The reality is that for most people, insurance is boring. Heck even when I was majoring in finance in college, my insurance courses were the most painfully boring ones…and I took a tax accounting class! Nevertheless, I am here to provide you with this complete guide to insurance.
Why? Well because even though insurance is boring, it is a key piece in your financial life. Without it, the puzzle that is your life is not complete and just like with a missing puzzle piece in a real puzzle, not having insurance means you have a big ugly hole staring right back at you. And in real life, missing this insurance puzzle piece can completely destroy your finances in an instant.
So let’s get started with the guide to insurance. I will explain all of the different types of insurance coverage in my attempt to help you understand insurance and enjoy learning about it at the same time.
Why Do We Even Need Insurance?
What is the real point of insurance? Is it for companies to make money on us because we never use it and in the event we do use it, for them to raise our rates? It sure feels like that sometimes. But insurance has a place in our lives and there is a good reason for it.
In order to understand insurance, we need to understand risk. In life, we deal with risk in one of three ways:
1. We accept it
2. We mitigate it
3. We transfer it
In the case of accepting risk, we simply take into account the likelihood of the risk and accept it as part of life. In many of the things we do in life, we accept the risks and just keep living. For example, we accept the risk of falling down the stairs. We don’t avoid the stairs, we just know the likelihood of falling down the stairs is low and therefore we use them without worry.
When it comes to mitigating risk, we still accept the risk but we do things to make the likelihood of the risks less probable. Let’s use an example of crossing the street. We don’t just meander out in the middle of traffic in hopes of making it across the street. We stop, look both ways, and then walk briskly to get across. By doing this, we lessen the chances of something bad happening.
We sometimes even mitigate a risk we accept taking. Using the walking down the stairs I mentioned above, if we have a box in our hands or are unsteady, we use the handrail. By holding onto the handrail, we mitigate, or lessen the risk of falling.
In the event we aren’t willing to accept or mitigate the risk of something, we transfer it. This is where insurance comes in to play.
Insurance is there to protect you for risk that you are not comfortable taking on yourself. You transfer the risk over to someone (or some company). For example, most of us will have insurance in the event our house burns down. We don’t want the risk of having to pay to rebuild the house, so we transfer the risk to someone else.
When you transfer the risk, you have to pay for this privilege. There is no one person or company that will take on large potential risks without having some form of compensation to offset the losses.
Of course, when you transfer the risk, you still have to accept some form of risk. This is why you have to pay a deductible and pay insurance premiums. You can’t transfer 100% of the risk.
In both of these cases, you have to determine how much risk you are willing to accept (the amount of our deductible) and how much you want to transfer away (the amount of our premium).
This is why different people have different levels of coverage and varying deductibles. We’ll get into these a little later in this post.
So your goal at the end of the day when it comes to risk is to figure out what you are willing to accept, what you are willing to mitigate and what you are willing to transfer to someone else. Luckily, the issue of weighing risk will come up throughout this post, which will help you to get a better idea of where you stand.
For now, let’s continue this guide to insurance by starting to look at the various types of insurance out there.
Your Guide To Insurance – Types of Insurance
Auto insurance is the most common type of insurance out there. For most of us, we don’t want to accept the risk of repairing our cars should we get into an accident, so we transfer the risk to someone else.
But the amount of the risk we are willing to accept varies from person to person. This is why there are various levels of auto insurance coverage and deductibles.
One important thing to remember about car insurance is that it follows the car, not the driver. This means if you lend your car to your friend to drive and they get into an accident that is their fault, you have to file the claim with your insurance company, pay your deductible, etc.
The driver’s auto insurance (in this case your friend) acts like supplemental coverage. This means their insurance will pay most personal liability and medical expenses. You can read more about this topic here.
Why You Need It: The reason you need auto insurance (other than the fact that in many states you need it to legally operate a car) is because of money. It costs a lot of money to repair a car. In the event your car is totaled, it costs a decent amount of money to buy a new car.
Also, you have to take into account the costs to repair the other driver (or drivers) cars if you are at fault for causing the accident. Since most of us are horrible at saving money, it makes sense to buy auto insurance. Without it, a car accident could easily bankrupt you.
Another component of auto insurance is liability coverage. This coverage comes into play when you have to pay for the repair of property and medical expenses for yourself and/or the other drivers. We’ll talk more about liability coverage in a little bit.
If you own a home, you have homeowners insurance. This insurance covers you in the event your house burns down, a tree falls on it, and many other things. Homeowners insurance also covers all of your belongings inside your house too. So if you get robbed and they take your TV or laptop, your homeowners policy will cover the cost for you to buy a new one.
Why You Need It: Getting into a car accident has a high probability of happening. As such, most people have that insurance coverage due to the likelihood of the risk occurring. When it comes to homeowners insurance, the likelihood of your house burning down is small. But many people still have insurance because of the financial impact should the risk occur.
If your house burns down, it will cost hundreds of thousands of dollars just to rebuild it. Add on the tens of thousands of dollars to buy everything that was in your house and you quickly realize that it makes sense to transfer the risk to someone else.
In addition to this fact, many mortgage companies require you to have homeowners insurance. This is because until you pay off your mortgage, the bank owns a percent of the house. So should it burn down, the bank wants to make sure it is covered.
Not everyone owns a home. Because of this, there is no point in buying an insurance policy that protects you in the event that your apartment burns down. The risk of rebuilding is not yours, it is the landlords.
But you still have personal belongings that could cost thousands of dollars should your apartment burn down or you get robbed. This is where renters insurance comes into play.
Why You Need It: As mentioned above, you need to replace your things should a risk occur. If you don’t have the money to replace everything, what are you to do? A renters insurance policy ensures your belongings are covered for pennies on the dollar.
For some readers, you might be thinking that you will accept the risks, but I caution you to think twice. Look over just how much stuff you really have. Your furniture, clothing, electronics, etc. are all items that would need to be replaced should something tragic happen and the cost to replace all of these things would be high.
Umbrella insurance is extra liability insurance. I’ll talk about why you need extra liability insurance below but right now I want to talk about liability coverage.
This coverage comes with auto and homeowners policies. Here is how it typically works. In the case of your homeowners policy, let’s say someone comes over for a visit and slips on some ice and breaks a leg. The liability portion of your homeowners coverage will come into play here and pay their medical bills.
This is the same concept with auto insurance. If you get into an accident, the liability coverage kicks in to pay medical bills for the other driver if you are at fault.
There are other times when liability coverage comes into play for these policies, but the two I showed are just to help you get an understanding of what liability coverage is.
Why You Need It: Most insurance policies limit the amount of liability coverage you can have. Umbrella insurance is an add-on to allow you more coverage. For example, your auto policy might cap liability at $500,000. Buying umbrella coverage will allow you to stack an additional $500,000 or more worth of liability coverage to protect you.
If you have a sizable amount of assets, then having umbrella coverage makes sense. But if you are just starting out or only have $50,000 worth of assets, then umbrella coverage is not typically recommended.
This type of insurance is a little more complex than the others we have talked about so far. The reason for life insurance is to protect your loved ones in the event of your untimely passing. For example, if you have a family and you earn $50,000 a year and pass away suddenly, it will be tough for your family to keep up financially without your monthly income. Therefore, you buy life insurance so that your family can survive financially.
Unfortunately, life insurance gets more complex. There are three types of life insurance, which I outline below:
- Term Life: insurance policy that pays a benefit in the event of the death of the insured during a specific term.
- Whole Life: insurance policy that pays a benefit in the event of the death of the insured and also accumulates a cash value.
- Universal Life: insurance policy that pays a benefit in the event of the death of the insured and also accumulates a cash value.
Broken down into plain English, a term life insurance policy is one you take out for a set period of time, say 20 years worth of coverage. You pay the premiums for the 20 years and at the end of the term, the insurance policy ends. You no longer pay the premiums and you no longer have the insurance coverage.
Whole life and universal life are a little different. In both cases, you take out a policy that pays a death benefit in the event of your passing. There are two differences between these and term life insurance.
The first is the term. With whole life and universal, there is no term. You have the policy until you cancel it or you pass away. Second, both whole life and universal build cash value. I’ll get more into this below.
The main difference between whole life and universal is that with universal, you can use the accumulated cash value to pay your monthly premiums.
The calculator below shows you what various life insurance policies cost.
Why You Need It: As I mentioned above, the point of life insurance is to allow your family to not take a financial hit with the loss of your income should you pass away.
The problem with life insurance is that people got involved and are now trying to make up reasons for you to buy life insurance. Take life insurance on your child as an example. This is not needed and is a waste of money.
Think about it. If life insurance is designed to allow for your family to replace your income, how does life insurance on your child really benefit you? How much money is your child contributing to the family’s bottom line?
The agents try to sell you on the investment part of the insurance. But let’s again look at the point of insurance. The goal of insurance is to transfer the risk of loss to someone else. Nowhere in this does it talk about saving and investing money. These are two completely different things.
Add in the fact that and “cash value” that builds up is kept by the insurance company when you pass away and the typical high fees of whole and universal life insurance and it is just a flat out bad deal. You can learn more about the perils and pitfalls of whole life insurance at Huntley Wealth.
Buy insurance to transfer the risk of loss to someone else. Save and invest your money as well, but do it elsewhere. Don’t buy a product that protects you and offers a saving vehicle. It is not worth it. There are too many fees and stipulations that it rarely makes sense for the majority of people.
Disability insurance is overlooked by so many people in favor of life insurance. In fact, you hear and see a ton of commercials about life insurance but not any on disability insurance. (Personally, I think this is because life insurance is more profitable for insurance companies, so they push that more than disability insurance.)
Disability insurance is coverage should you get injured and are not able to work. If you are out of work for the short term or long term, having disability insurance ensures you have money coming in and can still pay your monthly bills since they don’t stop just because you got hurt.
Why You Need It: The facts speak for themselves regarding disability insurance. According to The Council for Disability Awareness:
- 25% of today’s 20 year olds will become disabled before they retire
- Over 36 million Americans (12% of the population) are disabled
- There are 2.5 million disabled workers in their 20s, 30s and 40s receiving Social Security Disability Benefits as of December 2010
A typical female, age 35, 5’4″ tall, 125 pounds, non-smoker, who works mostly an office job, with some outdoor physical responsibilities, and who leads a healthy lifestyle has the following risks:
- A 24% chance of becoming disabled for 3 months or longer during her working career
- A 38% chance that the disability would last 5 years or longer
- An average disability for someone like her lasting 82 months
A typical male, age 35, 5’10″ tall, 170 pounds, non-smoker, who works an office job, with some outdoor physical responsibilities, and who leads a healthy lifestyle has the following risks:
- A 21% chance of becoming disabled for 3 months or longer during his working career
- A 38% chance that the disability would last 5 years or longer
- An average disability for someone like him lasting 82 months
If the person smokes or is overweight, the odds of disability are even higher.
The truth is, you are much more likely to become disabled, either for a period of time or permanently, than you are to die prematurely. I’ll let that one sink in for a minute.
Now I know what many are probably thinking. Social Security Disability will be there for me. Or, most likely you’ll get hurt at work, meaning your worker’s compensation will cover you. Hopefully, these stats open your eyes:
- 65% of initial Social Security Disability claims were denied in 2009
- The average benefit paid is $1,065 per month, with 52% of people receiving LESS than that
- 95% of disabling accidents are NOT WORK RELATED, meaning worker’s compensation will not cover you
Based on these facts, it would make sense to not accept this risk and instead transfer it to someone else.
Health insurance is there to offset the costs of needing medical help. This includes routine doctor’s visits, having a child, and medical care because of an accident.
There are many types of plans when it comes to health insurance. First you have the standard HMO which has been around for many years. With this type of plan, your out of pocket costs are low, but the monthly premium you pay is high.
Then there are high deductible plans. These have a higher out of pocket cost but cap this amount after a certain amount. They also tend to have lower monthly premiums.
Of course there are all sorts of nuances when it comes to health insurance. To get a detailed look at all of these, you can check out this post I wrote about health insurance.
Why You Need It: You need health insurance to help pay for the ever increasing cost of medicine and health procedures. Just getting an MRI would set you back a few thousand dollars without health insurance.
Luckily most people get coverage through their employer while the rest of us can turn to the Affordable Care Act to get coverage.
Miscellaneous Types of Insurance
No guide to insurance would be complete without talking about the miscellaneous forms of insurance out there. These are smaller, type specific insurances that have become popular in recent years. They include:
- Credit insurance
- Pet insurance
- Cell phone insurance
- Dread-disease policies
- Identity theft insurance
- Flight insurance
- Body part insurance
This isn’t a complete list, but you get the idea of the types of insurance I am talking about.
Why You Need It: For the most part, you don’t need any of these insurance policies. For example, identity theft insurance covers you if your identity gets stolen. If your identity gets stolen, most (if not all) credit cards will never make you pay the charges that were made without your authorization. So this insurance product doesn’t have much value.
If you are clumsy or accident prone, you may want to consider buying cell phone insurance, but for most people it is not worth it. You can easily get your cracked screen fixed for around $100.
Now body part insurance can make sense for professional athletes. Many take out insurance policies on their own body parts in case they break down. They want to make sure they cash in on their talents. In the recent NFL draft, there was a player that took out insurance on his draft position! If he dropped to a certain spot, an insurance company would pay him for missing out on the larger contracts that go along with getting drafted high in the first round. This isn’t typical, but he was coming off a major surgery and teams were scared to draft him early.
How To Save Money On Insurance
So there are the various types of insurance coverage you can buy. Some of them are needed and others can be ignored. For the ones you are going to buy, you need to make sure you do everything in your power to get the most coverage for your dollar. How do you do this? Here are some tips to consider:
Shop around for auto/homeowners insurance. Studies show people who stick with one company tend to pay more. Don’t be fooled into thinking your insurance company loves you so much they are giving you a deal. Odds are they aren’t.
Furthermore, each insurance company uses its own actuaries and actuarial tables to determine rates. So the cost for the same coverage between two insurance companies is going to vary. Therefore, take the time to compare rates.
Match coverage with need. Make sure you are only buying what you need in coverage. If you have no children and your partner is not dependent on your income, then life insurance probably doesn’t make sense for you. Likewise, if you are fresh out of college and buy car insurance, you don’t need coverage up to $500,000.
Taking this one step further, if you only have a house and belongings worth $200,000 and $50,000 respectively, it doesn’t make sense to have a $1 million dollar homeowner policy. You won’t be able to get that extra amount as cash or get a better house if something happens. It’s just a waste of your money.
Get what you need now and revisit it as your wealth grows and your needs change.
Bundle policies. When you buy homeowners and auto insurance from the same company, they will give you a discount. In some cases, this discount can be significant. So make sure you are bundling policies with one insurer. But refer back to the point above about only getting the coverage you need. Don’t fall for the trap of spending more to save more.
Get all your discounts. Bundling is one discount that is available to you. There are many others too. If you have teen drivers or older drivers in your household, taking a defensive driving course can help to give you a discount. Be sure to ask your insurance carrier what discounts are available to you.
But be careful. Don’t just do things to your house to try to save a few dollars on your insurance premium. A classic example is with a security system for your house. You might get a 10% savings on your premium, but how much will you be spending a year on the monitoring? Be sure to look at both sides of the issue before jumping for discounts.
Accept more risk. Let’s say you drive an older car worth $8,000 and have a net worth of $2 million. While you do need auto insurance to cover you from liability, you probably don’t need collision coverage. By dropping this coverage, you accept the risk of your car being totaled. Can you afford to pay $10,000 to buy another car? With a net worth of $2 million, the answer is probably yes. A good insurance agent will tell you the same thing.
Raise your deductibles. The more risk you accept, the lower your premiums. If you can afford it, raise your deductibles up to $1,000.
Mitigate risk as much as possible. Take some time to go around your house and cars and see if there are things you can do to lower the chances of having to file a claim. While you can’t protect yourself 100%, you can do some things to lower your risks.
A cheap, easy option for your house is to put security stickers around your house. You might even buy a fake security camera and mount it somewhere visible. Doing this will make a burglar think twice before breaking into your home.
For your car, keep valuables out of sight, lock the doors and be more attentive when you drive. The more you can do to mitigate risks, the lower number of claims you will have to file and this will help to keep your premium low.
Check for duplicate coverage. Many auto policies have towing coverage and funeral expenses as part of the coverage. If you belong to AAA and have a life insurance policy, you can cancel the coverage in your auto policy.
Take some time to review your coverage and the separate services you have as well and where you have any duplicate coverage on and cancel one.
Be healthy. This is a great way to lower your cost of life insurance. When you take out a life insurance policy, you are going to have to get a medical test. The healthier you are, the lower your premium will be.
In addition to this, you can also save money on health insurance by being healthy. I am on my wife’s insurance plan and we take an at home test annually. Doing so reduces the premiums we pay by $60 a pay period.
Think before you buy. Before you buy a new car or a house, be sure to first reach out to your insurance carrier. Doing this can save you money by steering you in another direction.
When I graduated college, I fell in love with an Acura RSX. I really wanted it. At the time, I was driving my 1986 Honda Accord. My insurance on that car was about $800 a year. When I called my insurance carrier to ask what my premium would be with the new car, I almost fainted. It was going to be $2,200. That was the wake-up call I needed. I quickly didn’t want that car and instead bought a newer used car.
The moral here is to talk to your insurance carrier first to see what the impact is to your premium and then go from there.
Keep finances in good order. When it comes to auto insurance, your credit score has an impact on your premium. It sounds odd, but the insurance companies did research and found a correlation between high credit scores and low amounts of claims. So if you want a lower premium, work on building your credit.
Educate yourself. Finally, you have to educate yourself. I’m not telling you to get a masters degree in insurance or risk management, but rather to understand the basics of insurance and various options for self-insuring or getting discounts. This guide to insurance is a great starting point.
The more effort you put into staying on top of things, the greater the chances you have of keeping your premiums low and saving money.
Determining The Levels of Coverage Needed
I won’t go into great detail in this guide to insurance about the ideal coverage levels you should have because everyone’s situation is different. I will just highlight some things you need to think about and talk to your insurance carrier about.
For this coverage, be sure to look at your net worth to determine how much coverage you need. If you don’t have many assets, you don’t need to be covered for a huge amount of money.
Additionally, look at your cars value compared to the cost of collision coverage for the year. In some cases on old cars, it makes sense to cancel this portion of coverage because you are paying more in premiums than the car is worth. In other words, you might be paying the insurance company $800 a year on a car that is worth $500. Should you total your car, you will only get $500.
When it comes to insuring your home and belongings, keep two things in mind. First, make sure the coverage you get is for replacement value and not actual value. The difference is that replacement coverage will give you the money to buy the item at today’s prices. Actual value takes into account deprecation.
So, if your 5 year old $2,000 flat screen TV is stolen, replacement coverage will give you the money to buy a comparable size flat screen at today’s prices. Actual value will give you the amount your old TV is worth, which in this case, will be much less than you paid for it.
If you are renting, add up the value of all your belongings and then add 10% to that number. Then talk it over with your insurance carrier to make sure you estimated correctly.
For most people, just getting coverage up to $1 million is sufficient. But make sure you do this only if you have the assets to justify it. Again, if you only have $100 to your name, then umbrella insurance is not needed. But if you have $250,000 or more, then it makes sense.
When looking at life insurance coverage, you need to estimate how much your loved ones will need in order to survive without your salary. Now, before you jump to $10 million dollars worth of coverage, know that the more your death benefit (the $10 million in this case) the higher your premium.
So do some math. Remember that once your kids finish college they can get jobs and support themselves. You really only need to cover the monthly expenses up to this point. A good starting place is $1 million dollars. This might seem high to some readers, but you have to take into account inflation here. In 15 years, $250,000 isn’t going to buy what it can buy today.
So come up with a number and then talk to a person who deals with life insurance. Just don’t let them talk you into whole or universal life!
One final note regarding life insurance is coverage for those with pre-existing conditions. Luckily you can still get coverage (contrary to popular belief) so that your loved ones can be provided for financially should something happen. You can find a great reference article on this topic by QuoteWizard.
Determining how much you need for disability coverage is much like life insurance above. You want to figure out your monthly income and expenses to figure out how much coverage you need.
From there, you need to look at your savings to see how long it could last to cover you (self-insure) and then decide on how long you would want disability coverage for.
Again, talking with a professional will go a long way in helping you narrow in on an amount right for you.
When it comes to health insurance, you want the plan that fits your needs best. If you rarely ever go to the doctor (because you are young and healthy and not because you choose not to go) or go almost every day, a high deductible plan might be best for you. This is because for the healthy person, they can save money in an HSA account for the future. I talk about this in detail in this post.
For the people that see the doctor every day, the high deductible plan is a good option because once you hit your out of pocket limit for the plan year, your health costs are drastically reduced.
But your overall best option is to talk to someone at your work who knows the plans that are offered to you. They can best help to steer you in the right direction.
For these, only you will know want makes sense and what doesn’t. For most people though, most of these extra insurance options are not worth the money. You are better off self-insuring and taking the risk on yourself. Just save up some extra money to cover things should the need arise.
So this completes this guide to insurance. It was a lot of information, but it is all important information. Remember, insurance is boring for many people, but that should not be an excuse as to not having the right coverage and policies for you and your life. It is an important puzzle piece to a healthy and complete financial life.
Take some time to review your current coverage, where you are over covered and under covered and take some action to fix these things. When you do this, you can sleep better at night knowing that should something happen, your financial life won’t be completely throw to pieces. You will have a life raft there to help you get through the turbulent times.