This chapter (and book) is meant to help you take responsibility for your life. It’s for people who don’t want to be victims — people who want the tools and information to be empowered when they make decisions. If that sounds like you, you’re in the right place.
This chapter focuses on seven guiding principles of insurance, covered in detail. Follow these seven principles when making decisions about your insurance program, and your decisions will be good ones.
Keep It Simple
Managing risk (the chance of a loss happening) and buying insurance is tough enough without making it any more complicated than it has to be. For every risk, generally more than one strategy exists that effectively minimizes that risk. Using the keep-it-simple principle, you take the simple path. Simple means easier and more likely to be implemented — simple is not less effective.
Here’s an example of this principle: Following a major fire or burglary, one of the requirements in a homeowners policy is to create an inventory of what was lost or destroyed, including, if possible, any receipts and canceled checks. Does that sound like a nightmare to you? It is! Even harder than documenting what you had is remembering what you had! Imagine coming home from a hard day at the office and finding either charred remains of what was once your dream home or finding your front door broken and your home torn apart by a burglar. The emotional trauma is bad enough. But in addition, you have to remember what’s missing, because you get paid only for what you can remember.
A policy is the legal contract between you and an insurance company in which the company agrees to pay covered claims when you have them in exchange for a monthly (or some other periodic) payment from you. Any given policy contains many coverages.
Conventional insurance wisdom has always held that the solution to this dilemma is to fill out a household inventory booklet prior to any loss, listing descriptions and values for every piece of personal property you own in every room of the house. Talk about a fun way to spend an evening — or, more realistically, your two-week vacation.
A written inventory isn’t such a bad idea, but it violates the keep-it-simple principle because it’s complex, and it takes far too much time. As a result, it’s rarely accomplished.
A far simpler strategy for handling this documentation is a video or photographic inventory. This approach is easy, fast (you can video the whole house in an hour or two), and even fun — especially when you add a verbal description: “This vase here that looks like a garage sale reject is really an antique from the Ming Dynasty worth $2.5 million.”
The video strategy is a good one because everything you own can be on one hard drive or DVD (or both, or two of both, one of which should be stored off your premises). Your video is easily stored, and, best of all, you can add to it when you acquire new things. If you don’t own a smartphone or video camera, you can rent or borrow one. An extra benefit of having filmed documentation at claim time is a reduced need for receipts: Most adjusters will waive that requirement if they can see the item in your home prior to the loss, in some kind of photographic format.
All in all, the video strategy is superior in every way to the written inventory strategy. Of course, if the house burns down, so will all your records, so be sure to store the hard drive or DVD safely off premises (for example, in a safe-deposit box at your bank).
Don’t Risk More than You Can Afford to Lose
Risks can be good if they make economic sense. Carrying large deductibles (the amount of a loss that you pay out of your own pocket before insurance kicks in) to lower insurance costs is a smart gamble if you save enough on your premiums (the price you pay for the insurance policy covering a defined time period — for example, six months or a year). Not buying collision insurance on older cars that you could afford to replace is another smart gamble. But be sure to insure any risk that is a part of your life if the risk could cause you major financial loss — if it’s more than you can afford to lose.
For example, the financial hardship of your paycheck stopping as a result of a long-term illness or injury is substantial. About one-third of all workers, at some point in their career, have a long-term disability. Yet many people who totally depend on their paycheck don’t have disability insurance. Big mistake — it’s a clear violation of the principle to risk only what you can afford to lose. Disability insurance is the most under-purchased major insurance coverage in this country. (Coverage is a promise to pay a certain type of claim if it occurs; other examples include automobile liability coverage, theft coverage, and so on.) If the loss of your income would cause major financial problems in your household, and your employer doesn’t provide disability insurance for you, make sure you carry a good disability policy.
Don’t Risk a Lot for a Little
Spending a little now (for coverage) makes more sense than spending a lot of your own money later when something happens that you’re not covered for.
Most people who buy insurance can’t afford to buy unlimited quantities; you probably don’t have millions of dollars of liability coverage, for example. So you tend to buy a limit that feels comfortable and doesn’t blow your budget. But too many people are considerably underinsured, and, tragically, they’re seldom aware that better insurance would cost them very little.
Liability is your financial obligation to another person (or persons) for injuries or property damage you cause. Liability coverage is a promise in an insurance policy to defend you in court and pay what you owe another person (or persons) for injuries or property damage you cause, up to the liability limits you chose.
Using car insurance as an example, the most commonly purchased liability insurance limit in the United States today is $100,000 per person for injuries you cause to others. Is that enough to pay for a seriously injured person’s medical bills and lost wages as well as compensation for that person’s pain and suffering? Just the medical bills alone could easily use up the entire coverage limit, leaving you to personally pay all other costs, plus some of your own defense costs. Your personal, uninsured financial loss could easily reach several hundred thousand dollars. Table 1-1 shows some typical annual costs for additional liability coverage for two cars in a metropolitan area.
TABLE 1-1 Typical Annual Liability Costs for Two Cars
Liability Limit
Additional Annual Costs beyond the Cost for $100,000
The Amount of Additional Coverage beyond $100,000
$300,000
$50
$200,000
$500,000
$80
$400,000
$1.5 million
$150
$1.4 million
$2.5 million
$225
$2.4 million
Following the rule to not risk a lot for a little means that you shouldn’t buy only $100,000 of coverage when each additional $100,000 of coverage costs so little. In fact, you can usually pay for the extra cost simply by boosting your policy deductibles to the next level. Increasing your deductible by $250 to $500 often saves you enough on your insurance bill to pay for most or all of the added cost of additional liability coverage.
Consider the Odds
This rule says that when the odds of a claim happening are virtually zero, and the insurance costs are inappropriately high, you shouldn’t buy the insurance. Considering the odds also means buying insurance when the possibility exists that a serious claim could occur.
Homeowners policies exclude earthquake losses. But they do offer an option to buy the coverage for an additional charge. Here are two examples of how the principle of considering the odds applies: It’s estimated that only about 20 percent of California homeowners had earthquake coverage to protect themselves against the devastating California earthquake of 1989, despite the high odds of an earthquake occurring. The 80 percent who were uninsured were in clear violation of both this rule (to consider the odds) and the rule not to risk more than you can afford to lose. As a result, many homeowners suffered ruinous, uninsured earthquake losses that easily could have been avoided with the purchase of insurance.
But if you live in an area that has no prior history of earthquakes and is located nowhere near any known fault lines, the probability of an earthquake may be near zero. In this instance, considering the odds means maybe not buying earthquake insurance if it costs more than a few dollars a year.
Like earthquake damage, flood and surface-water losses are excluded under the traditional homeowners policy. Considering the odds means that if your home is located high on the pinnacle of a hill overlooking a valley and your basement is unfinished, you probably don’t need to spend your money on flood insurance. On the other hand, if your home is located in a low-lying flood plain or near a river, you probably should consider buying flood insurance, because the odds of a large loss are good.
This principle encourages you to avoid insurance when the risk is small in relation to the amount of the premium. Say, for example, that you own a 2002 Honda worth $1,000. You were just hit with a DUI, and you’re facing premiums of two to three times what you had been paying — not just this year, but for each of the next three to five years. Your collision insurance premium with a $500 deductible has just increased from $100 to $300 a year. If you keep this coverage, the maximum risk to the insurance company is the value of the car ($1,000) minus your deductible ($500) minus the salvage value of the car ($50), which totals $450. This rule advises you not to buy what turns out to be $450 of insurance for a $300 annual premium. Under these circumstances, the smart move is to drop the collision coverage.
Avoid Las Vegas Insurance
Avoid any insurance that transfers only part of the risk to the insurance company, leaving you unprotected for the rest. Accidental-death insurance purchased from an airport vending machine is a good example. It often pays only if you die in a plane crash in the next few days! What you really may need is more life insurance, protecting you all the time and from any cause.
With “Las Vegas insurance,” you are, in effect, betting that if the claim occurs, it will be the result of a limited cause of loss you bet on. Not smart. Table 1-2 shows some examples of Las Vegas insurance and a better alternative that gets rid of the gamble.
TABLE 1-2 Types of Insurance and the Associated Risks
Type of Insurance
The Pitfalls
Better Solution
Accidental death
Pays only if you die accidentally
Life insurance
Travel accident
Pays medical bills only if incurred on a trip
Major medical health insurance
Cancer or dread disease coverage
Pays only medical bills caused by a specific calamity
Major medical health insurance
Rush-hour liability insurance
Doubles your lawsuit protection if the accident occurs between 7 a.m. and 8:30 a.m. or between 4:30 p.m. and 6 p.m.
Adequately high auto liability limits
Yes, the last item in Table 1-2 is tongue in cheek — no insurance company has come out with rush-hour insurance yet — but it makes the point. The bottom line? If you buy any insurance that transfers only part of the risk — as these examples of Las Vegas coverage do — you leave yourself vulnerable. Spend a little more money, and get much better insurance.
Buy Insurance Only as a Last Resort
This principle advises you to buy insurance only when it’s the best and most cost-effective solution. You have many options in treating any given risk; insurance is only one. Treat your risks with noninsurance strategies first.
Here’s one example of how this principle works: Say you’ve inherited Grandma’s heirloom sterling silver. It’s precious to you, so, naturally, you want the best coverage possible. Your agent has you get an appraisal that costs you $100. You buy a special rider to your homeowners policy covering the silver’s appraised value of $10,000 at a premium of $90 a year. One year later, burglars break into your home and steal your precious heirloom. In the meantime, the silver has increased in value to $15,000. You collect the $10,000 insurance proceeds from the policy, but you’ve suffered three disappointments:
The $5,000 difference between the value of the stolen silver and the amount that insurance covered.
Grandma’s pattern has been discontinued, and it’s difficult to find an identical match.
Even if you find the same pattern, it doesn’t have the sentimental value that Grandma’s exact set had.
Insurance is not the best solution for managing this risk — not only because cash is a poor substitute for treasures but also because of the hassle and cost of the appraisal as well as the insurance premium that’s due every year.
A better, noninsurance method for handling Grandma’s silver risk (and at the same time following the keep-it-simple strategy mentioned earlier in this chapter) is to store the silver in an off-premises safe-deposit box, thus preventing the loss almost entirely. Or, if that isn’t practical because you want to use the silver for special occasions, hide it well, reducing by about 90 percent the chance of a loss through theft. You can further reduce the risk by adding a central burglar alarm.
When it comes to irreplaceable treasures, preventing the loss altogether is a far better strategy than insurance, without the costs or the pitfalls of insurance coverage.
Making good insurance decisions
A policy is the legal contract between you and an insurance company in which the company agrees to pay covered claims when you have them in exchange for a monthly (or some other periodic) payment from you. Any given policy contains many coverages.
A far simpler strategy for handling this documentation is a video or photographic inventory. This approach is easy, fast (you can video the whole house in an hour or two), and even fun — especially when you add a verbal description: “This vase here that looks like a garage sale reject is really an antique from the Ming Dynasty worth $2.5 million.”
Avoid any insurance that transfers only part of the risk to the insurance company, leaving you unprotected for the rest. Accidental-death insurance purchased from an airport vending machine is a good example. It often pays only if you die in a plane crash in the next few days! What you really may need is more life insurance, protecting you all the time and from any cause.