Imagine sitting around a table, drinking coffee with your friends, and out of the blue someone asks, “Hey, what are your thoughts on insurance?”
What? You mean that’s never happened to you?
Well, since I’m a financial advisor, that scenario has played out on more than one occasion, so I thought it’d be helpful to write a blog post about some of the basics regarding insurance including…
- The purpose of insurance
- How to know when you need insurance
- And how to buy insurance
You know, the things “everybody ought to know about insurance,” hence, the title of this blog post.
So, grab a cup of coffee (or your beverage of choice) and let’s get started!
The purpose of insurance
Contrary to what some people think, the purpose of insurance is NOT to get rich. While this certainly may happen, this is the exception rather than the rule.
Think about it.
If EVERYONE received more money from an insurance company than what they paid the insurance company, then the insurance company would eventually go out of business.
So, what is the real purpose of insurance?
The purpose of insurance is to protect your finances from risks you typically shouldn’t take. You do this by transferring these risks to someone else, typically an insurance company.
Does this mean we should obtain insurance for every possible risk known to mankind?
No, of course not. In fact, that’s not even possible!
But even if it was possible, it still wouldn’t be advisable.
Not only is excessive insurance coverage a waste of money that could be devoted to other financial goals, it’s also a symptom of a deeper heart issue. It may indicate you’re putting your hope and trust in the insurance coverage, rather than in the One who “supplies our every need” (Phillipians 4:19, ESV).
How to know when you need insurance
- 1. Determining the right TYPE(S) of insurance
- 2. Determining the right dollar AMOUNT of coverage
Both of these are HIGHLY dependent on your individual situation, so I recommend working with a a good fee-only financial advisor who will work alongside your independent insurance agent to make sure you secure the right type and amount of insurance coverage for your needs and goals.
But there is a quick way to determine whether or not it makes sense to at least consider purchasing insurance to negate certain risks.
The picture below is an example of a “risk matrix” that will help you determine whether or not it is wise to consider purchasing a certain type of insurance.
As you can see, there are four options for dealing with a particular risk (or “peril” as it’s called in the insurance industry). Each of these options are outlined below, along with a “real-life” example of each type of risk.
TRANSFER a risk LOW in FREQUENCY and HIGH in SEVERITY
An example of this type of risk would be the risk of a tornado destroying my home. Although I live in Oklahoma, it’s still incredibly unlikely that my house will ever be demolished by a tornado (low frequency).
However, in the unlikely event that a tornado does strike, the financial impact of having to replace my home would be quite devastating without insurance (high severity).
Due to the low frequency, yet severe nature of this risk, like most people, I choose to TRANSFER this risk to an insurance company by purchasing homeowner’s insurance.
A few more obvious examples of insurance that helps transfer risks low in frequency and high in severity include life insurance, long-term disability insurance, and personal or professional liability insurance.
AVOID a risk HIGH in FREQUENCY and HIGH in SEVERITY
It’s probably not news to you that the more frequent you text or talk on your cell phone while driving, the higher likelihood of you getting in a car accident (high frequency).
Depending on the value of the car you drive, a car accident may or may not be severe from a financial standpoint, but could very easily be severe from a personal health standpoint (high severity).
Due to the high frequency and high severity of this risk, the best course of action is to AVOID this risk by not texting or talking on your cell phone at all while driving an automobile.
REDUCE a risk HIGH in FREQUENCY and LOW in SEVERITY
I don’t know about you, but it seems like I’m a magnet for other people dinging my car door. It happens ALL the time (high frequency).
Granted, it’s not that big of deal because it doesn’t usually leave a mark, and even when it does, it’s not worth fixing or turning into my insurance company to get repaired (low severity).
In this scenario, it makes sense to simply REDUCE this risk as much as possible by parking my car further away from other cars and by making sure there’s plenty of room on both sides of my car when I’m forced to park next to other vehicles.
RETAIN a risk LOW in FREQUENCY and LOW in SEVERITY
An example of this type of risk would be losing my cell phone and having to replace it.
I have my cell phone at arm’s length most of the day. Therefore, it is highly unlikely (low frequency) that I would lose my cell phone and even if I did, having to replace my cell phone would not mean utter destruction for my wife and I’s financial situation (low severity).
Rather than waste money on “cell-phone insurance,” we simply choose to RETAIN or “self-insure” for this type of risk by purchasing a sturdy protective phone case and screen protector.
How to buy insurance
Now that you know the four ways to deal with risks, let’s talk about the best way to purchase insurance.
Just like in the financial advisory world, there are some good insurance agents out there and there are some not so good ones.
My obviously biased advice is to develop a relationship with a fee-only financial advisor who will work alongside your insurance agent to make sure you get the right type and amount of coverage at the best possible price.
A fee-only financial advisor doesn’t sell any products, so their recommendations will be independent and unbiased, allowing you, the client, to take an objective look at all of your available options. You can then make the decision that YOU think is best for your situation, instead of being pressured into a decision you weren’t ready to make by a product salesperson passing themselves off as a “trusted advisor.”
Back to basics…
How was your coffee or other beverage of choice?
I know mine was good!
Hopefully, after reading this post, you have a little better grasp on a few of the basics “everybody ought to know about insurance.”
Still have questions?
Simply email me or click the button below to schedule a complimentary 15-30 minute initial phone call at a day and time that’s convenient for you.