Should You Buy Insurance?

June 26, 2015

Insurance is one of those tricky topics because it can be extremely complicated, can be very helpful in some cases and pretty useless in others. To make matters worse, it is sold aggressively, so it is difficult to know whether you are getting good advice on what insurance you should buy. Since we don’t sell insurance, allow me to provide you with a framework for deciding what insurance you need.

 

One of the best ways to approach insurance is to consider what you are at risk for and what the consequences of that risk are. For simplicity’s sake, we suggest breaking up the type of risk into frequent and infrequent risk and risk consequences into low consequence severity and high consequence severity. By defining those two categories you can then figure out what the easiest way to mitigate that risk is using the following chart:

Let’s consider four different scenarios: one for each of our four boxes.

 

Scenario 1: The Risk of Dropping Your Phone In the Toilet

 

Usually, when you purchase a new electronic device the salesperson asks you if you’d like to insure the product for a nominal fee. For the most part, this insurance rarely gets used and is a great way for the salesperson to increase their margins on the sale. This is because there are very few instances in which the electronic breaks to the extent that it is covered by the insurance. The risk in this situation is that your electronic gadget may break, but this risk is not likely and even if it does occur, the consequences are not too severe. If you do happen to accidentally drop your phone in the toilet, the worst thing that will happen is that you might have to replace your phone. Because the risk of this happening is infrequent and the consequences are manageable, you should probably avoid paying extra for the insurance.

 

Scenario 2: The Risk of Leaving Your Iron on and Burning Your Shirt

 

As a professional in a fast paced environment, I often find myself having to iron my shirts early in the morning as I’m getting ready for work. In the rush to get out the door I’m often worried about forgetting to unplug the iron. While the consequences of this risk are moderate (I burn my ironing board), I can mitigate this risk by purchasing an iron with an automatic shut off. In doing so I am able to easily reduce a frequent risk.

 

Scenario 3: A Spouse Dies Leaving Behind Young Children and a Homemaker

 

While this is a scenario that you hope never occurs, it is possibly one of the most important things to consider and one of the best instances in which you should consider purchasing life insurance. While the risk of this occurring is infrequent, the consequences of it are severe particularly for a family with a single earner. If something were to happen to that earner, it could cause severe distress to the family. In this instance, it would make sense to insure. Note however that once you have retired, the consequences of the lost income may decrease. For example, a retired couple, living off retirement savings probably no longer needs life insurance because the consequences are no longer as severe.

 

Scenario 4: Choosing To Build A Home In a High Fire Risk Location

 

This scenario is particularly applicable for those of you who live in very dry parts of California. There are some areas that are prone to frequent wildfires during seasons for drought and the effects of these fires can be devastating. Consequently, the most obvious way to mitigate this risk is to be smart about where you choose to live. Interestingly enough, there are areas of California that companies actually refuse to insure due to the high risk of fire. When considering this risk, your best bet is to avoid it altogether.

 

Once you have identified a risk that you should insure, it is incredibly important to take your time and do your homework when shopping for an insurance policy. More often than not, insurance policies are loaded with hidden fees and small print that make them very lucrative for the policy seller and less than helpful for the buyer. We highly encourage you to read through all of the material and ask all of your questions (and keep asking until the answers make sense) before purchasing a policy.

 

*chart used with permission from money-eduction.com

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DISCLOSURE Information on this website and others should be used at your own risk. Past performance does not guarantee future results. Securities investments involve risk; returns in such investments vary and may involve gain or loss. The materials and content herein are not a substitute for obtaining professional tax, personal financial planning, or other relevant financial advice from a qualified person or firm. For full disclosure click on the disclosure link at the bottom.

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