expected loss
Also called: expected cost
The average cost of a risk over a period: the chance it happens times the size of the loss. Comparing it with a premium shows how much of the premium pays for the insurer's costs and profit.
The expected loss of a risk is what it costs you on average: the chance that it happens in a period multiplied by how much one such loss costs. If one phone in ten needs a 4,000 UAH repair in a year, the expected loss is 10% × 4,000 = 400 UAH a year.
It is the fairest yardstick for an insurance offer. On average an insurer pays out less than it collects, because it has costs and wants a profit, so a premium is always above the expected loss. The question is by how much, and whether the loss is one you could pay from your own savings.
For small, frequent losses the premium is often several times the expected loss, and the loss itself fits in a cushion: paying it yourself is usually cheaper over time. For big, rare losses, such as an earner's income or damage to a neighbour's flat, the chance is hard to estimate and the loss would be ruinous, so the comparison matters less than the question “could we survive it?”
Example
A shop offers Sam a two-year extended warranty on a 15,000 UAH phone for 2,250. In this example one phone in ten needs a 4,000 repair each year, so the expected loss over two years is 2 × 10% × 4,000 = 800 UAH.
Both repairs fit in the family's 10,000 of savings, so the family pays them from the cushion instead.
Common mistakes
- Judging by fear. “Screens break all the time” is a sales line; the expected loss is a number.
- Ignoring the period. Compare a two-year premium with two years of expected loss.
- Using it for ruinous losses. For a loss you couldn't survive, insure even if the premium is above the expected loss.