Insurance: useful or unnecessary?

While playing football in your neighbourhood, your ball lands in your neighbour's conservatory – broken window, damage: a few hundred francs. Annoying, but manageable. Now imagine that you hit a pedestrian while cycling, she has a bad fall and cannot work for months. Suddenly, you face hundreds of thousands of francs in compensation – money that neither you nor your family simply has.

This is exactly why insurance exists. Its basic principle is remarkably simple: Lots of people regularly pay a contribution into a shared fund – and the few who suffer a loss receive compensation from it. In other words, the group bears the individual's risk.

Here is an example calculation: in one town, 1000 people each own a bicycle worth CHF 800. Experience shows that about 10 bicycles are stolen each year – a total loss of CHF 8000. If all 1000 people share this loss, each person pays CHF 8 per year. The insurer's costs and profit must be added, so the premium might be CHF 12. This is the price you pay to transfer your risk: you pay a small, predictable amount rather than a large amount that could threaten your financial security on the rare occasion that something happens.

This also shows you that insurance is not a savings account. Normally, over the years you pay in more than you receive – in return, you are protected if something happens to you. Whether this is worthwhile depends on the risk. There are two rules of thumb to help you decide.

Rule of thumb 1: Insure against risks that threaten your financial security – cover small losses yourself.

A broken mobile phone screen will not ruin you: it is a small, manageable loss. By contrast, a liability claim worth millions could burden you and your family for the rest of your lives – a risk that threatens your financial security. Because every premium also includes the insurer's administrative costs and profit, the rule is: anyone who insures every little thing will lose money in the long run. Anyone who does not insure against the big risk is risking everything. So insure what you cannot afford to cover yourself.

Rule of thumb 2: Do not mix insurance with saving.

Some products – a typical example is endowment life insurance – combine insurance cover and a savings plan in one contract. That sounds convenient, but is usually expensive and inflexible: the costs are difficult to understand, and anyone who withdraws early often loses money. The rule of thumb keeps the two clearly separate: buy protection with pure insurance and save separately – that way you remain flexible and can see exactly what each one costs you.

Here is another term you will encounter everywhere: the excess (also called the deductible). This is the share of a loss that you pay yourself before the insurer pays. It has a sensible purpose: people who contribute towards the cost remain careful and do not report every minor loss – this keeps premiums low for everyone.

Using the two rules of thumb, you can place almost any insurance offer into one of five categories:

1. Compulsory – you have no choice here because the law or your employment contract requires it: health insurance (basic insurance – compulsory for everyone who lives or works in Liechtenstein), accident insurance through your employer (you are automatically insured from the first day of your employment – important when you start your apprenticeship!) and motor vehicle liability insurance (no car or moped may be driven on the road without it). One special feature in Liechtenstein is that sickness allowance insurance is also compulsory for employees aged 15 and over – it replaces part of their wages during a longer illness.
2. Highly advisable – personal liability insurance: for around a hundred francs a year, it covers losses that you cause to other people – and these can run into the millions. Rule of thumb 1 in its purest form: a small premium protects you against a risk that could threaten your financial security.
3. Depends on the situation – useful depending on your circumstances: household contents insurance (worthwhile when you have your own home), comprehensive car insurance (for a new, expensive car – hardly worthwhile for an old second-hand one), travel insurance (perhaps for an expensive long-haul trip, but not for a weekend in Ticino).
4. Usually unnecessary – mobile phone and device insurance, extended warranties: the potential loss is small and manageable, while the premium is high in comparison – policies (the name for insurance contracts) like these are very good business for providers, but rarely for you.
5. Examine critically – endowment life insurance: it breaks rule of thumb 2 because it mixes insurance and saving. Always seek independent advice and compare alternatives before taking out a policy.

Important: categories 3 to 5 do not mean ‘always wrong’ – they mean: think first, then sign. You are about to practise precisely this classification.