International Styles

Life Insurance Changes Uncertainty into Certainty and Is the Opposite of Gambling

Although life insurance serves indirectly to increase the productivity of the community by eliminating worry and increasing initiative, its direct economic function is to change uncertainty into certainty and thus enable the insured to transfer the hazard of premature death to the insurer at the lowest possible cost. The real gain from life insurance is due to the combination of many separate risks into a group with a view to making possible the "substitution of certain for uncertain loss". As already explained, the larger the number of separate risks comprising a group, the less uncertainty will there be as to the amount of loss, and the less the uncertainty of loss the smaller will be the premium that the company needs to collect annually from the insured.

This function of insurance is perhaps most readily understood in connection with fire insurance. Thus let us assume that each of 5,000 persons owns a house valued at $10,000, that all the houses are alike, and that the annual loss by fire as regards the entire number, although varying slightly from year to year, averages one-half of 1 percent, of the value, or $50. In the absence of any system of insurance making possible the application of the law of average, it is clear that none of these owners can effect any arrangement which will place them in a position of absolute security. At best they can only anticipate their uncertain losses by practicing self-insurance, i.e. by increasing their rentals by an amount considerably in excess of the average annual loss of $50. But even assuming that they can increase their rentals by four or five times the amount actually necessary under a system of insurance, they will still remain subject to a large gamble. At the end of the year the great majority of these owners, since they suffer no loss, would have the entire extra sum collected from tenants as a clear gain, while as regards those unfortunate few who suffer a total loss the extra sum collected would prove woefully inadequate to indemnify the value destroyed.

But let us now assume that these 5,000 house-owners can combine their risks into a group. By doing this they can substitute for the great uncertainty of loss which confronted them as individuals a certain definitely known loss, amounting on the average to $50 per house and $250,000 for the group. This sum plus a proper addition for expenses, contingencies and reasonable profit, is all that the company needs to charge in order absolutely to secure these owners against the risk of loss by fire". The risk that an insurance company carries is far less than the sum of the risks of the insured, and as the size of the company increases the disproportion becomes greater". Now just as each house-owner was enabled to use fire insurance to substitute certainty for uncertainty at the lowest possible cost, so it is also possible through life insurance to hedge against the uncertainty of life by providing for the payment of a definite sum of money at death, whenever that may occur, to replace the economic value of the deceased individual. From a family and business standpoint nearly all lives possess an economic value which may at any time be snuffed out by death, and it is as reasonable to insure against the loss of this value as it is to protect oneself against the loss of property. In the absence of insurance we saw that property-owners could at best practice only some form of self-insurance, and that it was impossible for them to effect any arrangement which would give absolute certainty.

Similarly, in the absence of a system of life insurance which makes possible the application of the law of average, no arrangement can be found which will render certain the indemnification of the value of a human life lost through death. The practice of saving such a sum in anticipation of probable death by no means takes the place of insurance as an agency in substituting certainty for uncertainty, because saving requires time and death may occur before the savings fund has reached an appreciable size. Unlike the practice of saving a life-insurance policy means certainty because it guarantees a definite estate from the moment the first premium is paid. Moreover, it furnishes this element of certainty to the public at the lowest possible cost since the companies are enabled through the combination of many risks to determine the exact average cost of the protection for the entire group. From the company's point of view we have seen that life insurance is essentially non-speculative; in fact, probably no other business operates with greater certainty. But it is equally important to remember that from the insured point of view life insurance is also the antithesis of gambling. Nothing is more uncertain than life, and life insurance offers the only sure method of changing that uncertainty into certainty. Failure of the head of a family to insure his life against the sudden loss of his value through death amounts to gambling with the greatest of all chances, and the gamble is a particularly mean-one since in case of loss the dependent family and not the gambler must suffer the consequences.

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