Lesson 4b: Insurance
Insurance is a mechanism to control your financial risk. You will not be able to eliminate all risk, but there are certain risks that you can and should transfer to an insurance company. The basic rule of thumb is that you should transfer the financial risks that occur less frequently and have the largest negative consequences. You should retain the risks that occur more frequently and that have little variability in their outcome. For example, you would not buy dental insurance if it just covered teeth cleaning because you can expect to have two dental cleanings at a relatively low cost each year. This insurance would be expensive because the insurance company would charge you for the two cleanings and would include additional costs to cover their profit margin and administration costs. On the other hand, you may want to buy insurance to cover major teeth reconstruction because it is harder to cover this cost on your own. In addition, the likelihood of needing the insurance is usually minimal, and this equates to low cost. So when buying insurance, understand what risks you are transferring because transferring smaller risks may not be worth the cost. Thus, self-insuring smaller risks may save you money.
There are many different types of insurance coverage. There are some standards in the industry that will vary depending on who you talk to. Thus, you should understand the risks involved to see if you want to buy insurance to cover your specific risks and circumstances. For example, a factory worker with few assets may only need basic automobile liability coverage, while the owner of the factory with significant assets may want to buy extra liability coverage using an umbrella policy to protect his assets.
Many probably already know most of the common types of insurance. Yet, have you thought about ways to save money by self-insuring the risk yourself or have you reviewed your risks to see if you are properly insured? .Some of the more popular insurance policies are:
As you can see, there are ways to self-insure your financial risks with higher deductibles on automobile and home insurance and building up sufficient assets and emergency funds for short-term disability, in order to save money. However, it is not wise to self-insure other risks like long-term disability and catastrophic medical coverage. To determine if you have the right amount of insurance, you can review your current policies with two or three independent agents. During the review, the agents should explain their reasons for increasing or decreasing your coverage. You should be able to tell which of the agents has the most knowledge and which policies are right for you through their explanations and by what questions they ask you in order to understand your situation. The agent that gives you the most comprehensive review, probably has your best interest at heart. Unless you have significant knowledge about insurance, I would avoid using just one review because you will not really know if the agent really understands what he is doing (e.g., using a one size fits all approach).
For example when buying life insurance, does the agent quickly recommend term life insurance that is 10 times your salary? Or does he ask about your expectations if something were to happen? For example, will your spouse go back to work (if currently at home raising children)? Will you want to fund your child's education and if so, how far along are you with the education fund? Many times, a rule of thumb is used (insurance should equal 8 to 10 times pay) without understanding that each situation can and will be different based on individual expectations. Why pay more for life insurance than is needed, when other risks may not have been addressed, like long-term disability?
Lastly, with a potential for a large difference in costs for similar policies, finding your insurance at the lowest price (and reasonable quality of the insurance company) should be researched. A website that I have used to compare prices of various insurance policies without having to provide a lot of detailed personal information is Insure.com and Ehealthinsurance.com. However, there are other similar websites (some may require more personal information than others) which are listed on Suze Orman's website.
|Financial Topic : Planning Emergency Fund|
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