Insurance: A Tax on People Who Don’t Take Time to Do the Math?
/By Shelley Murasko
My daughter dropped her cell phone while hiking recently and cracked the screen. While searching for a replacement, I found a model for $150 at Gabb Wireless, a company that offers phones for kids and teens with only texting and calling services. I noticed that the company also offered insurance to cover phone repairs for $5 per month. Since my daughter’s previous phone had lasted only nine months, I thought this insurance protection might make sense.
Around the same time, my son smashed his phone when he accidentally kicked a soccer ball into it. While his cell had survived twice as long, a whopping 18 months, he was also in need of a replacement.
It was then I remembered that my son’s replacement phone would be free due to a special Christmas deal we’d gotten at the time of purchase. I also recalled that my daughter’s phone was originally free in May because it had been part of a special Mother’s Day sale.
As I compared these options against buying the Gabb phone, I discovered in the fine print that Gabb would still charge me $40 to replace the phone if damaged. So while the replacement phone would cost less, it would not be totally free.
After calculating the lower phone cost offered by Gabb and the required $40 replacement fee, I realized it would have been MORE expensive to buy the Gabb phone with the insurance option. In fact, without insurance I would have saved $65 between the two phones for my kids.
During my investigation of these expenses, I also discovered that neither of my children was using a screen protector. This additional low-cost risk reduction step could have minimized the damage, if not prevented it altogether. Instead, my kids are spending the money they earn to pay me back for their phone replacements.
The reason I’m sharing this story is to help you understand that insurance – whether it’s for your phone, car, house, life, health, or pets – is a profitable field that uses fear-based marketing to convince you that it’s necessary. In addition, many consumers purchase insurance without doing any actual cost calculations of their own. Instead, they rely on the insurance company to provide the tally, which may or may not include hidden fees like phone replacement costs.
Do You Really Need Insurance?
If you’re like most consumers, you likely spend thousands of dollars per year on insurance. But do you really need to spend large sums of your hard-earned money on it? Once you dig a little deeper into the math, you may be surprised to discover that you don’t. Or that there are ways to reduce your insurance costs if you decide you do need it.
The first thing to know about insurance companies is that they ARE making money off you — lots of it! They do this by hiring intelligent mathematicians called actuaries who analyze loads of statistics about the typical behavior of people just like you. Then they carefully determine how much money they expect to pay out on your claims. After that, they set your premiums to a level where, on average, they can pay your claims, compensate their employees, and still make a large profit for their shareholders. They have, of course, rigged the odds against you. When buying insurance, you’ll most likely pay more into it than you get out of it.
There are only two ways in which this scenario would be wrong:
1. If the brilliant actuaries had incorrectly assessed risk. Even if this were true, it would not be the case for long. You can bet those actuaries would be fired and the insurance company would adjust their fancy formulas.
2. If somehow you had inside knowledge of how to defy the odds of their calculations. In other words, your crystal ball is better than theirs!
The fact that the insurance company will most likely come out ahead seems obvious. Yet the average consumer still feels like they are missing out if they do not own at least twenty different insurance policies on every facet of their life; and the sale of insurance exists on just about anything that you can imagine including wedding events, to kidnappings, patio furniture, fantasy football and even alien abduction. I’m not kidding. Look it up!
The Importance of Doing the Math
Recently, I learned about a financial advisor who encouraged a woman in her mid-20s to buy life insurance for $2,500 per year, even though she had no dependents and her odds of dying within the next five years was 1 in 100,000.
During another recent insurance-related conversation, an acquaintance told me, “I need pet insurance, so I don’t have to pay the $200 every time I take my dog to the vet!” Of course, the vet policy cited cost the individual $75 per month, had a $500 deductible, and included several other limitations on coverage.
It’s important to note that most pet insurance policies won’t cover pre-existing conditions or end-of-life matters. In addition, they often have phase-outs at a certain age and leave out coverage for many elective procedures or preventable diseases.
These two examples demonstrate why it’s important to run the numbers when considering an insurance purchase. Despite the belief that you need insurance to SAVE money, most often the opposite is true! Once you understand this, you’ll realize there are only four possible reasons to get any type of insurance.
1. You’re required to have insurance (i.e., house insurance to obtain a mortgage, auto insurance to drive a car).
2. You can’t afford the consequences of a major life event (i.e., a burned-down house, a year in the intensive care unit at $20,000 per day, or the cost of losing an income if one spouse dies prematurely).
3. You’re riskier than the insurance company thinks you are. For example, perhaps you take your dog skydiving with you every weekend, or you never floss your teeth and eat three bags of candy each day. Or, on a more serious note, maybe you’re expecting a baby, suffer from a chronic health condition, or possess genetics that make you more likely to acquire a particular disease in the future. In these cases, it may be wise to set yourself up with an insurance plan featuring a lower deductible.
4. You insist on the peace of mind that comes with paying a lower monthly insurance premium versus the possibility of having to pay a higher expense all at once. Mathematically, that peace of mind is not a solid reason for buying insurance. Yet many individuals prefer to keep various types of insurance for emotional reasons.
Ways to Win the Insurance Game
The list above covers many of the possible insurance categories. But what about coverage for events that may be unlikely to happen, yet you couldn’t afford if they did? For instance, should you get kidnapping insurance on yourself to cover up to a $3 million ransom? Extended warranties from Best Buy® on your laptop? Hair color insurance because you’re fed up with your stylist’s rising prices? Grocery insurance because the cost of eggs has hit an all-time high?
Stop! It’s all a trick.
Luckily, there’s a solution: Simplify your insurance holdings now by reassessing which ones are worth the money. For this discussion, let’s set aside the insurance types mentioned above that are legally required, would keep you from going over the financial edge, or cover a known higher risk factor. When you narrow your focus to essential needs, you really can simplify your risk management to insurance types like auto, health, home, and term life insurance (if you have dependents).
If you own a business, it may also make sense to take a hard look at umbrella insurance, errors and omissions insurance, and other appropriate insurance types that apply to your specific business area.
Do you have a healthy emergency fund and a savings built up that allow you to afford most unexpected outcomes? If so, then carefully consider whether you truly need the less essential insurance types, such as dental, pet, whole life, and long-term care. You may also want to consider annuities insurance if you have a solid income stream in retirement relative to your expenses. Just keep in mind that insurance companies today can raise their premiums anytime they wish.
I’m not saying you shouldn’t have these types of insurance; I’m merely saying that it could serve you well to look at the math and the insurance policy exclusions carefully before purchasing.
Once you’ve shortened your list to the insurance types you feel are important, consider how you might tailor them to fit your actual needs. If you have life savings above and beyond your financial goals, you can probably go with the highest deductibles on policies for cars or your home.
If your car is over 14 years old, it might be time to drop collision coverage. If your pet is 13 and your pet insurance doesn’t cover pets over age 14, it might be time to drop the policy. On the other hand, if your home insurance policy still has your home’s reconstruction costs set at 1985 values, you may want to consider updating it.
For the insurance products you decide to keep, plan a nice afternoon to do some shopping around. I did this last January and sliced about $300 per year off my remaining home and car insurance.
When you’ve completed this task, put all the savings from these premiums into growing your nest egg. Then sit back and enjoy the fact that you’re now getting paid to be your own insurance company.
Although streamlining your insurance might sound risky at first glance, it will feel quite satisfying once you’ve done it. By not buying into a product where the odds are stacked against you, you’re statistically likely to win. While you can’t predict the future, you do have one tool that lets you turn the unknown to your advantage: statistics. Understanding the role that statistics plays is a huge advantage when it comes to becoming wealthy.
As your savings of thousands of dollars adds up to a sizeable nest egg over time, you’ll find greater confidence in knowing that you can handle the larger ticket items without the need for unnecessary insurance.
