Money Sundays: Is All That Insurance Really Worth It To You?

Warning to readers: if you happen to sell insurance or work in the insurance industry, don't read this. It will just make you mad.

From a comment from long-time reader Chacha:

My total insurance bill (renter's, health, life, and auto) is nearly $1000/mo for a family of two healthy adults in a rental household with paid-off cars.

We have the highest-possible deductibles that our company will allow on renter's and auto. We have multiple discounts etc for safe driver, secure parking, low mileage, etc. Our cars are 1996 and 1999 models - hardly high theft risk - and neither of us has ever caused an accident.

But we live in Beverly Hills, CA, and that alone apparently doubles the premiums (it's far worse of an inflation factor than we've found applied to rent).

For those readers interested in reducing the money they spend on insurance, here are a few things to consider:

1) Save up in your regular savings account the difference before your prior, lower deductible and your current, higher deductible. Then, jack up your deductibles, exactly as Chacha did.

For example, if you are carrying a deductible of $250 on your auto collision and comprehensive policy, increase it to $1,000, as soon as you've saved up an extra $750 (the difference between the two deductible levels) in your savings account. In other words, you will use your own savings to "self-insure" your first $1,000 of potential liability, rather than paying through the nose to an insurance company to do it for you.

Hiking your deductibles usually results in compelling savings. Making a change from $250 to $1000, for example, could save you some $150 a year in premium costs every year (your mileage may vary). And the way to think about that $150 in premium savings is to see it as a permanent, tax-free 20% annual return on the incremental $750 you're holding in your savings account. Not too shabby!

2) Don't bother carrying collision and comprehensive insurance on older, paid-off cars. Remember, in the event of a loss, the insurance company will only pay up to the blue-book value of your car. After 14 or more years (Chacha's cars are 14 and 17 years old respectively), even expensive cars will have depreciated down to just a few thousand dollars. This is an asset that you can far more cheaply self-insure with personal savings.

Thus, you should save up a few thousand extra dollars in your savings account, and view that as your collision and comprehensive "insurance policy." Then you won't have to pay money every year to some dumb insurance company. If this step sounds a little bit like step 1, it is--except in this case you are relying on your personal savings to protect you entirely from a risk, rather than using your savings to cover the difference between a low and a high deductible.

An aside: if you've read my series on Your Money Or Your Life and you're pursuing your personal road to greater financial independence, you'll find that as you build your savings cushion into thousands--or tens of thousands--of dollars, you can dramatically increase deductibles and significantly reduce all of your insurance needs. You'll be able to save hundreds, if not thousands, of dollars in annual premiums.

3) Now, with regard to your legally required auto liability insurance, consider carrying the minimum amount required by your state combined with the highest deductible possible. These steps will save you big time on your insurance costs.

4) Let's move on to renter's insurance. Two thoughts: First, do you really have valuables that are valuable in the monetary sense, or are they just valuable in the sentimental sense? Insurance companies can only give you money... they can't actually reverse time and miraculously replace your stuff.

And if that thought didn't sufficiently bake your noodle, how about this one: How much value do you really get out of having expensive stuff if you're also stuck paying still more to insure yourself from losing it? Roll this over in your mind and you may decide renter's insurance has no value at all.

5) Life insurance. Under what circumstances, really, should you carry it?

You can make an easy case for purchasing life insurance if your household depends on a primary breadwinner. For example, if you're the primary earner in a one-income household with small children, you're probably a good candidate for a policy.

In this case, however, you should only buy a basic term life policy. Avoid fancy "universal life" type policies which wrap investments, variable annuities, etc., around a life insurance policy. These types of financial products are fabulously lucrative for insurance agents and insurance companies, but their value to consumers is dubious. They can be complex, hard to understand, and they can contain disturbingly high investment fees.

Furthermore, as good as they are at collecting your premium payments, insurance companies are often surprisingly mediocre at investing. I make this statement based on my own professional investing experience at an unimaginably large insurance company that, in 2008, went through an unimaginably embarrassing bankruptcy.

As the old saying goes: buy term and invest the difference. Get a simple, competitive, inexpensive, plain-vanilla term policy, and invest the savings in premiums yourself. You'll save on fees, your money will be in your own hands--and you'll probably enjoy superior investment returns.

Of course, if your circumstances allow for it, don't pay for life insurance at all. For example, a two-income household with no children shouldn't need life insurance. Without kids and with both spouses working, what is a life insurance policy really for? Who is it for?

A final word. Insurance is a product that, typically, is both sold and bought emotionally. At its core essence, it is a product designed to (try to) protect you from your fears. Therefore, it shouldn't be a surprise that the people who sell insurance want you to see and feel your fears as much as they can.

Don't let yourself be goaded into carrying water for the insurance industry. Be sure you really need insurance before you buy it, and be sure your need is economic one, not an emotional one. Remember, an insurance company can only give you money in the event of a loss--it can't give you back your car, your stuff or your loved ones.

The counterintuitive ideas on insurance here may already be obvious you. If so, great. But for many people these ideas are far from obvious. If you know someone who could benefit by reading this post, please forward it to them. You might help a friend or family member save many tens of thousands of dollars over the course of their lives.

1) Jack up all your deductibles and reap the savings on premiums.
2) Ditch collision and comprehensive on any car that's old. Instead, self-insure with your savings.
3) Carry the minimum liability insurance required in your state.
4) Don't own expensive stuff and you won't need renter's insurance in the first place.
5) With life insurance, don't buy it based on fear. Buy it only if you need it, and then get only a simple term policy. Buy term and invest the difference.

Sometimes insurance is necessary. Don't get me wrong. But insurance also quite often fulfills our emotional needs at the expense of our financial needs. As you continue on your road towards financial independence, you'll most likely find you need very little of the insurance you once thought you did.

Related Posts:
Becoming a Knowledgeable and Sophisticated Investor: Six Tips
What Is a Scarcity Mindset? Investing and Living In a Zero Sum Paradigm
How To Make the Tax Code Work For YOU
Is Looking For Tax-Efficient Investments Icky? Or Intelligent?
On Timeshares, Beware
Extreme Savings

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Matt said...

Nice post, some great points. I love the way you point out the emotional factor in insurance, and I agree wholeheartedly. Insurance can be just like any other consumer product or service, sold to us to fill an emotional need, a need which is never fully satisfied and thus keeps us buying more.

Plus, I laughed when I saw the tl;dr at the end!

Little Old Les said...

"carrying water for the insurance company" - what an excellent phrase!

Brittany said...

But man is the emotional factor important when there is a disaster! I would caution that these tips are really only good if you are already in a financial place that you can provide the "emotional security" with your own savings. (That is, don't cheap out on insurance *in order to* save up a big enough nest egg to buy a new car if yours is totaled. Get the savings first.)

Having been through a house fire, a car wreck where my car was totaled by an uninsured driver, and an exploding water heater that flooded the downstairs of my (rented) house (during the middle of a breakup from a partner who was living with me), insurance has had my back in some of my most stressful moments. To me, the "emotional factor" is the peace of mind that I'm not going to take a massive financial hit because of a (totally common) freak disaster. I know insurance is, essentially, a bet against yourself and someone has to be losing out for them to be making money, but had be covered so far.

My point is not that you should ignore all this advice and have ALL THE INSURANCE. It's that the the emotional factor *is* an important factor that should be weighed in consideration with your financial state, the impact a disaster would have on you, and your tolerance for risk. It's not just a frivolous "emotional need." (Emotional needs are real needs! I don't understand this dismissal, actually.) I think you should BALANCE your emotional needs (and risk tolerance) with your financial reasons, not ignore them.

Brittany said...

(Although, full disclosure, I just decided to forgo dental insurance for the first time ever for a few months while self-employed (went to the dentist right before I left my last job), and have paid $3000 out of pocket to fix some sudden and extremely painful dental problems in the last month. And even though I had the emergency fund to cover it, I'm feeling pretty pro-insurance/anti-being-cheap-with-my-insurance at the moment...)

Daniel said...

Nobody is dismissing emotional needs. Rather, I'm asking this question: Can an insurance company actually *meet* those emotional needs?

Remember, the insurance policy can only give you money.


chacha1 said...

Hi Dan, glad to see some responses here. It's a thought-provoking start to a discussion ... as I mentioned to you, my husband and I recently self-insured with Kaiser on a high-deductible plan, which is going to save us $200/mo over what we paid for my employer's group lan. That money is already earmarked.

We have also pretty much agreed on saving up the blue-book value of both cars and then deleting collision coverage. We will not be cancelling comprehensive, though, because of the hordes of uninsured drivers in CA.

Now if I can just convince him to unload the motorcycle ... .

Brittany said...

I was primarily responding this line: "Be sure you really need insurance before you buy it, and be sure your need is economic one, not an emotional one."

I think the emotional needs/risk tolerance are also important when considering buying insurance. (I also disagree that they give "only money." For starters, insurance equals money + peace of mind. Second, I have always gotten legal, logistical, and practical support from my insurance company in the wake of disasters.)

Perhaps I just live in a part of the country where the cost differential isn't as high as chacha's? (Although I'm curious how much of that $1000/month is health insurance, which is way more expensive than renters insurance generally and wasn't touched on at all.) But it was only about $10-$15 more a month to have comprehensive instead of liability only or to go from a $250 to $1000 deductible. And saving $150/year while giving up protection on a $5000-$10000 asset strikes me as pretty penny-wise, pound-foolish.

Renter's insurance also cost me $15/month. Yet my exploding water heater and related flooding did $1500 worth of damage in only a few hours, and it only damaged two rooms. (And I don't even own that many nice things!) If I think I am going to have an equivalent disaster more than every 8 years or so, I'm ahead by having insurance.

I guess I was pretty disappointed in the tone of this article, which didn't discuss much practical advice in terms of figuring out when insurance is or is not a good financial decision and instead just advocated cutting your insurance to the bare minimum and made it seem as if insurance was always throwing money away on "some dumb insurance company" as opposed to something that required a balanced approach and assessment. Le sigh.

Although I also giggled at the tl;dr. =)

Daniel said...

Brittany, I have to admit, I didn't know what tone you were expecting when I sat down to write this article. I'll try harder to get it right next time. :)

I'll see if I can address some of your examples in a future post. But keep in mind, I can't possibly know your financial situation or anyone else's, and that obviously plays in here. If you are unable or unwilling to cover a loss of a given amount, by all means insure for it.

But in the scenarios you present, you are thinking through the costs, and balancing them with your tolerance for financial risk. Quite frankly I don't see you making an emotional decision here, which is a good thing, and is pretty much the entire point of the article.

These are money questions after all: reasonable minds can look at the same set of facts and reach different conclusions.


Cayla Dupont @ Harlan Insurance said...

I find that the necessity of insurance depends on each individual's case. Certain situations may cause some people to get higher premiums while others would rather invest in something else. That said, you have some great points that can give everyone something to think about when it comes to getting insured. You've also shared great tips on how to get our money's worth. Thanks, Daniel!