately, die. But at least your family gets the financial safety net they need.

  • Box 4 is the worst situation – you die, your family can’t make ends meet without your income or has to drastically change up their financial plan. No one is happy with this outcome.

Playing the life insurance odds

The outcomes are pretty obvious. But the thing you need to keep in mind is that this isn’t a spectrum. You don’t fall somewhere on a line. It’s binary. Either you’re insured, or you’re not. Either something bad happens to you, or it doesn’t.If you’re not insured and something bad happens, you automatically go from box 1 to box 4. (Or in the case of life insurance, your family does.) You lose access to the entire middle ground of boxes 2 and 3. You have to hope that nothing bad happens to you. Here are some sobering facts:

These might not be high numbers in the grand scheme of things, but they’re also non-zero. Here’s the thing: Given a sample of 100,000 people, there are some statistical certainties about how many calamities will occur to the group at large. But every individual will tell you, "it won’t happen to me." It’s just human nature.It’s also irrational, since in reality we know bad things will happen to some of them. And if that would put your family in financial straits, wouldn’t you want to take some action to prevent that?You don’t have a say in the bad things that happen to you. Even if you take all of the necessary precautions, bad genetic disposition or a freak accident can cause your life to take a turn for the worst.But you know what is within your control? Whether or not you have life insurance. Cold, rational calculation is your only real way of reducing the influence of chance in your life. In this sense, buying insurance coverage is the opposite of gambling.In reality, not buying life insurance, knowing you’re betting that nothing bad will happen to you, is the real gamble.

You shouldn’t want to use insurance

Here’s the secret about insurance – life insurance, health insurance, car insurance, whatever: you shouldn’t want to use it.No one gets jealous when their neighbor has to make a claim with their auto insurer after their car is totalled. No one says, "I finally got cancer, now I can put that health insurance to good use." And no one will tell your grieving family how lucky they are that you died. I mean, they’re sad for you, obviously, but at least that life insurance policy didn’t go to waste.Insurance is a safety net. The definition of insurance is literally "just in case." You don’t buy it because it will pay out. You buy it in case it has to.You win if it doesn’t pay out because you’re still alive. You win if you’re insured when you do die, because your family is taken care of (admittedly, this is less of a win-win scenario than the previous one, but still). You lose if you’re not insured and you’re constantly worrying about what will happen to your family if you die. And you definitely lose if you die when you’re uninsured.

Return of premium life insurance

Okay, by now you’re probably convinced that life insurance is not a gamble and that you should be concerned with the peace of mind it’s providing rather than whether or not it’ll make you money.But there are contrarians in every crowd. So for those of you who still don’t want to "waste" your money, this is for you:You can get your life insurance premiums back.That’s right. A return of premium life insurance policy is one where, minus very negligible fees, your premium payments are refunded to you at the end of the term (assuming the death benefit hasn’t been paid out, of course). There are a few catches – it’ll raise the cost of your life insurance policy slightly, and your eligibility might be limited by the carrier, term length, and coverage amount – but if you’re really concerned about the money you’re spending on life insurance, it’s worth looking into.The important thing to remember about life insurance is that it isn’t for you – it’s for your family. It’s not there to deliver a return. There are a hundred different ways of investing if you want to make money. Life insurance provides valuable peace of mind, and it’s hard to put a price on that.