People make insurance mistakes in three ways. People who make the mistakes are generally considered to be insurance poor.
Consider an accidental death policy. Sometimes it is double or triple indemnity on a regular life insurance policy.
The three mistakes:
- Overvalue the coverage, or
- Overestimate the probability of loss, or
- Misunderstand the policy limits or coverages.
Accidental death would be unfortunate and costly, but very rare. It looks like you get a big payout and a small premium. Most of the time the premium is multiples of its real value to you. People with this coverage frequently multitask all three mistakes.
Overvalue the coverage. I once had a client with a $1,000,000 “personal catastrophe” policy. The premium was less than $300 per year. Upon examination we discovered that the only likely claim would be if he were trampled to death by a rabid yak while climbing the north side of a mountain in Tibet. Even then, he might be able only to stop paying premiums. The payout looks large for the premium. If you stop there, you may have overlooked a real risk and you or your family will be poor if the other event occurs.
The probability of occurrence matters. Accidental death is not common. We remember those because they are usually more spectacular than other forms. Fewer than one in fifty of all accidental death policies ever pay.
More commonly seen, workers compensation overestimates probability. Only a tiny fraction of disabilities occur on the job. I have seen statistics that say as few as 1 in 30. In most cases, premiums are lower than individual disability insurance but not nearly 1/30. You are much more likely to collectively be in a car accident or fall off your roof or have a heart attack or get cancer, than you are to be hurt at work.
Definitions matter. Accidental death is a narrowly defined condition. The policies implicitly limit it to “accidents.” If an event that causes death is “reasonably foreseeable,” then it is not an accident. Playing Russian Roulette for example. Walking on a bridge parapet. Climbing a high tree without safety gear. The essence of it is that behaving stupidly is not a covered condition.
Insurance is merely a financial tool. Decide what risk you possess and cannot afford to have occur. Decide what kind(s) of insurance address that specific situation. Compare the value of the loss to the premium to avoid it. Implement the refined decision.
Insurance poor conventionally means you pay too much for a policy or buy any policy you do not need. Insurance poor also means that you had too little or none when an event occurs. Either condition is avoidable.
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.