It can just start with something small. Burning dinner gets a little bit out of hand. Driving to work after a winter storm you hit a patch of ice and cannot stop sliding. A sore throat does not go away and the doctor diagnoses something worse. Next thing you know, the bills are piling up and the cost is a lot more than your emergency fund could ever hope to cover.
This is where insurance comes in. Insuring for every potential hazard is not only impossible, but would be ridiculously expensive. Instead, insurance is split up into smaller realms of coverage and our job is to recognize what coverage is prudent for us to get.
Insurers are a business like any other. Their goal is to provide a service while still making a profit. They take money in the form of premiums from a lot of people for similar protection. They pay money out for claims that meet the criteria of the insurance. If the company did a good job estimating what the claims would be from the people they cover, they will make money. If they do a poor job, they will lose money and eventually go out of business.
This is important to us, because who the insurance company pools us with will determine how much money they expect to need from the pool of insured people to meet their costs. So, the behavior of the people we are lumped with will impact how much we need to pay for our insurance coverage.
An example of this is earthquake insurance. Being grouped with people who live in southern California will cause your insurance premiums to be more expensive than if you were grouped with people in southern Florida. This holds true regardless of what kind of insurance you are buying. If your risk factors make it less likely that you will have a claim on the insurance policy, you will be grouped with other people who are also low risk. This keeps your insurance rates down, while higher risk people’s rates are higher.
For most people, there are a core set of insurance policies that are prudent to obtain and keep. Auto insurance is often required by the state, and even if it was now, few of us could afford to pay off our old car after an accident and purchase a new one much less cover any liability we would have for other people’s vehicles and medical bills.
Life insurance is not for your benefit, but is for the people who you would leave behind. Not only are funerals expensive, but who is going to pay the mortgage or rent for your family if you die? Sufficient life insurance can not only help pay the bills for months, years or decades, it can also give your family time to grieve without having to worry about cash.
Homeowners or rental insurance is the last big one that you should secure. These policies will protect you by helping you replace your belongings if something happens to your home or apartment. For homeowners, this insurance comes with a giant caveat. Like many Katrina victims found out too late, homeowners insurance will not protect from flood damage. Fortunately, flood insurance is available to cover that exclusion.
Other insurance policies may or may not be reasonable to get. The previously mentioned earthquake policy is an example. If you are not in a seismically active area, the low likelihood of an event means that you are better off investing the money. Disability insurance, travelers insurance, computer insurance, and jewelry insurance are other categories that will make sense for some people and not for others.
The real judge for determining if a particular insurance coverage is prudent is to ask yourself how likely the covered event is to happen. If it is reasonably likely, then ask if you could absorb the financial hit without insurance. Finally, if you could not handle it without insurance, are the rates something you can afford.
At that point, if you can afford it, it would be wise to get the insurance. If you cannot afford it, you will need to find an alternate way to protect yourself from that event, which may include moving out of the danger zone. Would moving insurance help you then?