Insurance Strategies

Defensive Tactics for the Insurance Shopper

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If you understand how insurance works, you can cut through all the sales pitches and assumptions so that you can insure the necessities without breaking the bank.

All insurance should be treated as a financial expense and not as a potential financial windfall. You never “win” with insurance, you can only protect against a major loss. Insurance companies, like gambling casinos, always collect more than they pay out. Likewise, most policyholders pay far more in premiums than they will ever collect.

Should You Accept or Insure Risks?

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Anytime you decline insurance coverage, reduce a coverage, increase a deductible or a co-payment, you are deciding that you are prepared to accept the consequences of a potential risk. Of course, you should always insure risks that you are not financially able to cover alone. But it is perfectly acceptable to pay for things that go wrong, by yourself, if your finances allow it.

You don’t win just because an insurance company picks up part of the tab. Remember, an insurance company always takes in far more than it will ever pay out. It’s not possible to insure yourself against everything that could possibly go wrong, nor should you. Neither is it necessary to insure small risks.

Weighing Risks vs. the Cost of Premiums

Almost any risk can be covered by insurance, but only a few coverages are good values. Always weigh the potential financial risk with the cost of the premium to insure that risk.

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Raise Your Deductible

For example, if raising a deductible on an automobile collision policy from $500 to $1,000 cuts the premium by $200 annually, you would save $200 every year by accepting $300 more net risk ($500 minus the $200 annual premium)-potentially not a bad risk to take. If you go two years without a collision claim, you are ahead of the game. In this example, paying $200 annually in order to insure $300 (net), is not a cost-effective use of your premium dollar after the second year.

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Consider Self-Insurance If a Premium Is at Least 10% of the Amount of Self Insurance

There are certain insurance coverages that are neither a good value nor a good financial decision. A good rule-of-thumb to use is 10%. If the annual premium is at least 10% of the amount of coverage, “self-insurance” will likely be the best financial strategy. This benchmark is only a guideline and is given strictly as a tool to encourage you to compare premiums vs. risk. To determine the premium percentage of coverage, use the following formula:

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Since the ratio is greater than 10%, it would be better to be self-insured for this amount.

Our definition of self-insurance is “having enough personal wealth to cover potential risks of financial difficulty so you don’t have to rely on a claim produced by overpaid insurance premiums.” *Remember, always check with a licensed professional before making ANY type of decision related to insurance.

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If You Decide to ‘Self-Insure’, Invest an Amount Equal to the Annual Premiums of Insurance

After you have decided to accept a particular risk yourself by declining a certain coverage, become self-insured for this peril by diligently investing amounts equal to the annual premiums. If you encounter that particular peril in the future, you can use the funds from this investment to help cover your financial loss. If you don’t have a loss, you keep the money and earn interest on top!

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Set Up Separate Investment Accounts Earmarked for Different Categories of Coverage

For instance, every time you are pressured to purchase an extended warranty on a new appliance (always a poor value) such as a TV, computer, DVD player, camcorder or refrigerator, invest an amount equal to the premiums on the insurance in an account earmarked for “appliances”. Based on claims statistics from repairs on new products, you will have more than enough money in your account to pay for any future appliance repairs!

Insurance Advice from Agents: Objective or Conflict of Interest?

Undoubtedly, the majority of insurance salespeople are honest and well-meaning, but most agents are compensated by commissions. Because of this “incentive” structure, insurance agents are motivated to sell coverages and products that are in their best financial interest, not always yours. The majority of people don’t get insurance advice from an objective source, one that has no vested (or conflict of) interest in the insurance recommendations given.

Other coverages and products of lesser or no value to the consumer, but incredibly profitable to the insurance companies, are policies that cover perceived risks. Perceived risks are those that policyholders recognize as existing, but consider greater than they actually are.

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Avoid Extended Warranties on New Vehicles

This is a good example of perceived risk. Let’s face it, the likelihood of a policyholder ever collecting on what is actually covered in the policy (beyond what is already automatically insured by the manufacturer) is almost non-existent. This is a huge profit-center for insurance companies.

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Avoid Credit Life Insurance

Another type of highly-profitable coverage for a legitimate risk but of poor value is credit life insurance. These coverages are designed to pay off a mortgage or other debts upon death (a possibly good risk to insure) but are a terrible value.

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Choose Term Life Insurance

Term life insurance stands out as a much more cost-effective value for the amount of coverage per premium dollar compared to whole life insurance. Remember, insurance is NOT an investment, it’s only a way to protect you from substantial loss.

Insurance is a large topic, with nearly unlimited options for every individual. We have tried to highlight key concepts and strategies in this area, but we urge everyone to check with a licensed professional before making ANY type of decision related to insurance.

 

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