Wednesday, November 3, 2010

Being Insurance Poor

I was invited to speak to a class of vocational students about insurance. In reviewing the various types of policies, their coverage and usual costs I asked the group, "So what do you think of all this stuff? Does it seem fair?" And one student said, "No, it's not fair. You can't afford it. It's all so expensive."

I had to agree with the reasoning that, if you bought all the coverage you needed, you probably couldn't afford it. Higher limits for auto and home liability coverage, flood insurance, life insurance, disability income insurance, health insurance. You would be basically sending a great percentage of your monthly income to pay for all the premiums.

I then turned around and wrote the word TRAP on the board and, in the last few moments before their dismissal, proceeded to explain the concept of Risk Management. I'll explain that acronym down below.

Basically the matter is that we're all dealing with risk everyday and we owe ourselves and others and certain degree of responsibility. Whether we like it or not, the law and society set expectations for that - so we either accept it and provide for it, or suffer the consequences of being ill prepared.

In a nut shell: Non-fortuitous events happen in life. Sometimes causing US personal loss or sometimes through our actions, causing OTHERS a loss through bodily injury or property damage.

The possibly large and unknown figure is the liability for which we can be held to account for which we've caused others. Imaging causing an auto accident which killed a young father and seriously injured a child. Do you imagine the mother of that child will be content with your minimum limit bodily injury amount ($25,000 per person)available to her for that accident? What many people don't realize is that the insurance company can settle the loss for policy limits and then walk away but you are still responsible to them for the total injuries that may be assessed to you by the courts for the tort you've caused. So higher limits are essential. That's where you can truly find yourself insurance poor.

It is pragmatic to accept some losses for yourself when they are fixed and certain and sustainable. For instance you don't need to pay annually for Comprehensive and Collision coverage on an old car that has a relatively low value. If you would either take out a small loan or pull from savings to obtain a replacement vehicle, it pays to save the annual premiums and accept this part of the risk. Then use that savings to buy higher and more responsible liability limits.

So let's touch on this TRAP term I mentioned above:

In relation to the risk in your life. You're exposed to all kinds of risk and there are generally four approaches to manage that risk.
T - Transfer the risk to an insurance company in exchange for a fixed premium
amount. That is trading uncertainty for certainty.
R - Retain the risk. When it is an affordable and known quantity, like the older
used car in my example above, it can make since to not insure it. It is possible
to buy your jewelry twice by covering it to the hilt with expensive premiums.
A - Avoid the risk. If you can't afford to lose it, did you need to buy an expensive
ring, watch and earrings? Then the premiums just add to the cost of ownership if
you need to insure it. So sometimes avoidance makes sense too.
P - Protect the risk. Take steps to help diminish risk. Buy and use a SAFE for your
guns and jewelry. Keep up with your purse, lock the car. Don't leave bicycles or
clutter out in front of your house, etc.

Many of us use a mixture of these methods, insuring the part we don't want to retain and protecting things because we would rather not incur a loss and the deductible anyway. But taking the time to assess risks in your life and choosing to insure those parts that would cause financial devestation is what good personal risk management is all about.

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