Explanation graph.

I feel that a lot of people don't understand the true cost of insurance, so I threw together this graph to help explain to anyone interested whether a person should purchase insurance or not. The same line of thinking applies to item warranties. Purchasing insurance, GENERALLY SPEAKING, costs more, on average, than not purchasing insurance and having to pay out of pocket to cover the costs the insurance company would have covered. However, that is CERTAINLY not to say you should never purchase insurance...

So, when should I purchase insurance?

• When the "worst case scenario" would ruin you financially. E.g. being sued, having to buy a new house, and very costly medical expenses.
• When insurance companies get discounts on the products they cover. This is sort of an everybody wins scenario. The most apparent example that comes to mind is medical expenses. If you didn't have insurance, you might have to pay $10K for an operation. With insurance, the insurance company only has to pay $4K because of their contract with the hospital/doctors. The risk premium you pay for the insurance may actually make it cheaper in the long run. I don't have any data to back this up though.
• When the worst case scenario would devastate you emotionally. If you simply wouldn't be able to get over the fact that you have to replace the $600 phone you bought last week and dropped into the toilet today, then that might be a reason for insurance. However, this is a clear example of emotions overriding good financial decisions.

So, when should I not purchase insurance?

• Any time none of the conditions above are met.