Insurance: Disaster versus Annoyance

My father, who was pretty savvy about money, once told me, "You always insure for the disaster, not for the annoyance."

What did he mean by that? 

Don't use insurance to avoid minor financial blows, only the ones that are going to knock you down and out.

I'm watching a commercial for a major insurance company. A lady has come into a "store" to buy "customized auto insurance," so customized that there's a little picture of her on the box. (Yes, in this admittedly amusing fantasy world, insurance comes in a box.) She wants "a lot" of insurance (a little "gas tank" style dial appears, showing almost full)  but, no, she wants "a little less" (the gas tank dials itself back to three-quarters full) "a little less"(we're now down to a little bit above half) "and a low deductible."

It's an amusing commercial, pleasant and friendly. However, this is not the way you should buy insurance...of any type.

Let's face it. As I've said elsewhere, most of us only have so much money to spend on insurance. We need to be careful to spend it wisely.

As an example, let's talk about auto insurance. 

There are two main types. One covers repairing damage to or the loss of your car; the other involves damage to everything else, including people.  (You can also buy insurance to pay your medical bills if you're injured in a crash, and insurance to pay you if the other driver is at fault, but has no money and no insurance.) 

Collision insurance repairs or replaces your car if it's involved in a crash: you run into another car, a lamp post or a 2000 lb Brahma bull. (Don't laugh; I once saw one strolling down the Texas road on which I lived; I called the sheriff, and he sent someone to round it up.)  Comprehensive insurance covers just about anything else that might damage your car--a tree falls on it, a tornado takes it to Oz, a graffiti artist uses it for a canvas or someone steals it. 

Collision and Comprehensive almost always involve a deductible. You can choose the amount, usually starting at $500. The amount the insurance company will pay will be either the cost of repairing your car or the cost of replacing it--less the deductible--at your car's current market price.  Keep that last phrase in mind; we'll come back to it later .(To prevent people from trashing their own car when they need money, some insurers will always pay less than the replacement cost. Check your policy.) 

The second kind of insurance is liability insurance. This is insurance to cover damage that you are responsible for, especially if you are judged negligent in some way. You hit someone's car or run into their house (it happens!) or hit them because of those worn tires, or because you didn't see a stop sign, or because you were texting someone and this insurance provides money to repair or replace their damaged car or property, for medical bills or to pay damages if you are sued  Most states now require drivers to have a minimum amount of liability insurance. Drive without it and you can be fined or even jailed.

And this is where the "annoyance" versus "disaster" situation shows up. 

Far too many people worry first and foremost about repairing their damaged car. They buy Collision & Comprehensive with a low deductible, and skimp on liability insurance. But a higher deductible--say $1,000-- means you'll only be out of pocket $500 more  if your car needs to be repaired. That's a financial annoyance.

You don't think so? Then skimp on liability insurance;  if you seriously injure or kill someone, you are now at risk for losing, not a car, but everything you own...and then some. That's a financial disaster.

Here's a hypothetical example.

Ruth and Amy both buy identical new cars that cost $18,000. They both budget the same amount of money to spend on car insurance.

Ruth buys C & C with the lowest possible deductible, $500, which means that if her car gets damaged, she's only out $500 to get it fixed or replaced.  A low deductible costs much more than a high deductible though,  so she opts for only $50,000 worth of liability insurance, the minimum her state requires.

Amy opts for C&C with a $1,500 deductible, which costs much less; with the savings, she buys $300,000 worth of liability insurance.

Five years into their car ownership, both are involved in major crashes. They aren't injured, but other people are. Both Ruth and Amy's cars are totaled.  Ruth was texting on her cell phone when she crashed; Amy failed to see a stop sign.

Both are sued by those injured for $350,000 in medical bills and damages.

Ruth contacts her insurance agent and is stunned to find that they will only pay her the current market price of her five-year-old car, approximately 40% of what she paid for it, less $500. The court awards those suing her a total of $250,000; her insurance carrier pays her $50,000, the full amount of her liability insurance. She has no savings,and owns no property other than her car; she will therefore spend decades paying off the additional $200,000. For her, this is a financial disaster.

Amy is paid $1,500 less than Ruth towards replacing her totaled car. But she has $300,000 of liability insurance, enough to make it worth the insurance company's while to negotiate with the lawyers of those who are suing her. They agree on a settlement of $190,000, which the insurance company pays. Amy is able to  buy a decent used car and goes on with her life.  Even if she'd had to pay $250,000, like Ruth, the insurance would have covered it.

Because she was willing to risk paying $1,000 more to replace her car, this has been a financial annoyance.   

Consider risks versus cost when you buy insurance....and buy protection for the financial disaster, not the financial annoyance.  

Life Insurance: Who Really Needs It...and Who Really Doesn't

A type of marketing mailout I've been getting a lot lately involves pitches for life insurance policies for little children.

The offer is simple. Insure a small child now and you'll "lock in" an incredibly low premium for the child's entire life. This is a seductive idea, especially for grandparents who are struggling to pay ever-increasing life insurance premiums themselves. Little Susie or Billy will still be paying $15 a month for life insurance when they're eighty! What fond grandma or grandpa wouldn't be thrilled with the idea of such a deal for their darling grandkids.

Often such pitches also point out that if your child dies, you'll have money for funeral expenses. Who can object to that?

Well, I can. Let's take a little closer look at these great deals.

The purpose of life insurance is to make sure a death in the family doesn't create a financial disaster for the survivors. When a breadwinner dies, that income disappears. Immediately, the family can be in serious financial trouble, especially if they have little or nothing in savings. Without money to pay the rent or the mortgage, money for utilties and food, such a family can literally be homeless in a matter of a few months. Even a family where both parents work can face a financial crises if one of the parents dies and the household income drastically drops. If it's a stay-at-home parent who dies, the family will still need money for house cleaning, child care and the hundreds of other services that parent provided.

In such cases, a generous life insurance payout can keep a family's financial situation stable for years. Even a relatively modest amount can give the family enough time to adapt: time to move to a smaller home, for example, or time for the surviving parent to learn a skill and obtain a job.

But children do not provide income or services, and when they die, the family isn't faced with a financial crises. I can't imagine anything more emotionally devastating than the death of a child, but in pure financial terms, it's rarely a disaster. And though it might be an effort, most families can find the money to pay for a child's funeral, either by dipping into savings or taking out a short term loan.

So there's little or no actual financial need to buy a life insurance policy for a child.

What about locking in that low, low premium rate? Or the fact (claim the mailouts) that the benefit can never be canceled or reduced due to changes in the child's age or health. Isn't that a good deal?

First of all, let's actually check those low, low rates. I looked at a major company providing such insurance and, using the example of a 3-year old little girl living in Texas, was quoted a rate of $15.25 a month for $25,000 worth of insurance.

What's wrong with that?

First, this hypothetical child won't have a family to protect for at least 15 years. (No underage child brides in this article, thank you very much!) So a parent or grandparent would pay $2,745 in insurance premiums before insurance was even necessary.

Second, $25,000 worth of insurance may sound like a lot, but it's actually a small amount to act as a safety net for a family, especially if you factor in cost-of-living increases for the next 15 years. If Amy (let's give her a name) gets killed in a car accident twenty years from now, $25,000 may only be enough to last her family a few months. So eventually she'll need to buy more life insurance....and I guarantee you she won't get the additional coverage at that highly-touted low, low monthly rate.

Third, how does one even know that an insurance company will be around in fifteen years?Insurance companies, like any other company, can get into financial trouble or even go bankrupt. (Check the recent history of insurance giant AIG.) Although there are usually safeguards in place to make sure policy holders' claims are paid, there are no guarantees that Amy's super special lifetime rate of $15.25 wouldn't change if another company took over the policy.

Fourth, such policies are almost always whole life policies, and premiums for whole life policies are traditionally much, much higher than term life insurance premiums. (For an brief explaination of the difference between whole life and term, check here.)

Example? I decided to get some idea of how much term life insurance $15.25 a month would buy, so I checked Met Life's online sample quotes.Everything will vary, of course, for any specific situtation, but I still got quite a shock.

Assuming both 3 year old Amy and 30 year old Amy are in good health, here's what they can buy for less than $16 per month.

For 3 year old Amy, $15.25 a month will buy $25,000 worth of insurance.
For 30 year old Amy, $12 a month will buy $250,000 worth of insurance.

Ten times as much. Is that pitch for insuring your kids or grandkids sounding quite as good now?

But, Cathy, you say, what if Amy gets sick between the ages of 3 and 18? With the whole life policy, she still gets those low rates. (It says so right in the mailout.) With the term life policy....who knows?

Here's where we get to the crux of the matter.

Most of us have a limited amount of money to spend on insurance of all kinds: life, health, auto, home. The financial well-being of our families depends on how well we allocate what we can afford to spend.

So, if Amy gets seriously ill between the ages of 3 and 18, it's going to do her a lot more good if her family has spend a little more money on health insurance for her, rather than buying a life insurance policy that she doesn't actually need. Even if her parents get basic health insurance through work, the relatively small cost for supplmental health insurance might be a much better buy.

And if Mom and Dad are struggling to buy enough life insurance for themselves, it might make much more sense to spend that $15.25 a month to help them afford more. Remember, buying a life insurance policy for Amy benefits her dependents, not her. Doesn't it make more sense to spend your money to protect Amy herself while she's growing up?

Don't just accept the word of an insurance company marketing mailout that whole life insurance for a child is a great idea. And don't believe every promise you read in such pitches, including the claim that there are no conditions whatever that could cause that premium to increase. (Always, always, always check the fine print of the actual policy before you agree to buy.)

Also, keep in mind that when Amy is 80, she won't need much life insurance. Her kids won't be dependent on her any more, her house will likely be paid off, and she and her spouse may have savings or investments to supplement any retirement income. (Besides, in 2086 when she's eighty, how much will $25,000 actually be worth?)

Check and compare premiums, and know the pros and cons of different types of insurance before you buy. And remember.... spend your money to protect your kids and grandkids when they're children. Let them make their own insurance decisions when they're grown.

Bits and Pieces: Useful Tips from the Internet

If you have trouble controlling your urge to spend for the sake of spending, here's a good article on the subject from Get Rich Slowly.

If you've ever considered getting a "payday loan" you need to read this first.

And the home mortgage mess gets murkier....ever hear of a liar loan?

Term vs Whole life insurance....the real question is, what will most benefit those you leave behind?

Finally, choosing a consumer credit counseling service can be like choosing a diet plan....there are companies out there that promise a lot and deliver very little. Learn which services will really help you out of debt....and which will cause more problems than they solve.

Check With Your Insurance Company Before You Let Your Teen Get Behind the Wheel

A lot of people find it hard to resist the combined pressure of convenience and teen nagging when it comes to letting teens drive. In our busy lives, it's helpful to have kids who can ferry themselve around....and who doesn't get weary of hearing them bug you for their own car?

But costs are a big part of this situation....and one of the the biggest costs, and possibly your biggest financial surprise, may be the huge jump in your insurance bill. This is largely because teens, both inexperienced and often easily distracted, are involved in a proportionally higher number of accidents than other drivers.

Insurance costs can jump 100% to 300%+ when you add a teenager to your list of family drivers. So you definitely need to check with your insurer before handing over the keys. You can get discounts for a number of reasons: putting your teen's car insurance on your policy for a multi-car discount, buying your teen a car with certain safety equipment, your teen being a good student, or restricting how much your teen can drive the family car. Ask your insurer about such discounts, then do some comparison shopping with other insurers.

Otherwise, you may get a different sort of "sticker shock" when you open your next insurance bill.

A good brochure to explain insurance to your teenager is available at the Insurance Information Institute's website at http://www.iii.org/media/publications/brochures/oops/

Insurance: Make A Video Record Of Your Stuff

With fires, hurricanes, floods and other disasters in the news lately, one thing you might want to do is make a video or photographic record of your possessions. If something happens, this will make things much easier when you deal with your insurance acompany. A walk-through of your home with a video camera, taking close ups of your high-dollar possession (furniture, electronics, antiques, artwork, etc. ) can be a valuable record. If you don't have a video camera, take pictures and write down brief descriptions.

Then put the video or the photos in a safe deposit box. Remember, it can be tough to prove what you had after your home has been destroyed by a natural disaster.

Finally, make a disc copy of your computer files periodically and put that in your safe deposit box too, especially if your computer contains family records or photos. You can replace the computer, but not the files if the computer is destroyed and you have no backup.