This may see like an odd time of the year to be discussing insurance. No doubt your mind is geared toward preparing for Christmas and figuring out how to save money on all the presents, decorations and food you will buy during the holidays. There is a reason however why this is coming out now, one that highlights an issue many people have when it comes to insurance.
This post idea to go over the basic reason why we need insurance has been listed in my “blog topics to cover” spreadsheet since March. But I keep putting off writing about it, pushing it back month after month. Honestly, I don’t enjoy researching and talking about insurance.
It’s like the black sheep of the family. Every family has one at some level, right? That person who brings immediate tension to the room whenever their name is brought up? That historical figure we’ve conveniently deleted from the family ancestral tree?
Insurance is that black sheep in our personal finance family. With the exception of insurance salesmen, I don’t know anyone who gets up in the morning fired up about reviewing insurance policies. I’ll worry about saving, getting out of debt, investing, budgeting, root canals…anything before insurance.
Is it just me or is anyone else with me on this? Insurance can be really frustrating and confusing to deal with.
But I know it’s important and that I need it…badly. Without it I could be putting myself in serious jeopardy.
The Basic Reason We Need Insurance
At the most basic level, the reason we need insurance can be summed up in three words – to reduce risk.
The risk we are in need of reducing is of course financial risk. Without insurance we could be forced to pay excessive amounts of money to cover accidents, illnesses, or lawsuits people bring on us for one reason or another. These amounts could become so exorbitant that they might bankrupt us. An entire life savings could be wiped out over one incident.
This is where an insurance company steps in. Insurance companies will contract with the individual to help reduce the risk of a financial catastrophe. They will shoulder the burden of helping you cover excessive costs in exchange for a monthly premium from you. Here’s how that works.
How Insurance Premiums Work
If I purchase a $30,000 car and choose not to have insurance I’ve put myself at considerable financial risk. If I have an accident and the repairs cost $15,000, then I’ll be expected to come up with all that money myself to pay for the repair. That’s an expensive repair!
In steps the insurance company. When I have an insurance policy with a company, I pay them a monthly premium. In exchange, they will cover the cost of the repairs past a certain amount (called a deductible) and up to a certain point (called the limit). I’ll be responsible to pay for everything up to the deductible amount.
So for example, the deductible on XYZ automobile policy is $5,000. With the accident mentioned above I would pay $5,000 in repairs and the insurance company would cover the rest of it – $10,000. That’s considerable savings and how insurance reduces risk and our financial exposure to life events.
Generally speaking, premiums and deductibles are tied to one another within insurance policies. All other things being equal, the more personal financial risk you are willing to assume (which would mean a higher deductible amount) the lower your monthly premiums will be. The less risk the higher the monthly premium.
Monthly premiums and deductibles will vary depending on the insurance policy. They will fluctuate depending on whether or not you have an insurance claim (an personal event for which they pay) during the year. And, as we’ve seen recently with healthcare, they can also change based on things completely out of our control.
Sending off those monthly premiums may feel frustrating. You may be tempted to cut them out of the monthly budget to save money. I’d advise against that as the financial consequences of being uninsured or underinsured are too great to ignore.
An Insurance Series
For 2015, I’ve decided to put together a series of posts dealing with each type of insurance. The main types of insurance are of course auto, homeowners, life, health, disability and umbrella policies. I’ll tackle each one of those separately and in depth, doing one each month through June.
I may pull my teeth out writing these posts. (I’ll try to make it informative and entertaining at the same time.) However, it’s important information to cover for our personal finances and will help me personally solidify in my own mind a deeper understanding of each category.
We work too hard to have our life savings used up in paying for a catastrophic event. We can make sure that doesn’t happen by being properly knowledgeable about how insurance helps us. It really is our friend not the black sheep of the family.
Does insurance frustrate you? Have you ever had a life event where insurance really saved you financially? Do you prefer to have low or high deductibles on your policies?