What if the insurance doesn't pay out because it too is a flawed contract?
Adding on N redundant insurance contracts increases the total cost of insurance by N * value * r * time, assuming that the risk of insuring another insurance contract is extremely low. That number explodes extremely fast, and there's no obvious way to solve the problem apart from buying insurance without blockchain-based proof of solvency. But if you're doing that, why do it on the blockchain at all?
Your argument is valid, but consider that most contracts execute very quickly and so the scope of the insurance is quite limited. For more elaborate contracts, or for a set of inter-related contracts, insurance will be available for highly demanded combinations.
Also, since much of the insurance is against fraud, as parties became more trusted the price of insuring against their bad behavior would decrease.
Insurance is and has always been a profitable business simply because pooled risk is desirable in many circumstances. Blockchains don't alter this basic reality, and they make it far cheaper to offer proof of solvency and other meaningful transparency measures that benefit consumers.
Consider, for example, if employees could do a solvency audit of the PBGC at the click of a button.