It's a Money Thing®
Intro to Insurance
Insurance coverage is something that we all will need at some point in our lives, but understanding the ins and outs can be a challenge. Although individual insurance policies and coverage details can seem endlessly complex, the fundamentals of insurance coverage—and your attitude towards it—can be simple. Understanding the expectations you have of your insurance policy can make much of the confusion and second-guessing disappear, so that you can focus in on what you truly need from your insurance provider.Insurance is available for pretty much everything in life; our phones, homes, pets, even our lives! However, coverage can be tricky to shop for, because it requires making specific financial decisions about some hazy and unpredictable concepts. Depending on the type of insurance you’re looking into, you might find yourself pondering some downright uncomfortable questions:
- What would happen if I get sick the day before I'm supposed to leave for the three-week European vacation I've been planning forever?
- What would happen if a major earthquake damaged my home? If my basement flooded? If there was a fire in my apartment building?
- What would happen if I became so ill I couldn't work anymore?
- What would happen if I had a break-in?
- What would happen to m family if I dies tomorrow?
Insurance is a transfer of financial risk.
When you take out an insurance policy, what you’re actually doing is paying your insurance provider to take on your financial risk regarding a specific situation outlined in your contract. Consider this: your insurance provider fulfills this responsibility whether or not that specific situation ends up taking place.
As an example, let’s say you have a car insurance policy that includes coverage of any damage resulting from a tree falling on your car. Let’s also say that, statistically, there’s a 1% chance that a tree will fall on your
car this year. By paying your annual premium, you are transferring any financial consequences associated with that 1% risk over to your insurance provider. If a tree falls on your car (a rare scenario), the insurance provider reimburses you for
the damage. If zero trees fall on your car this year (the most likely scenario), there is no tree-related damage for the insurance provider to reimburse. The insurance provider is still assuming that 1% risk. You pay your insurance provider to
hold up its end of the deal, and the provider is doing that, whether or not a tree ends up falling on your car.
Insurance protects against losses.
When shopping around for insurance coverage, it’s best to think of your policy as simply a way to cover a significant financial loss—and significant is the key word.
Purchasing insurance for something that you could easily replace yourself in the case of a loss (like a $20 set of earbuds) doesn’t make a ton of sense, because it often costs you more to have it insured than to just assume the small financial loss yourself, should you need to replace it.
A significant financial loss, by contrast, is a seemingly impossible amount of money to recover—tens and even hundreds of thousands of dollars. A significant financial loss is the kind that would literally change the course of your life and the lives of your dependents. It’s for those losses that insurance coverage offers the best protection, but how can the insurance company afford to pay that kind of money to all those they insure?
Insurance companies operate by pooling the risk of a large number of policy holders.
Out of all the policy holders paying their monthly premiums, only a small percentage will make significant claims over the lifetime of their policy, while the other policy holders will not submit any significant claims. The premiums of the many are used to pay the claims of the few- ensuring that funds will be available when you need them for your emergency.
Insurance policies are complex, but your attitude towards them can be straightforward. Insurance policies are not designed to grow your money—they’re designed to protect you and your family from significant loss by transferring your financial risk associated with a specific set of unpredictable circumstances. It’s up to you to determine which unpredictable circumstances warrant protection (and how much protection to have in place), but by simply identifying the role of insurance in your financial plan, you’ll be better prepared to make smart decisions about what to insure.