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Are You Paying for Too Much Insurance?

You can save money with a careful pruning of your policies

types of insurance such as health, auto, life and home are  are illustrated in chalk on a blackboard

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En español | I've heard people say you should buy as much insurance as you want and that you can't have too much of it. I would agree only if the insurance were free, but it's not.

Insurance companies must cover their costs and make a profit — which means, in general, the odds are good that you will collect less in benefits than the premiums you will pay. My advice has always been that you should only insure for anything you can't afford to lose. Let me give two extreme examples.

  • For my new iPhone 11, I can buy insurance from an independent company for as low as $11 a month, or $132 a year, that extends the warranty and covers accidental damage and theft. If I were to break my phone, I suspect I would wish I had the insurance, but paying for a new iPhone won't mean I'd have to change my lifestyle. If my phone were stolen a year from now, I could probably buy a refurbished phone for far less than I paid for my new phone. Thus I decide to self-insure, which means if it gets folded, spindled or mutilated, I pay for the replacement.
  • When it comes to my family's health, I definitely need insurance. The cost of treatment for a critical health condition such as an organ transplant can easily be over $1 million. That's a cost I'm not willing to try to self-insure. I am, however, willing to self-insure for the deductible, which is why I buy a high-deductible plan where I'm on the hook for the first $6,000 of costs.

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In general, you want to insure only for what you can't afford to lose. With that in mind, here's how you could think about these decisions for different types of insurance.

Auto insurance

Regardless of whether it is required by law, you want liability insurance, which covers damage you do to others. I have a high amount of liability insurance plus an umbrella policy to cover me for any conceivable incident where I would accidentally disable or kill someone. The umbrella policy covers most accidental liabilities such as someone being injured in our home, or any liabilities above the limits on my automobile insurance. Considering our cars are older and have relatively little value, we skip the collision and comprehensive insurance. Another option would be to partially self-insure by choosing a higher collision and comprehensive deductible.

Homeowners insurance

If your house burns down, most people can't afford to rebuild it or replace all of its contents. And if you have a mortgage, the bank will typically require it. But it's unlikely your home's foundation will be destroyed, so you may want to see if your insurance company will insure for less than your home's current replacement cost, which will save you some money. You should consider high deductibles as well, if you can afford the deductibles. Both options will typically lower your premiums while keeping you appropriately covered.

Life insurance

The purpose of life insurance is to protect your family should something happen to you. When we were young, we needed to make sure our spouses had enough income to replace ours if we died. But the older we get, the fewer the years of income we need to protect, especially if the kids are on their own. In many cases, a couple's expenditures might go down should one spouse pass away. You may no longer need that life insurance.

Two caveats, however. First, I'm referring to pure term insurance, because the analysis of cash value life insurance such as whole or universal life is far more complex and dependent upon the policy and your circumstances. Second, if you have a level premium term policy, where you pay the same amount for insurance for 10 years or more, remember that you are getting the better deal on the last few years of the policy because our likelihood of passing away increases with age. And, of course, you generally wouldn't cancel if you had a life-threatening health condition.

Disability insurance

Becoming disabled when you are young would have catastrophic consequences as you and your family could both lose the income from the job and have high ongoing costs of care. But disability policies often pay out only to age 65, or they offer drastically lower benefits at age 65. Though becoming disabled at age 64 has a far lower payout than if one became disabled at age 32, I've found the premium hasn't decreased. So look at your policy and understand the maximum payout you could receive — then compare it to the premium you are paying to decide if now is the time to cancel or reduce the benefit.

Long-term care insurance

I can't ignore the elephant in the room, but the decision on long-term care insurance is perhaps the most complex analysis of all. So many policies purchased years ago are having huge rate increases. There are various types of hybrid polices where premiums don't increase, but they are far more expensive as they also have life insurance benefits. I examined long-term care insurance in this article.

When it comes to insurance, my advice is to fight inertia and don't just keep paying the premiums. Understand what losses you can afford to take and which ones you can't. For the former, consider dropping the insurance or evaluating how much you'd save by increasing deductibles. Shop around to see if another insurance company can save you money. The savings may allow you to spend more on yourself and your family.

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