Have you ever felt like you were over-insured? No one wants to waste money on unnecessary insurance premiums because every dollar wasted is a dollar that could have been invested or spent on something a lot more exciting than insurance.
On the other hand, not having the right types or amounts of insurance can be very detrimental to wealth building and enjoyment of life. How can we find the proper balance?
As mentioned in the rules of prudent risk management above, the key is to cover only the potentially catastrophic risks we cannot completely avoid. The following types of insurance cover risks in that category:
- Auto Insurance
- Homeowners Insurance
- Umbrella Liability Insurance
- Medical Insurance
- Long Term Disability Insurance
- Long Term Care Insurance
- Life Insurance
These types of insurance are critical because uninsured losses we may experience in these areas have the potential to financially devastate us. For example, if we carried only the minimum required auto insurance liability limits and seriously injured or killed someone in a car accident, how would we pay for the vehicle damage, medical expenses, and income loss of the other driver? The damages could add up to hundreds of thousands, even millions of dollars. How could we pay medical bills for unexpected cancer treatments, surgeries, and long-term hospital confinement if we had no medical insurance?
If we choose not to have insurance in any of the areas listed above, we need to create a realistic plan for how we would cope if disaster struck. For example, if we choose not to acquire disability insurance, we would be foolish to say, “I do not need it because I am never going to get sick or hurt.” Of course no one ever plans to get sick or hurt. It happens when we least expect it.
A realistic alternative plan might be the following: “If I cannot work because of sickness or injury, we will move in with my in-laws and use our retirement and college savings to pay for my wife to go back to school so she can earn enough to support us. We will no longer help our children pay for their college education, and we will postpone retirement for another 10-15 years beyond what we originally planned for.” If we cannot think of an alternative plan that is realistic and acceptable to us and those who financially depend on us, then transferring the risk to an insurance company might be the best strategy.
In my opinion every other kind of personal insurance is optional: dental insurance, short term disability insurance, accident insurance, home warranties, extended warranties on cars and appliances, credit insurance, travel insurance, and many others. These are nice to have if someone else is paying for them, but the premiums tend to be very high for the benefits provided, and no loss in any of these areas has the potential to ruin us financially. Therefore, if we are underinsured in the essential areas but are paying for coverage in optional areas, it may be wise to terminate nonessential coverage and use the premium savings to increase critical coverage.
The Right Amounts of Insurance
How can we know how much is the right amount for each type of essential insurance? The short answer is as much as the insurance company is willing to give us, for the lowest possible cost.
I want full replacement value for all of my most valuable assets. If my home burns to the ground, I want the insurance company to pay to rebuild the whole house, not just the kitchen. If they would not rebuild my house the way it was before the fire, what is the point of even having insurance? I also want to retain as much of the risk as I can afford to retain through high deductibles so my premiums will be as low as possible without sacrificing high coverage limits.
Although everyone’s insurance needs are unique and should be reviewed by a competent advisor, the following sections provide general guidelines for each type of coverage.