Discussing insurance is like being forced to watch a corporate PowerPoint presentation about the benefits of rice cakes—over a slow internet connection.
Did any kid ever dream of growing up to be an insurance adjuster?
Nonetheless, insurance is the bedrock of becoming wealthy. Without it, your financial house is built on sand and can crumble anytime.
I used to think insurance was a giant waste of money, but if you think you are getting “ripped off” by your insurance company because you never have a claim, that’s silly. The point of insurance is to outsource risk.
You pay a relatively small recurring fee to an insurance company, and in exchange, they take on the legal liability for some risk you have, like getting into a car accident. The likelihood of getting into a serious accident is small, but if you do, it’s a bill you can’t pay.
Most years you make insurance payments and never have a claim, but if you do, the lifetime of payments you make helps cover the cost of that big payment. All the people in the plan who don’t have accidents that year also help pay the cost of your big expense.
Outsourcing risk is one of the most important jobs in a free-market economy. So long as the insurance company pulls in more money than it pays out in claims, they make a profit. They deserve to.
The odds are that you’ll pay far more in “premiums,” or payments, to your insurance provider than you will even get back in claims or payments. If you end up being paid back more money than you put in, something has gone tragically wrong with your life.
That isn’t a good thing, but fortunately you have insurance. That’s why you purchased it.
All things being equal, it is better not to have any claims and let the insurance company win—and sleep well at night.
However, insurance is expensive, and you never want to pay for goods or a service you don’t need. Just because outsourcing risk is important, doesn’t mean you need to outsource every risk. The key to finding good insurance is always remembering what insurance is for: outsourcing a risk you can’t afford to take.
If you get cancer, you probably can’t afford the treatment on your own, so you need health insurance. Should you run a red light and hit a cyclist, you’ll never be able to pay for that. You’d better have good liability insurance.
If the teenager at the checkout counter tries to sell you a $5 insurance policy on your new $35 keyboard, that is a waste of money. Should the keyboard break shortly after purchase, the store’s return policy will cover it.
If it breaks three or four years down the road, could you afford the risk of replacing it on your own? If the answer is yes, you don’t need insurance. You can “self-insure” and replace it.
If the answer is no, you’ve got bigger problems to worry about. Also, if your keyboard does break in a few years, will you even remember about that insurance policy or know how to redeem it? Probably not. You’ve just thrown $5 into the trash.
I love the convenience of online shopping, but they often try to sell an insurance upgrade for items I purchase. Those policies are generally a waste of your money. If one item does break, and you wish you had the insurance, the cost of replacing it is likely less than the price of buying an insurance policy on every purchase.
Self-insure for the small stuff. That is why you, hopefully, have an emergency fund. It is your self-insurance protection for minor accidents and emergencies. Purchase insurance only for those risks or losses you can’t afford to pay for on your own.
When you do need to use it, insurance is more beautiful than wisteria in moonlight.
Doug Lynam is a partner at LongView Asset Management in Santa Fe and a former Benedictine monk. He is the author of From Monk to Money Manager: A Former Monk’s Financial Guide to Becoming A Little Bit Wealthy — And Why That’s Okay. Contact him at email@example.com
This material is intended for educational purposes only. You should always consult a financial, tax, or legal professional familiar with your unique circumstances before making any financial decisions. Nothing in this material constitutes a solicitation for the sale or purchase of any securities.