Question

Explain why risk-averse individuals are willing to pay an insurance premium to remove risk.

Answer 1

Risk-averse investors prefer lower returns in place of high returns with high risks. They avoid risks at any cost.

As they tend to avoid risks at all costs, they prefer paying insurance premiums , instead of suffering unknown losses.

Main purpose of Insurance is to protect the insured from some unforessen & unexpected financial loss. It is a type of risk management, hedging against the risk of some contingent loss---for a sum of money, called the insurance premium, paid by concerned policyholder for the coverage enlisted in the written agreement called the insurance policy .

The risk averse investor, naturally prefers to bear expenses towards the premium & pass on the risks to the insurance company, than to suffer financial losses later.

He wants to ensure saftey of money , and hence willing to forego some amount of income, than to lose more quantum of money.

Safety of returns is more important to him, than more returns themselves , as the latter is fraught with more risks.