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(Excerpted from Stop Getting Ripped Off) Everyone hates insurance. You hate talking about it. You hate shopping for it. Most of all, you hate paying for it. Until you need it. Then….well, you might still hate your insurance company, depending on how it handles your claim, and how much it punishes you later. But in the moment, you’ll be glad there was a safety net in place when you took that fall. The average American consumer spends about $4,000 each year collectively on auto, life, home, and health insurance. Yet most of the time, buying insurance feels like you’re getting nothing for something. For example, only about one in 14 drivers make a claim on their comprehensive insurance every year. That means you could easily pay $10,000 in auto premiums from age 25 to age 35 and feel like you’ve gotten absolutely nothing for that money. On the other hand, when your day comes, you will likely be glad you paid up. The average comprehensive claim payment is about $4,000. Those $65-a-month payments will sound like a bargain when that $4,000 bill gets paid. Of course, if you elected to pay $55 a month and picked a high $1,000 deductible, you will probably kick yourself when you walk away with $3,000 instead. If all this sounds a bit like gambling, well, it is. No one can predict the future, and the truth is, very few people are very good at even having hunches about the future. Yet you pick your premiums for auto insurance, life insurance, and homeowners insurance based on some vague notion of the likelihood that you’ll need it some day. Naturally, insurance companies are much better at these predictions than you could ever be. They have years and years of data for comparison, they have big computers that crunch the numbers, and they have salesmen and women who are good at scaring you with visions of disaster. All these factors make buying insurance one of the most mystifying choices a consumer has to make. As a result, most consumers are either overpaying or underinsured. So I’m going to simplify insurance purchasing for you. Here’s two things you need to remember, no matter what kind of insurance you’re talking about: 1) Insurance isn’t really a product you buy. It’s a concept 2) Insurance is about preventing an unexpected catastrophe. It’s a safety net for large disasters, not small ones. Knowing these two things can save you a lot of money when shopping for insurance. It will also simplify your choices when the confusing sales pitches come. Now, let’s work through these two points. No. 1: Insurance, the concept, not the product It’s often said that insurance was born thousands of years ago, invented by Chinese merchants who would plan for potential shipping disasters by instructing captains to redistribute their goods among each others’ ships. That protected an individual merchant from being ruined if a single vessel were shipwrecked. The odds that all shipments involving a single merchant would fall to ruin were extremely low. In other words, by adding slightly to their costs, and sharing risk, merchants dramatically decreased their odds of complete disaster. Another subtle aspect of the tale, however, is the social contract. Insurance embodies a notion that society is better off absorbing the risks and consequences of catastrophes, rather than allowing individual victims to be devastated by them. In China, when there was a shipwreck, each merchant suffered a manageable loss, rather than allowing the ruin of one. This is generally referred to as the “pooling” of risk. Modernizing the idea is easy. Nearly every homeowner purchases homeowners insurance for a few dollars per day. A tiny percentage each year have a tree fall on their house. When they do, the insurance company builds them a new house…paid for, essentially, by everyone else. It might sound socialistic to you, but it plays an important role in capitalism, too. Any time you reduce someone’s risk, you encourage them to invest. Merchants might quit the shipping business when presented with the possibility that one storm could end their career. With that risk minimized, more merchants are emboldened to join the business. So insurance – the pooling of risk – is an important concept that evolved simultaneously with the evolution of societies and markets. The Code of Hammurabi, the first known codification of law, actually includes provisions for insurance. In the U.S., government agencies often mandate insurance. In most states, it’s illegal to drive without insurance, for example. In fact, certain levels of insurance are prescribed. And yet, insurance is bought and sold by for-profit companies in a kind of pseudo-free market. Obviously, the market isn’t free if consumers have no choice. Imagine how easy it would be for insurance companies to conspire with each other to keep prices artificially high. To prevent this kind of abuse, the insurance industry is subject to heavier regulation than other industries. State insurance regulators try to keep up with insurance firms and make sure they don’t gouge customers. As a very general rule, insurance companies pay out 80 cents in claims for every $1 of premiums they collect. After costs for marketing and overhead, the difference is their profits – which are enhanced by the investment income the insurance firm makes during the year on the “float” of time between collecting premiums and paying out claims. If an insurance company is too profitable – meaning it’s paying out much less in claims than it’s taking in with premiums – regulators may step in and demand a price change. Now, see how far we’ve traveled from a normal for-profit industry? **** Insurance companies do well when they attract a lot of customers. The larger the pool, the easier they can absorb losses by individuals. They do even better when they attract the *right* kind of customers – good drivers, healthy people, homes in areas not prone to natural disasters. They are constantly working to separate out good customers from bad. One method for skimming off the cream is price. Higher-risk consumers are charged more. Smokers, risky drivers, people who live in flood plains all pay more. That way, they are either discouraged from signing up, or pay so much that they are ultimately profitable. How much more? How are those calculations made, and how can you get on the right side of the equation? That’s the question the rest of the chapter is about. The one factor that makes buying insurance maddening is this: insurance firms use complicated formulas to determine the price of their product. These formulas are a carefully guarded secret, and you’ll never know what they are. Oh, your agent might throw some terms at you, like “collision and comprehensive.” You might hear that rates go down when you turn 25, or when you get married. But basically, you will never know the reason why you pay the price you pay for insurance. That means you have only one way of knowing if you are overpaying for insurance: quotes. You have to comparison shop. You’ve got to bid out your insurance costs every year. And you must do this even if your rates don’t go up, because there might be a new discount formula you don’t know about from a competitor. Your credit score might improve, for example, and at some companies that might mean lower rates. Or you might have reached an age that puts you into a new “bucket” of safer drivers. But you’ll never know unless you try. More than other kinds of purchases, you must regularly pit companies against one another to find out what’s a fair price. Remember, you are buying a concept rather than a product – you are buying a little piece of risk protection. The only way to get a fair price while dealing with the concept of insurance is to be a pesky guppy in the pool of risk. No. 2 -- Catastrophe vs. convenience. Insurance is there to prevent you from losing everything in one unlucky event. It is not there to make your life perfect, or to make you 100 percent whole after a disaster. It’s there to prevent a complete catastrophe. So principle number two is this: always buy high-deductible insurance. If your car is stolen, you’ll be glad you paid for comprehensive insurance. It will help you get the $15,000 you need to plunk down another $15,000 for a new car, and help you keep your life in order. But you shouldn’t see insurance as a tool for making everything perfect and risk free. If someone steals a $300 GPS from your car, you should just chalk it up to experience and learn to park your car somewhere else. You shouldn’t expect someone else to pay for that. The biggest mistake insurance consumers make is overpaying for “make everything perfect again” insurance with low, low deductibles. In fact, you should always buy auto insurance with a $1,000 deductible, and you should be ready to pay the first $1,000 to recover from a theft or fender-bender. Raising a deductible from $200 to $1,000 will save about 40 percent on the cost of comprehensive insurance -- roughly about $100 a year for the average driver. But how will you pay that $1,000 should something happen? You’ll think big. You will self-insure, like all the big companies do. That means they are big enough to set aside money to cover unexpected disasters, and don’t need to pay for insurance. Of course, you can’t do that. But you can self-insure against your deductible.
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