This was the post that I meant to write yesterday – only, I got distracted by Alien Abduction Insurance (Insuring Yourself Against Aliens).
Here’s how insurance companies make money:
- They sell insurance policies to a pool of people,
- If the premiums collected are less than the claims paid out,
- Then the insurance company makes money.
In a perfect free market world, there would be so many insurance companies that none of them would be able to charge a premium insurance premium (that is: a monthly insurance fee that is excessive relative to the risk of whatever you’re insuring against). Because if any one insurer did that, then their policyholders would switch to a rival provider that offered a lower premium for the same insurance cover. This market force would naturally keep insurance premiums in check.
And because there are so many insurance companies out there: in theory, you should always be getting a good deal on your insurance.
Which makes very little sense to me.
My Swathing Indictment of Free Market Fallacy
In order for that whole system of free-market consumer preference to work, you need the following:
- Fully rational consumers
- With perfect information (ie. omniscience)
- Who are willing to deal with the admin of changing insurers.
In practice, insurance companies deal with:
- Paranoid and panicked consumers
- Who haven’t read the fine print, relying mainly on broker advice
- And are full victims of inertia (ie. they’ll throw their hands up and move their policies only after the insurance company has enraged them by refusing to pay out a claim, based on some technicality or something).
But I don’t believe that this (necessarily) results in higher premiums being paid. After all, there are far more interesting ways for a fat cat to get its skin:
- Insurance policies at a nominal price that you really don’t need.
- Multiple insurance policies that cover the same thing.
- Slow and painful claim approval processes.
- Oh, and of course, fine print.
Unfortunately, because insurance companies deal with the currency of fear (although paranoia is preferable), it’s often difficult to know where to start, or gauge what is, and what is not, necessary.
Some Suggested Rules of Thumb
I’m a believer in principles.
The point of insurance is not to remove all risk from your life: the point of insurance is to mitigate the risk of those events that would destroy your life without actually killing you (although there is insurance for that as well).
1. Insure What You Cannot Afford To Lose
These are the big ticket items: like health insurance.
2. Insure What Your Family Cannot Afford To Lose
When you die, you’ll be leaving your loved ones with estate duties, no income, and the cost of a funeral. That’s why you buy life insurance policies.
3. Insure Anything That Requires Credit-Approval For You To Buy It
Cars and houses. You don’t want to end up paying for both the old one and the new one because you still owed the bank for the original.
4. Don’t Insure Sentiment, Because You Can Do Without It
A wedding ring is mainly valuable because it has the adjective “wedding” attached to it. If you lost it, you could save up the money to buy a new one. So don’t do it.
5. Extended Warranties Are A Gimmick
You don’t need an extended warranty. Like ever. Yes – ever. If something goes wrong during the extended warranty period, it’s time to buy a new one.
A Short List Of Non-Negotiable Insurance Policies
While you’re busy buying insurance for your new watch at the counter, just be sure that you have these floating around somewhere:
You know what they say at Harvard… “Your family is just one serious illness away from bankruptcy.” This is not the place to fool around. You need to make sure that you are covered for all serious illnesses and emergencies. That said, I think that outpatient, dental and medication extras are a bit negotiable. Because everyone faces these so regularly, it’s not worth an insurer’s time to insure these, short of charging an exorbitant premium with high excesses and all manner of disclaimer. But don’t get distracted – it’s the medical emergencies and hectic treatments that will bankrupt you, not the dentist!
Long-term Disability Coverage
If you’re suddenly disabled, then you’re probably going to lose your income. Don’t think it can’t happen – because if it does, it’s a game-changer. Shocking statistic: nearly 50% of all mortgage foreclosures in the United States are caused by someone becoming disabled. In my mind – this is the one that everyone forgets. Because sure, your medical costs might be covered – but what about the lost income?!
I mean – I guess this depends on where you live. But if you use your car to get to work, then no car means no getting to work. At the same time, if you bought the car on hire-purchase, and you lose it, then you’re going to get stuck paying for both the car you lost, and the car you had to buy to replace it. To say nothing of all the suing that will take place if the accident was your fault and someone got injured… Third Party Insurance and some comprehensive cover – have it.
If you have a family and most of your assets consist of your house, then you need to have something that frees up cash immediately post your demise. For everyone else’s sakes.
Mainly for the house itself (if you decided to buy one). I go back to the point about owing the bank for the house, and your debt being separate to the existence of the house itself.
And Don’t Forget…
That the real insurance policy is still your community. When you go into crisis, most families will recover by borrowing from siblings, parents, children, distant relations, and well-to-do friends. They’re the ones with the vested interest in getting you (hopefully) back on your feet.
So what you’re actually doing when you take out insurance policies is limiting the amount that they will be burdened with.
It’s a point that we often miss, I think. But there it is.
*dashes out to arrange long-term disability coverage/income protection*