Why Do People Buy Life Insurance?
The classic circumstance of the ideal insurable risk is when the potential loss has extreme financial consequences but the probability of such loss is low. The economic model is that an insurance company can collect a relatively small premium from the many who have similar risk profiles, earn a reasonable profit, and have sufficient reserves to cover the liability should it occur.
Seemingly contrary to that model, life insurance is a contractual arrangement in which the policy owner makes periodic payments to a life insurance company on behalf of an insured so that there will be a substantial income tax-free cash amount paid at the insured’s death, no matter how soon that might happen, and even though-but for timing-the event is a certainty. What makes life insurance work, then, is that in large groups (one million or more) of individuals, there is a high degree of certainty on how many of those one million will die each year. During times of plagues, wars, peace, and terrorist attacks such as 9/11, the likelihood is fairly constant that in a group of a million 37-year-old males, one thousand will die this year.
No one can say when a specific individual will die. Thus, insurance companies can create a viable economic model to insure certainties, as long as the distribution of risk is determinable.
Because we don’t know when someone healthy enough to qualify will die, the timeframes are likely to span many decades, making life insurance a financial intangible. Furthermore, life insurance is not typically thought of as something one would touch or "enjoy" during the life of the insured. So with almost $1.6 trillion "individual" (as opposed to group, credit, etc.) life insurance policies purchased in 20002, why do people buy so much life insurance? Of course there are many reasons, but at a practical level it boils down to this: We buy life insurance and Home insurance either because we love someone or because we owe someone.
