Please Read Part I and Part II before reading the conclusion.
Insurance policies are designed taking advantage of this psychological bias – we don’t see the reality, we end up taking our investment decisions on what is presented to us, not what we need or understand. The job is very well done by agents and brokers. They may not be aware of making profit calculations, or in judging whether this policy is good or bad for the customer, but they gradually become experts in taking advantage of psychological biases and mentioning about the circumstances in which we may need a particular policy.
They initially start by telling you why this policy is good and what it can offer – slowly they move to inform you about clubbing the insurance policy with Equity investments, bond investments, regular income, education shield, accident cover, health insurance, tax savings, blah, blah, blah, blah – the list is endless. Rest of the ambience is created by our own wellwishers – colleagues, friends and relatives. They are these smart-alecs who first buy such policies, and then they start advocating about the intelligent investment they have made and also persuade others to do the same by buying the similar policy or make similar investments. In my previous company, there was one such real fanatic “trader”, who would go to such an extent of forcing people to start trading that he would sit with them individually and discuss with them for hours about how good it is to trade and real money is in trading only. He was even willing to schedule meetings with the brokerage firm agents to open trading accounts.
As salaried individuals or businessmen or doctors or other professionals, we find it difficult to devote time to understand these financial calculations. The interesting irony is that these financial decisions are made to secure our future financially – and while buying such products we are the least bothered about the nitty-gritty. Ultimately, it’s human nature – the only thing that can be done is to educate ourselves and use some more presence of mind. We work so hard to earn our money – we leave our money decisions to agents and well-wishers! We get trapped with what is presented and ignore what is right and what we want.
Engineer's Finance 
Very interesting trilogy of posts! It is good that you have brought this highly debated topic up for discussion.
Firstly, you have disguised the cases A and B very well in two different posts making it cumbersome for a reader to follow them properly. In the end you say that the options are the same in both the cases which makes sense, but only little:
In the first case, there is nothing at stake. You just have 50 rupees to lose in option 1 and 25% chance of 200 rupees loss in option 2. But in the second case, there is already a bike in place. That bike – which would be the result of your hard-earned money.. the one which you love so much… the one which you dont want to harm in any case. So is it not obvious that you will try and reduce the risk at any cost? Forget the 25% chance – even if there is one percent chance that your bike will be harmed, you will try to reduce that. I feel this alone is the reason for insurance policies to thrive.
About your advice on not falling prey to marketing agents and “fanatic” traders, it is the right kind of advice and I completely agree with you 🙂
@Shashi : I could not put the complicated one in a simpler manner. I tried my best. It might not be that clear I guess. I shall explain it in better way some time later.
Sir, you have done well to bring up such a complicated issue! I did no say that you were not clear or something. The topic of insurance is itself like that – playing with the emotions of people. So it really takes guts to bring up such a subtle financial article in your blog and I admire your courage for doing that 🙂 Keep it up!
And whenever you feel like explaining more about it, please do
@Shashi : Thanks for the kind words :). I shall do it some time. I don’t like playing with emotions. There should be a business sense to your investments.