In this post, we are going to discuss viewing insurance from a different perspective, and then use that perspective to identify potential cost savings.
The Purpose of Insurance
When personal insurance was originally created, its purpose was to provide money in the event of a catastrophic life event such as death or illness (life insurance and annuity contracts). Similarly, property insurance came about to protect our homes and most expensive assets, as if either were rendered unusable, the monetary loss would be impossible to overcome. Then of course, other types of insurance came about to help in the event of disability or to provide assistance paying legal damages as well.
Insurance was meant to protect you from infrequent events for which you would not be able to monetarily recover from. In the industry, we always talk about how to handle risks in terms of their frequency at which they occur and the severity of the loss. This diagram is often used.
Allow me to elaborate:
- For an infrequent loss with a low severity of loss, you should retain (i.e. do nothing with) that risk. An example of such a risk is a lightbulb burning out. Light bulbs are cheap, and burnouts, especially with LED lights, are rare, so it makes no sense to buy “lightbulb insurance,” if such a thing exists.
- For a frequent loss with a low severity, you should reduce the risk. In other words, nobody likes when their phone runs out of battery. To reduce the impact of this risk, you can either carry a spare battery pack or keep a charger with you when you leave your house.
- For a frequent loss with high severity, you should avoid that risk all together. For instance, skydiving, while fun (I did it once), is not the safest of sports. By engaging in that sport, you are regularly exposing yourself to a potential risk of death. Therefore, those activities should be avoided.
- Finally, the only types of losses which should be insured are ones which are infrequent, but bring about very severe losses. The probability that our car hydroplanes and we drive into another car, hurting those inside, is extremely rare. But, in those events, medical costs, property repair costs, and litigation costs will be so high that you could not afford to pay them. Therefore, we insure the risk.
Note that insurance is used to protect against risks and events which we could not afford to remedy ourselves. Somewhere along the line (likely since insurance agents are incented to sell policies with higher premiums) insurance morphed from “true insurance” to a “discount plan.” With deductibles as low as $0 for car insurance, we are paying to insure events which we never needed insured, such as a small paint scuff caused by a rogue shopping cart or a baseball cracking a bedroom window.
And yes, if you do the math of the average claim, the average time between claims, and the differences in policy cost, lower deductible policies will chip at your wealth over the long run!
Extreme Example: Saving Money Waiving Collision & Comprehensive Auto Insurance
Before going through this exercise, you need to understand how much money you could afford to spend in the event of needing to replace/repair your home or auto. Additionally, you need to give an honest self-evaluation of how risky your own lifestyle behaviors are.
For instance, if I wanted to replace my old Hyundai with another old Hyundai, it would cost me only about $4000. While I don’t enjoy the thought of doling out that much cash, I can afford it. Therefore, and considering how little I drive, I have decided to completely opt out of collision and comprehensive car insurance. I still carry substantial liability coverage to pay for someone else’s damages if I’m at fault in an accident. My car is just not covered.
That alone saves me $50 a month on my car insurance. “My current premium” reflects how much I pay for auto insurance with no collision and comprehensive coverage while “Your quoted premium” includes those coverages with a $100 deductible.
The Middle Ground: Higher Deductibles
I realize for most people, especially driving newer or leased cars, that waiving collision and comprehensive coverage is unfeasible. In this case, I would again go back to answering the question of “how much money could you come up with easily and quickly in the event of an accident?” Whatever that number is, you should consider selecting that as your deductible. For example, my car insurance is only $14 a month more if I elect for collision and comprehensive coverage with a $2500 deductible versus waiving coverage entirely.
A similar exercise can be done with homeowners’ insurance. For instance, most homeowner’s insurance claims are small and due to weather events, such as wind blowing off some shingles or heavy rain leading to minor leaks into your basement. If you can handle paying these smaller damages with your emergency fund, you should consider raising your deductible so you are covered for the catastrophic losses (from fires, hurricanes, tornadoes, etc.) that you cannot financially afford. I increased my deductible from $500 to $3,000 when I lived in Pittsburgh and the result was a cost savings of $60 per month.
For most people, choosing a higher deductible will save you money over the long run. For this reason, I generally advise choosing a deductible based on how much money you quick quickly come up with in the event of an emergency.
Summary: Buy Only as Much Insurance as You Need
Insurance is expensive, which is why I only like to purchase as much as I need. By increasing your deductibles and waiving coverage if and where appropriate, you can dramatically reduce the cost of your property insurance. Similar exercises can be done with renters, medical, disability, and long-term care insurance. I hope you found this article helpful, and make sure to check my other articles on cutting your major recurring expenses!