Insurance often has an emotional aspect in the decision process so it is important to be careful of biases that may arise out of these emotions when picking your insurance. Insurance salesmen capitalize on people’s natural bias against loss to create fear in their customers. Insurance salesmen use this fear to convince people to buy more insurance than they need which gives the salesman a bigger commision check. Some insurance agents do it unconsciously and others consciously do it but all insurance salesman do it because that is where their salary comes from.
“It is difficult to get a man to understand something when his salary depends on him not understanding” – Upton Sinclair
We need to guard ourselves against the fear insurance salesman create so that we can make a rational decision. To do this, we need to keep the purpose of insurance in mind. Insurance is not an investment and it doesn’t stop bad things from happening. The purpose of insurance is to help you replace things that you can’t afford to replace.
Insurance companies pay their salesman along with all other typical business expenses and still have profit left over for the owners.
“Your expected return will always be negative when you buy insurance”
This is why you only want to buy insurance when you truly need it. This means that replacing this thing will affect your finances to the point of significantly reducing your quality of life. Even if you determine you need insurance, you want to reduce the monthly costs of this insurance by making the deductible as high as you can afford without destroying your finances.
Following are some examples of good and bad uses of insurance to make applying this more clear.
Good Use of Insurance
Example 1: You have a wife and children that depend on your income and you haven’t saved enough to last them until they are self-sufficient. You would buy a term life insurance policy for the difference between your savings and how much it would cost to fund your family until they are self-sufficient. You would keep this policy until either you saved enough or your family is self-sufficient whichever comes first.
Example 2: You own a house that you could not replace with other savings. You would buy home insurance until you could replace the house.
Example 3: You have a car and are legally required to have liability insurance or a mortgage on a house that requires you to have insurance.
Example 4: You don’t have enough saved to cover massive medical bills (cancer, heart attack, stroke, etc…) so you buy health insurance with a deductible as high as you can afford.
Bad Use of Insurance
Example 1: Buying life insurance on a permanent basis as an investment. Remember that the insurance company takes a huge fee out of your policy and this is what pays for all of their salesmen’s lucrative salaries, other business expenses, and profits for the owners. You are much better off buying the minimum amount needed until your family can support itself and investing the rest yourself. Remember, buying insurance does not prevent you from dying; it only provides on average less money than you contributed to them. This is never a good investment.
Example 2: You break your phone a lot and you get insurance for it even though you can replace the phone yourself without too much heartache. Take the money you would’ve spent on insurance and buy a quality case for your phone so you don’t keep breaking it.
Example 3: You buy windshield replacement coverage. You can afford to replace your windshield and you can prevent most replacements by sealing any chips as they occur for very little money. These replacements may seem like a good deal, but using them will increase your premiums for your auto coverage.
So, only get insurance for the things that would significantly affect your lifestyle if they were destroyed. For example, if driver A drives a $5,000 car but keeps $10,000 in an emergency fund, so driver A can afford to replace his car without a significant impact on his lifestyle. However, driver B drives the same car but lives paycheck to paycheck, driver B would have difficulty replacing his car. Driver A would be better off with only liability insurance to cover the legal limits, while driver B would be better off with full coverage to protect himself from the problems that would result in replacing his car.
Once you have decided that you need insurance, the next thing to consider is the deductible. This is the amount that you pay in the event of an accident before the insurance company starts paying. The lower the deductible the higher your monthly premium will be and the higher the deductible the lower the premium will be. This means you will want to use the same process that you used to decide whether or not to get insurance at all. You want your deductible to be as high as you can afford without significantly impacting your lifestyle.
One way you can save money on your insurances is by having some money outside of your retirement accounts that you can access within a month or so. Some people prefer to use an online savings account as an emergency fund; I prefer to keep that money working in a brokerage account. Either way the accessible money will allow you to increase your deductible on your insurances and lower your monthly payments and will even allow you to eliminate the need for some insurances.
Are there any insurance policies or warranties (house, life, health, car, cell phone, etc…) that you have that could be reevaluated to make sure you are optimized?