By Lyman Howard
Learn more about Lyman on NerdWallet’s Ask an Advisor
Insurance spreads risk of catastrophic financial losses across a pool of participant individuals. The group experiences small regular losses in the form of premiums paid, but any individual member who suffers a low probability (but high impact) event will be spared financial ruin.
Keep this in mind when while shopping for insurance of all kinds. Each of us has some financial capacity, based upon individual resources, to absorb unanticipated losses resulting from a house fire, an earthquake, a severe illness, a civil lawsuit, et cetera. How much of that risk should you take on based upon your resources, and how much should you insure? A good evaluation of your personal financial resources will help guide you to the proper amount of coverage for you.
You should not be:
- Overinsured: paying hundreds extra in premiums for redundant coverages or else paying extra to have a low deductible when you could actually afford some out of pocket expense.
- Underinsured: carrying enough coverage to help yourself, but not enough to save you from a major lifestyle cut or bankruptcy.
So what is the right amount of insurance? A thorough analysis of your lifetime financial goals will clarify how much money you need for all critical goals to be funded. If they would be derailed by some insurable event, you not only need to have that insurance policy, but also for its benefit to reimburse you enough to matter. If you have enough cash on hand to shoulder part of the losses on your own, you could safely raise your deductible amount and save on premiums. Any premiums savings you realize might even exceed the return of some investment choices out there today, so it makes sense to consider raising your deductible a few thousand dollars and keeping a “self-insurance” fund in cash rather than paying higher premiums to have the insurance company pick up the first dollar of loss as you invest your money elsewhere.
What would be the wrong amount of coverage? The wrong amount rebuilds only ? of your home after a fire, or just barely fails to stop a negligence lawsuit from bankrupting you, for example. You can work with a financial advisor to help guide you to the amount of coverage you need to keep on track in the event of things such as a car crash, disability, or a death in the household. Armed with those numbers you can get assistance from a trusted insurance broker who will identify the policy features and prices that best accomplish your needs and correctly estimate replacement costs. Expert help can truly pay off for you, because the devil is in the details of coverage contracts.
Being an educated consumer is especially important when shopping for insurance. Many people buy complicated policies because they are sold on features other than the insurance itself, such as tax deferral or annuity options. The terms of these permanent life policies can be quite confusing, even for experts. There is a place for sophisticated life insurance strategies, but usually only in cases where complex estate planning or tax planning needs exist.
Get yourself a good estimate of the losses you could safely absorb to your financial resources, then insure beyond that amount to enjoy peace of mind. Get the expert help necessary to shop for the best policies based on your risk factors. You might or might not locate some immediate savings, but you will definitely sleep better at night.