Unless you work in the industry, you may find insurance to be a dreadfully boring topic. Most people associate insurance with disease, death, and disaster and would rather do just about anything other than review or spend money on insurance. But because you won’t want to deal with money hassles when you’re coping with catastrophes — illness, disability, death, fires, floods, earthquakes, and so on — you should secure insurance well before you need it.
Insurance is probably the most misunderstood and least monitored area of personal finance. Studies show that more than 90 percent of people around the globe purchase and carry the wrong types and amounts of insurance coverage. Most people are overwhelmed by all the jargon in sales and policy statements. Thus, they pay more than necessary for their policies and fail to get coverage through the best companies.
Through this post I boil the subject down to three fairly simple but powerful concepts in this post that can save you time and bucks. And while you’re saving money, you can still get the quality coverage you need in order to avoid a financial catastrophe. Enjoy!
Principle-1: Insure Only For The Big Stuff
Imagine, for a moment, that you’re offered a chance to purchase insurance that reimburses you for the cost of a magazine subscription in the event that the magazine folds and you don’t get all the issues you paid for. Because a magazine subscription doesn’t cost much, I don’t think you’d purchase that insurance.
What if you could purchase insurance that pays for the cost of a restaurant meal if you get food poisoning? Even if you’re splurging at a fancy restaurant, you don’t have a lot of money at stake, so you’d probably decline that coverage as well.
The point of insurance is to protect against losses that would be financially catastrophic to you, not to smooth out the bumps of everyday life. The preceding examples are silly, but some people Purchase equally foolish policies without knowing it.
In the following sections, I tell you how to get the most appropriate insurance coverage for your money. I start off with the bigest that are worth your money, and then I work down to some insurance options that are less worthy of your dollars.
A. Purchase insurance to cover financial catastrophes – You should insure against what could be a huge financial loss for you or your dependents. The price of insurance isn’t cheap, but it is relatively small in comparison to the potential total loss from a financial catastrophe. The beauty of insurance is that it spreads risks over millions of other people. Should your home burn to the ground, paying the rebuilding cost out of your own pocket probably would be a financial catastrophe. If you have insurance, the premiums paid by you and all the other homeowners collectively can easily pay the bills.
Think for a moment about what your most valuable assets are. Also consider potential large expenses. Perhaps they include the following:
- Future income: During your working years, your most valuable asset is probably your future earnings. If you were disabled and unable to work, what would you live on? Long-term disability insurance exists to help you handle this type of situation. If you have a family that’s financially dependent on your earnings, how would your family manage if you died? Life insurance can fill the monetary void left by your death.
- Business: If you’re a business owner, what would happen if you were sued for hundreds of thousands of dollars or a million dollars or more for negligence in some work that you messed up? Liability insurance can bail you out.
- Health: In this age of soaring medical costs, you can easily rack up a $100,000 hospital bill in short order. Major medical health insurance helps pay such expenses. And yet, a surprising number of people don’t carry any health insurance — particularly those who work in small businesses.
Psychologically, purchasing insurance coverage for the little things that are more likely to occur is tempting. You don’t want to feel like you’re wasting your insurance dollars. You want to get some of your money back, darn it! You’re more likely to get into a fender bender with your car or have a package lost in the mail than you are to lose your home to fire or suffer a long-term disability.
Purchasing (or not purchasing) insurance based on your perception of the likelihood of needing the coverage is foolish. Insurance companies aren’t stupid; in fact, they’re ruthlessly smart! When insurance companies price policies, they look at a number of factors to determine the likelihood of your filing a claim. Take the example of auto insurance:
- Who do you think will pay more for auto insurance — a single male who’s age 20, lives the fast life in a high-crime city, drives a macho, turbo sports car, and has received two speeding tickets in the past year?
- Or a couple in their 40s, living in a low-crime area, driving a four door sedan, and having a clean driving record?
B. Take the highest deductible you can afford – Most insurance policies have deductibles — the maximum amount you must pay, in the event of a loss, before your insurance coverage kicks in and begins paying out.
On many policies, such as auto and homeowner’s/renter’s coverage, most folks opt for a $100 to $250 deductible. Here are two benefits to taking a higher deductible:
- You save premium dollars. Year in and year out, you can enjoy the lower cost of an insurance policy with a high deductible. You may be able to shave 15 to 20 percent off the cost of your policy. Suppose, for example, that you can reduce the cost of your policy by $150 per year by raising your deductible from $250 to $1,000. That $750 worth of coverage is costing you $150 per year. Thus, you’d need to have a claim of $1,000 or more every five years — highly unlikely — to come out ahead. If you are that accident-prone — guess what — the insurance company will raise your premiums.
- You don’t have the hassles of filing small claims. If you have a $300 loss on a policy with a $100 deductible, you need to file a claim to get your $200 (the amount you’re covered for after your deductible). Filing an insurance claim can be an aggravating experience that takes hours of time. In some cases, you may even have your claim denied after jumping through all the necessary hoops. Getting your due may require prolonged haggling.
When you have low deductibles, you may file more claims (although this doesn’t necessarily mean that you’ll get more money). After filing more claims, you may be “rewarded” with higher premiums — in addition to the headache you get from preparing all those blasted forms! Filing more claims may even cause cancellation of your coverage!
C. Avoid small policies – A good insurance policy can seem expensive. A policy that doesn’t cost much, on the other hand, can fool you into thinking that you’re getting something for next to nothing. Policies that cost little also cover little — they’re priced low because they don’t cover large potential losses.
Following are examples of common “small” insurance policies that are generally a waste of your hard-earned dollars (As you read through this list, you may find examples of policies that you bought and that you feel paid for themselves). Many of the following policies pay back even less — around 20 cents in benefits (claims) for every insurance premium dollar spent:
- Extended warranty and repair plans: Isn’t it ironic that right after the salesperson persuades you to purchase a television, computer, or car — in part by saying how reliable the product is — she tries to convince you to spend more money to insure against the failure of the item? If the product is so good, why do you need such insurance? Extended warranty and repair plans are expensive and unnecessary insurance policies.
- Home warranty plans: If your real estate agent or the seller of a home wants to pay the cost of a home warranty plan for you, turning down the offer would be ungracious. But don’t purchase this type of plan for yourself. In addition to requiring some sort of fee (around $50) if you need a contractor to come out and look at a problem, home warranty plans limit how much they’ll pay for problems.
- Dental insurance: If your employer pays for dental insurance, take advantage of it. But you shouldn’t pay for this coverage on your own. Dental insurance generally covers a couple teeth cleanings each year and limits payments for more expensive work.
- Credit life and credit disability policies: Credit life policies pay a small benefit if you die with an outstanding loan. Credit disability policies pay a small monthly income in the event of a disability. Banks and their credit card divisions usually sell these policies. Some companies sell insurance to pay off your credit card bill in the event of your death or disability, or to cover minimum monthly payments for a temporary period during specified life transition events (such as loss of job, divorce, and so on). The cost of such insurance seems low, but that’s because the potential benefits are relatively small.
- Daily hospitalization insurance: Hospitalization insurance policies that pay a certain amount per day, such as $100, prey on people’s fears of running up big hospital bills. Health care is expensive — there’s no doubt about that. But what you really need is a comprehensive (major medical) health insurance policy. One day in the hospital can lead to thousands, even tens of thousands, of dollars in charges, so that $100-per-day policy may pay for less than an hour of your 24-hour day! Daily hospitalization policies don’t cover the big-ticket expenses. If you lack a comprehensive health insurance policy, make sure you get one!
- Insuring packages in the mail: You Purchase a $40 gift for a friend, and when you go to the post office to ship it, the friendly postal clerk asks whether you want to insure it. For a few bucks, you think, “Why not?” Go spend your money on something else — or better yet, invest it.
- Contact lens insurance: The things that people in this country come up with to waste money on just astound me. Contact lens insurance really does exist! The money goes to replace your contacts if you lose or tear them. Lenses are cheap. Don’t waste your money on this kind of insurance.
- Little stuff riders: Many policies that are worth purchasing, such as auto and disability insurance, can have all sorts of riders added on. These riders are extra bells and whistles that insurance agents and companies like to sell because of the high profit margin they provide (for them). On auto insurance policies, for example, you can purchase a rider for a few bucks per year that pays you $25 each time your car needs to be towed. Having your vehicle towed isn’t going to bankrupt you, so it isn’t worth insuring against.
Likewise, small insurance policies that are sold as add-ons to bigger insurance policies are usually unnecessary and overpriced. For example: you can purchase some disability insurance policies with a small amount of life insurance added on. If you need life insurance, purchasing a sufficient amount in a separate policy is less costly.
Principle-2: Purchase Insurance That Provide Broad Coverage
Purchasing coverage that’s too narrow is another major mistake people make when purchasing insurance. Such policies often seem like cheap ways to put your fears to rest. For example, instead of purchasing life insurance, some folks purchase flight insurance at an airport self-service kiosk. They seem to worry more about their mortality when getting on an airplane than they do when getting into a car. If they die on the flight, their beneficiaries collect. But should they die the next day in an auto accident or get some dreaded disease — which is statistically far more likely than going down in a jumbo jet — the beneficiaries get nothing from flight insurance.
The medical equivalent of flight insurance is cancer insurance. Older people, who are fearful of having their life savings depleted by a long battle with this dreaded disease, are easy prey for this narrow insurance. If you get cancer, cancer insurance pays the bills. But what if you get heart disease, diabetes, or some other disease? Cancer insurance won’t pay these costs. Purchase major medical coverage, not cancer insurance.
Fears, such as getting cancer, are natural and inescapable. Although you may not have control over the emotions that your fears invoke, you must often ignore those emotions in order to make rational insurance decisions. In other words, getting shaky in the knees and sweaty in the palms when boarding an airplane is okay, but letting your fear of flying cause you to make poor insurance decisions is not okay, especially when those decisions affect the financial security of your loved ones.
It nearly impossible to purchase broad coverage. For example: when purchasing homeowner’s coverage, you find that losses from floods and earthquakes are excluded. You can secure such coverage in separate policies, which you should do if you live in an area subject to such risks. Many people don’t understand these risks, and it’s annoying and troubling that the insurance industry doesn’t do more to educate customers about such gaping holes in their policies.
Principle-3: Search Around and Purchase Direct
Whether you’re looking at auto, home, life, disability, or other types of coverage, some companies may charge double or triple the rates that other companies charge for the same coverage. Insurers that charge the higher rates may not be better about paying claims, however. You may even end up with the worst of both possible worlds — high prices and lousy service.
Worth mentioning: Most insurance is sold through agents and brokers who earn commissions based on what they sell. The commissions, of course, can bias what they recommend.
Not surprisingly, policies that pay agents the biggest commissions also tend to be more costly. In fact, insurance companies compete for the attention of agents by offering bigger commissions.
Besides the attraction of policies that pay higher commissions, agents also get hooked, financially speaking, on companies whose policies they sell frequently. After an agent sells a certain amount of a company’s insurance policies, she is rewarded with higher commission percentages (and other perks) on any future sales. Just as airlines bribe frequent fliers with mileage bonuses, insurers bribe agents with fatter commissions and awards such as trips and costly goods.
Shopping around is a challenge not only because most insurance is sold by agents working on commission but also because insurers set their rates in mysterious ways. Every company has a different way of analyzing how much of a risk you are; one company may offer low rates to me but not to you, and vice versa.
Despite the obstacles, several strategies exist for obtaining low-cost, highquality policies. The following offer smart ways to shop for insurance:
- Employer and other group plans – When you purchase insurance as part of a larger group, you generally get a lower price because of the purchasing power of the group. Most of the health and disability policies that you can access through your employer are less costly than equivalent coverage you can purchase on your own. Likewise, many occupations have professional associations through which you may be able to obtain lower-cost policies. Not all associations offer better deals on insurance — compare their policy features and costs with other options.
- Insurance without sales commissions – Purchasing policies from the increasing number of companies that are selling their policies directly to the public without the insurance agent and the agent’s commission is your best bet for getting a good insurance value. Just as you can purchase no-load mutual funds directly from an investment company without paying any sales commission, you also can purchase no-load insurance. Annuities, investment/insurance products traditionally sold through insurance agents, are also now available directly to the customer, without commission.
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