You are insurance poor if you have insurance that costs more than it is worth to you, or if you have too little of some insurance that has value for you. The are ways to cure the problem.
Step 1. Understand your assets and the probability of those being lost or destroyed. Pretty easy for the Picasso in the den, but there are other assets that are more difficult. The value of your career for instance. Fortunately for this one, the general probability of loss to death or disability is quite well known.
Step 2. Understand that there are four possible insurance risk states or conditions. Each has observable characteristics and there are general approaches to pricing them and for you to participate. More a bit later.
Step 3. Understand how insurance companies work. The total of premiums received plus investment income must exceed the total of claims, overhead and reasonable profit. You may have noticed that insurers tend to be profitable or be absorbed by ones that are. You will not win against an insurance company and you should not try. If you think they make too much money and so you do not want to play, would you feel better dealing with one that was losing money? Maybe not.
Back to step 2. Understand the risks. Simplistically, insurers, analyze a prospective insurable loss on two parameters. How big could the loss be if something bad happens and how probable is the something bad. You can analyze your insurance needs on those too.
State 1 – High Probability and the loss will be large. Taking a ship into a war zone for example. I know of a case in 1991, where an insurer wanted 20% of the value of the ship and its cargo for five days coverage in the Persian Gulf. High Cost/High Probability tend to be uninsurable situations and you should employ loss containment and loss prevention to deal with them. In the shipping case, the shipper went to Cairo, then overland to Riyadh.
State 2. The cost opposite of state 1. High Probability, but low cost. Maybe I need to visit a chiropractor or a dentist to get a filling. Bear in mind that insurers pay claims that total less than the premiums they receive. If you want to insure every possible loss, you can probably do it, but you will increase your out of pocket cost by the insurers overhead and profit. Your best approach is again loss prevention, self insuring some situations or by using a deductible.
State 3. Low probability / low cost. I might break my glasses, or lose my coat, or break a rental DVD. Self insurance is the only reasonable approach. Small claims high probability equals large premiums.
State 4 is the only reasonable insurable condition. Low probability/ High cost. The price of a death, sickness or fire may be devastating but the insurance is still affordable because it is so unlikely. The probability of a young person who can pass a physical dying soon, is almost zero. A million of life insurance on a 30 year old male is less than $100 per month. The million would be hard to come up with by other means if the individually improbable event occurs. Recall that having odds of dying in the next year of one in a thousand does not imply that all of the people in that class are 999/1000 alive and 1/1000 dead. Life and death are binary. You are alive or you are not.
Do your best to cover risks where you could not afford the loss if the event occurs. Avoid covering losses that are near certain to occur.
Group insurance often falls into this trap. A drug plan that has a very high coverage limit and a large deductible is a more intelligent choice than one with upper limits and no deductible.
I don’t know about you, but I would rather pay the first $1,000 on a $500,000 bill than have the insurer pay the first $100,000 and I pay the rest. You will find that the premium for these plans would be similar. The one with the deductible might even be lower.
Manage your insurance program based on all the factors. An insurer plans to bring in four quarters and pay out eight dimes. You have some control over the difference. Use it.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.
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