An important element of financial planning is protecting the things you can’t afford to lose: your income, for instance, or your house or car.
The proper approach is one of managing risks – not necessarily buying insurance, but doing a thorough and thoughtful assessment of the risks you face, then deciding to take one or a combination of these courses of action:
For most risks, you wouldn’t want to select Item 1. Although many people would prefer not to think about wrecking the car or losing their home to fire, most buy insurance against such disasters – with the former, it’s the law; with the latter, the mortgage company requires it.
(Unfortunately, too many “ostrich” the risk of death or disability. Because they’re not forced by law or lender to confront these risks, they ignore them. If they experience a loss, though, they and their families suffer.)
Proper risk management means using a combination of Items 2 and 3. That is, assume for yourself some of the risk, then pay an insurance company to assume the rest. Smart consumers will buy insurance to cover the risk of catastrophic losses – those that would result in financial ruin – and assume for themselves the more manageable risk of minor losses.
The result is usually a higher level of insurance coverage and lower premiums. This is because by their nature, risks that are more likely to occur are more expensive to insure. A telling example of this involves your car insurance. Comprehensive coverage with a $50 deductible costs substantially more than coverage with a $2,500 deductible. The $50 losses can occur every day; for example, a door ding or a stone thrown up by a truck. The $2,500 losses (for most drivers, anyway) will occur much less frequently.
As consumers we have limited funds available for insurance. Being smart means making a careful assessment of the risks we face, comparing costs among different carriers, then managing premiums by choosing appropriate deductibles.