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.

Flood insurance. Though there's a low probability you'll need this coverage — unless you live in a floodplain or low-lying area or on the waterfront — the potentially severe damage makes it a good idea. And because of pooled risk, the price is relatively low compared with the consequences of a flood. You should understand what is covered and what isn't (for example, whether a sewage back-up is covered depends on the cause of the problem).

Private mortgage insurance (PMI).

Lenders typically require this on mortgage loans when down payments are less than 20 percent of the sale price, so paying this amount down is the best way to avoid this expense. But after you've paid a substantial portion of the loan, there's no justification for the lender's continuing to require PMI because the accumulated equity protects them if you fall behind in payments. Many lenders will eventually drop the requirement for PMI, but this often takes a lot of campaigning by borrowers.

Long-term care insurance.

These policies tend to be pricey — often $2,000 to $4,000 per year — so consumers should carefully weigh the benefits against the cost. And even at this price most policies don't begin to cover this type of care until after three months. If you die or are well enough to go home by this point, these policies pay out nothing. Yet this coverage can be a good idea for many people, depending on their financial situation.

Disability insurance.

This covers the risk that you won't be able to earn a living because of health reasons. This coverage tends to be more expensive than it should be because some people buy it planning to later claim they're disabled. Again, you may or may not want to insure against this risk. One way to save money on insurance is to make a conscious effort to manage risk, which most people do already. You manage your risk of causing a car accident by driving cautiously and the risk of your television going haywire by selecting a well-reviewed model. Though you have health insurance, you may manage your risk of cardiovascular disease through diet and exercise.

When you do decide to buy insurance, compare vendor rates and terms and read policies carefully before buying. And be sure to buy from a reputable vendor.

Ted Schwartz, a Certified Financial Planner®, is president and chief investment officer of Capstone Investment Financial Group http://capstoneinvest.net. He advises individual investors and endowments, and serves as the advisor to CIFG UMA accounts. Because Schwartz has a background in psychology and counseling, he brings insights into personal motivation when advising clients on achieving their wealth management goals. Schwartz holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at ted@capstoneinvest.com.

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