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Through years of experience, you have learned that a $2,000 milling machine suffers a catastrophic failure (it is a total loss) about once in 5 years. An insurance salesman offers to sell you coverage that will replace the machine. The annual premium for the coverage is $1,800. Is this insurance a good deal?
$1,800 annual cost for insurance. Your machine is expected to break down once every 5 years. 5 x 1,800 = $9,000 The insurance is not a good deal because it would cost less to replace the machine itself, paying the $2,000 price then paying the insurance for 5 years, which would be $9,000.
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