The Insurance Calibration Rule
Insure large catastrophic risks only — take the highest excess you can afford
Most households make two systematic errors with insurance. First, they over-insure small risks — extended warranties on appliances, low-excess policies on everyday items — because the salesperson presents the product at the moment of purchase (buy mode) and invokes vivid worst-case scenarios. Second, they under-insure catastrophic risks — disability, flood, serious illness — because these feel abstract and the premiums feel like money wasted if nothing happens.
Ramadorai's calibration rule reverses both tendencies. The principle is: only insure risks you genuinely cannot absorb, and set your excess (deductible) as high as you can afford to self-fund. A high excess achieves three things simultaneously: it lowers the premium materially, it eliminates the psychological problem of 'paying for nothing' (because you are paying less), and it preserves the coverage for the genuine catastrophe when it arrives. For medium-sized incidents — a car dink, a broken appliance — you self-insure via savings.
For life insurance, the same logic dictates term over whole-of-life: you need the coverage for a defined period (while dependents are young, while a mortgage is outstanding), not for life. As assets accumulate, the need for insurance coverage decreases and you can exit the term policy. The rule is not 'insure everything' or 'insure nothing' — it is 'insure at the right level for your actual catastrophic exposure'.
- Insurance is for risks you cannot absorb — not for risks you merely dislike experiencing.
- A high excess lowers your premium, reduces moral hazard, and preserves coverage for catastrophic events.
- The psychological discomfort of 'paying for nothing' is a cognitive error — the premium buys peace of mind and catastrophic coverage, not frequency of payouts.
- Term life insurance covers a defined period of need; whole-of-life insurance is a forced savings vehicle with poor return characteristics.
- As net worth grows, insurance needs decrease because your assets become the buffer — exit coverage progressively rather than holding it indefinitely.
- Inventory your catastrophic vs absorb-able risksList every insurable risk you currently face. Classify each as: (a) catastrophic — a loss you could not absorb from savings without a serious lifestyle impact, or (b) absorb-able — an inconvenience you could fund from an emergency buffer. Catastrophic risks need insurance; absorb-able risks do not.Pro tipDisability is typically catastrophic; a broken phone screen is absorb-able. Most extended warranties cover the latter — a clear sign to decline.
- Set the highest excess you can fund from savingsFor each insurance policy you keep, set the excess at the highest level you could pay from liquid savings without disruption. The premium reduction from raising the excess is often substantial — this is the market's way of pricing the moral hazard you are removing by taking more risk yourself.Pro tipCalculate the break-even: (annual premium at low excess) minus (annual premium at high excess) versus the difference in excess. How many claim-free years does it take to recoup a higher excess? Usually 3–5 — if you rarely claim, the high-excess option wins.WarningDo not set the excess higher than your liquid emergency fund. The excess must be fundable without going into debt.
- Choose term over whole-of-life for life coverTerm life insurance costs a fraction of whole-of-life and provides coverage for the period you actually need it — while dependents are minors, while the mortgage is outstanding. Specify the term to match your longest dependency horizon and let it lapse when that risk has passed.Pro tipRolling the term over at expiry is usually cheaper than buying a 30-year policy up front, as your actual needs may change substantially over that time.
- Decline at point-of-sale extended warranties as a defaultExtended warranties are sold in 'buy mode' when emotional salience is high. The statistical expected value of an extended warranty is almost always negative for the buyer. The default answer is no unless the item is high-value and the failure mode is catastrophic.WarningSome premium credit cards provide extended warranty as a card benefit — check before buying third-party cover.
A consumer buys a television and is offered an extended warranty for £3/month. In 'buy mode', the salesperson invokes the image of a child throwing a cricket ball through the screen. The consumer, emotionally primed, agrees to the coverage on a product with a very low failure rate.
The host described breaking down without a roadside assistance subscription. Without coverage, each component of rescue is priced as an emergency transaction — pickup fee, labour, temporary tyre, recovery beyond 3 miles — totalling many times the annual subscription cost.
Ramadorai's recommendation: take term life insurance over the period your dependents need coverage. As you accumulate assets and your dependents become financially independent, reduce or exit the coverage.
The calibration rule emerges from Ramadorai's observation that the psychological aversion to 'paying for nothing' drives households toward exactly the wrong insurance decisions: over-paying for coverage they will use (small risks with frequent payouts) and under-buying coverage they will not use but desperately need (catastrophic risks). Correcting for this bias produces a counter-intuitive but economically correct set of choices.