A Frugal Man's Opinions on Insurance

In my rambling coverage of the cheap universe I live in, I'm tackling insurance today. In my opinion, most of us are incredibly over-insured. Cutting insurance down is an easy way to save cash with absolutely no impact on our lifestyle (and isn't that the best kind of cost-cutting?). ​

Insurance should be (and was always intended as) a hedge against disaster. In practice, you are giving up a small amount of money (i.e., your premium) with 100% certainty, in order to avoid a catastrophic financial event with a small probability of occurring. The probability of the bad event happening and how much it will cost you varies.

It should be apparent that insurance is a game of probability and insurance companies are the casinos. Their actuaries know everything - there's a table out there that will tell you the odds you'll die between the age of 70 and 71 (just checked: 2.3%). The odds of you getting a given disease or injury, how much it costs to treat, how likely it is to kill you, they know it all. They figure out how much they'll pay out, add a profit margin in, and sell you insurance. It is thus a mathematical fact that you will, on average, overpay for insurance over the course of your lifetime. The entire insurance industry is predicated on it. 

On the sales side, emotion tends to override rational decision-making. According to every single insurance salesman, insurance is as essential as toilet paper. According to reality, however, there are other options (the bidet, for example). Here's the truth: financially speaking, insurance is almost always a bad deal for the insuree. You probably intuitively know this - AIG, Geico, Travelers et al. are huge businesses that run profitably off of the excess revenue they take in from their clients. Mind you, this is not to say that all forms of insurance is unnecessary, just that it's usually a losing proposition.

Safety is an expensive illusion.

Insurance should only be purchased under the following two conditions:

(1) when the consequences of not having it would be disastrous. Not inconvenient, but life-wreckingly disastrous.

(2) When it's required. 

That's it. Only buy insurance for situations that would be, for you, absolutely catastrophic (financially, not emotionally).

This frugal mindset doesn't put food on the table for insurance salesmen. They make the best commissions on selling you garbage-y policies with poor value propositions (much like investment advisors do, another case of so-called professionals having incentives that are not in the fiduciary best interests of their customers). Knowing that a rational pitch is impossible, insurance salesmen reliably (and successfully) use fear to sell you policies. They'll ask you to dwell on the possibility of a disaster or accident, asking you to imagine just how glad you'll be that you've been carrying insurance. But they won't tell you that the likelihood of the bad event. I, however, will. Let's use auto insurance as an example.  

Auto Insurance

Of course every state has minimum coverage, which you should definitely have, but that only covers liability for damage you do. As you may recall, I'm a big fan of driving crappy cars . One reason for this is that you don't need to pay to cover them for collision damage. Go ahead and wreck your old beater - who cares? But let's say that you are actually entertaining the idea of insuring your car. What do you think the odds of your insurance paying off?  

Fortunately, we have the answer: on average, a driver will file a claim with an insurance company once every 18 years.  Now what's the cost to cover that one claim every two decades or so? To insure my trusty 2003 Corolla with basic minimum liability is $228 a year. To add coverage for my own vehicle adds another $509 a year (per the Nerd Wallet calculator). That's the extra amount I'm losing with 100% certainty to have "peace of mind". 

So let's do the math: Over an eighteen year period, I'm paying out an extra $9,162. What do I get for it? As an average driver, I'm filing a claim once every 18 years. Let's assume my car is totaled (so as to get the maximum insurance value paid out). Under the most optimistic KBB estimate (private party value for an excellent condition car) the payout is only $3,285. So I'm paying almost ten grand to get back - at most - three thousand bucks. 

Hold on there Texas Pete - you forgot the $1,000 deductible before insurance kicks in. You're only getting $2,285 from your claim. Thus, on average a driver will pay AT LEAST $6,877 extra for covering their own vehicle. Maybe you have bad luck and file multiple claims? Don't sweat it - insurance companies charge higher rates to drivers who file more claims, just like they charge you more to insure a newer, more expensive vehicle. It's all taken care of, and there's no way to come out ahead. 

If you read this and still think you need anything more then the bare bones auto insurance I say this to you: Are you fucking kidding me?

I'll close up by covering a few other types of insurance of varying utility.

Consumer Product Insurance - The most obvious sucker insurance

First of all, you should never hold insurance on any consumer product. This includes iPhones, personal electronics and any tangible object you can live without (this includes jewelry). Insuring a rapidly-depreciating object is always a bad idea. I've never seen an example where these were a good deal. Best Buy employees are pushed to sell crappy product service plans. Often, these are merely warranty extensions, a benefit that is attached to most major credit cards anyway. 

Health Insurance

Mandatory now, and with Obamacare it's generally cheaper to buy a plan than pay the fine. While it is technically possible to self insure, the possibility of catastrophic circumstances makes the need for health insurance compelling. Medical costs are potentially a bottomless pit. Health insurance is absolutely essential. However, if you're young and healthy, you might want to consider a high-deductible plan which I discuss later.  

Life Insurance

If no one is depending on you, you don't need life insurance. I once met some people who carried whole life insurance on their infant children. Why would you need a payout should your kid die? The advisor who sold it passed it off as some sort of investment that builds cash value. While this might technically be true, burying your money in a can in the backyard is a better way to build cash value.

Property Insurance

I'm lumping renter's insurance and property insurance all together. 

Would the loss of the property be catastrophic? For most of us, yes. Mortgaged properties require a certain level of replacement insurance. If the loss of your home is catastrophic (usually is, right), carry this insurance. But not too much and preferably with a high-deductible plan. 

High-Deductible Policies

In situations where you can self-insure via emergency fund, a high-deductible plan is a great way to save money. Because I can afford a $2,000 hit from some hail damage, I'm only going to need home insurance for something catastrophic, like a massive fire. Thus, a five thousand dollar deductible is OK because it drops my premium by 40%. Insurance companies hide these from you because it makes them less money (although they'll still sell you one because some profit is better than no profit). Health insurance is another one where high deductible is the way to go for most healthy people. You only want insurance to kick in when the shit really hits the fan. 

Self-Insuring - The Best Thing You Can Do

From the previous car example, you can see that you'll save about ten thousand dollars by not having bumper-to-bumper coverage. That's the price of a pretty nice used car. If you have the discipline not to spend the money, you can save the money in an emergency slush fund. This creates a reserve that allows you to self-insure, paying for the occasional claim from the money you're saving and take advantage of high-deductible plan  savings. In my book, it's the emergency fund, not the insurance, that gives real peace of mind. 

It's interesting to see how an emergency fund - basically cash that's doing nothing for you - can actually make you money. By self-insuring, you're avoiding death by 1,000 cuts. 
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Just remember, the next time someone calls to sell you insurance: Safety is an expensive illusion.