When and When Not to Get Insurance

PHOTO: Firefighters battle house fire

Most people believe that it's foolish not to have insurance, and in many cases they're right. Yet buying some types of insurance may be a costly mistake.

Many buy insurance out of fear instead of reason, even though this is a financial decision. Only by looking at the matter calmly and objectively can you make sound decisions on when to buy insurance and when not to. When you buy insurance, you're paying the company to assume your risk. Yet insuring some of these risks isn't worth the high price and other risks are too insignificant to consider insuring. Whether you should buy a given type of insurance depends on the price versus the likelihood of negative outcomes and the financial impacts of these outcomes.

Buying some types of coverage is a no-brainer. A good example is fire insurance for your home. Although the chances of a house fire are low, the financial impact of your home burning down would be devastating. Because there's a big market for this insurance, companies can pool this risk, covering the losses of the few with the premiums of the many.

Another example of insurance at its best is term life insurance. The premium for a healthy 25-year-old is low because of the slim chance that he will die in the next 20 years, and this risk is pooled with millions of others. Even though his chances of early death are statistically low, he should buy this insurance if he has a family.

For many other types of insurance, depending on your situation, you might want to just say no.

For example, many people wouldn't dream of starting their cars without automobile collision insurance covering damage to their vehicles from accidents that they may cause. But it doesn't make sense to cover a car that isn't worth much, especially in high-cost-insurance states. If your car is worth only $4,000, why pay $800 a year over the next five years for collision insurance? Instead, you could just put $800 in the bank each year. If you have an accident, you can buy a used car for $4,000. If you don't, you'll have the car and the $4,000.

It's a good idea to check on all insurance costs before buying a car. Also, remember that you can save a lot of money on a policy by choosing a high deductible.

Unnecessary insurance products and those that protect against trivial losses abound. These include car-loan payoff insurance (in case people can't make their car payments), extended warrantees on consumer electronic products (which have the disadvantage of being prorated), flight insurance covering your death in an airline accident (an extremely unlikely event already covered by your life insurance policy) and rental car damage insurance (most personal automobile liability policies cover this).

Choices for many other types of coverage aren't so black and white. Here are some types of policies you may want to consider:

Umbrella liability coverage.

This is a policy that adds coverage beyond the limits of your existing homeowner's or automobile policy. Because it kicks in only when these limits are exhausted, premiums are low — often $1 million in coverage for not much more than $100 a year. This coverage is a good idea for those with substantial assets to protect or professionals who want to beef up existing coverage against lawsuits.

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