While some insurance is mandatory, the majority of insurance isn’t. But even the elective insurances can still be a good idea.
Often times, Insurance buys peace of mind and you may want to consider insurance even when it’s not a “must have.”
For example, Our pet beagle Tobey died a few years ago. Our daughter, who was 3 at the time, didn't really grasp what that meant. To her, Tobey just wasn't around anymore and the reason was because “he died.” So for about six months, the first thing she'd say to people was that Tobey died. “Tobey died” was often literally the first thing she said. It was cute but kind of sad too.
While Tobey was getting older, we bought pet insurance. It's a tremendous luxury that many people don't have and we used it often in the last few years of his life. In the end, there was simply nothing we could do. There was no procedure that could improve his life and we had to say goodbye.
His passing was the ideal way. A good long life with us. No hard choices. No gray area or gambles. No amount of money would've made a difference. It was just his time.
Financially, pet insurance was a wash for us. After factoring co-pays and deductibles, we probably paid as much to the insurance company as we would've paid to the providers. We never had to deal with a big financial decision of whether to commit to expensive treatment. Our situation was more “death by a thousand cuts” than a massive charge – which I suppose is a good thing.
But had we been put to that choice, pet insurance would've made it easier. And that's why we bought it in the first place. We had the means and didn't want to have to be put to the choice.
And that's how I think about insurance – I'm paying to avoid a Sophie's Choice.
How Insurance Buys Peace of Mind
Not all insurances are the same. You don't have a choice when it comes to auto or homeowner's insurance.
You do when it comes to a home warranty, travel insurance, or other more “elective” insurance policies.
For elective policies, it's all about peace of mind.
Life insurance is peace of mind that your family will be taken care of after you're gone.
Disability insurance is peace of mind that if you become disabled, you still get an income.
Health insurance is peace of mind that you don't have to decide between a medical procedure and food on the table.
Long-term care insurance is peace of mind that in your elder years, your care won't be a burden to your family.
Lastly, your emergency fund is a small insurance policy in that it provides peace of mind that a minor emergency won't derail you financially. With a regular insurance policy, you pay premiums. With an emergency fund, you “pay” yourself into a savings account so it can earn interest while it waits for an emergency. 🙂
Your insurance policies make sure that the floor of financial pain is set at a point you're comfortable with.
Different “Tiers” of Insurance
When I think about insurance, there are three tiers:
- Must Have: These are insurances that are required by law or another entity plus those that are good financial sense
- Should Have: These are insurances that are nice to have if you can afford them
- Can Have: These are insurance where you are strictly buying peace of mind
Must Have Insurance Policies
The ones you must have are health insurance, auto insurance and homeowner's or renter's insurance. Health and auto are required by law and homeowner's insurance is required by the bank if you have a mortgage.
I'd also argue that these are those cases where the risk is very large relative to the cost of the insurance (well, maybe not in the case of health insurance).
In the last three years, I've seen three cases where there was a five to six-figure homeowner's insurance claims related to water. (two were friends, one was ours)
I would also add life insurance once you have a family and major liabilities, such as a mortgage. If you're single, you probably have few obligations. Life insurance is a nice luxury but if you died, you don't leave loved ones in a bad financial position.
If you need life insurance, here are our favorite online life insurance companies.
If you're married and own a home with a spouse, losing your income can be a significant burden to your surviving spouse. They are now solely responsible for any cosigned debts, like a mortgage or car note, and no longer have your income as a contribution on the income side of the household.
If you have kids, this is even worse as kids are extremely expensive with no ceiling on how much they cost! At least a mortgage is a known quantity.
With some must-have insurance policies, you can adjust aspects of them so that your premiums are lower. This transfers risk from the insurer to you.
For example, you can raise the deductible (how much you pay out of pocket before the insurer steps in) or decline optional protections. With auto insurance, you are required by law to have liability insurance but you can may be able to decline comprehensive insurance.
Should Have Insurance Policies
The “Should Have” category are those insurances that you should probably get once you have the means.
The three big ones are:
- Umbrella insurance – this is extra liability insurance that goes above and beyond your homeowner's and auto insurance.
- Disability insurance – Sometimes called disability income insurance, it provides a stream of income if you are unable to work.
- Long-term care insurance – As you near retirement and may need long-term care, this insurance may become critical.
Each of these insurance policies are important but if you are young then you can get away with not getting these for a while. Use the savings to bolster up the emergency fund, save to your 401(k), and built up your financial infrastructure.
If you work a full-time job, your employer may offer some kind of disability insurance and accidental death and dismemberment (AD&D) insurance too. It's often very inexpensive but coverage is limited to a percentage of your salary. You can opt to get it through there or a third party. The disadvantage of getting it from your employer is that you lose it if you quit your job. If you get it from a separate disability insurance company, it stays with you regardless of where you work.
Can Have Insurance Policies
Pet, travel, gap, identity theft, and home warranties fall into the category of insurances you may want to get just to get peace of mind. These are not necessarily “worth it” for the cost but what you're buying is more than the policy.
For example, when my lovely wife and I were just out of college, we booked a Carnival cruise out of Miami. My wife was still in college then and was a little worried about whether she might have an exam or something during the cruise and have to cancel. So, we paid an extra $50 to get “trip cancellation insurance” directly from the cruise line (essentially made it a fully refundable booking). It wasn't worth it but I was really paying $50 so that my wife wouldn't have that worry hanging over her head. We went on the cruise, had a good time, and the $50 was well worth it.
Identity theft insurance is a prime example of a “peace of mind” insurance. Identity theft is a huge problem. The 2019 Identity Fraud Study by Javelin shared that there were 14.4 million victims of identity theft in 2018, which was a drop from 2017 but still a huge number.
Even with such scary numbers, identity theft is unlikely to impact you but if it does, it can be a huge cost of time and money. That's why identity theft insurance exists – some would rather pay a small monthly fee to ensure that if they are compromised, there are resources they can use to expedite the repair process.
Lastly, you have the case of gap insurance. A common type of gap insurance is when you buy a car with financing, put down a small downpayment, and now your car depreciates faster than you pay down the loan. At some point, the car is worth less than what you owe on the loan. Gap insurance covers you in the event something happens and you lose the car. It's generally very inexpensive but still a bit of a luxury.
Insurance Can Be Temporary
Not all insurances are forever. With auto insurance, you are required to get it by law and as a result, you tend to have it for a long time.
A home warranty is an example of an insurance that you may want to get when you first buy a house and don't have much of a history with the various systems. As you familiarize yourself with the systems, their performance, and their likelihood of failure; you can cancel it after a year or two. You may also get it because you spent much of your savings on the home itself, so you want to pay a little each month to avoid a massive replacement you can't afford because your savings are so depleted.
Once you fatten up your emergency fund, you might cancel the warranty and self-insure.
What do you think? Is this a sensible way to think about insurance?