We have insurance because bad things happen in life — auto accidents, fire, floods, hail, medical crises, even death. When things go wrong, you will want to have some protection for you and your family.
Unfortunately, buying insurance is complex. It’s easy to have too much or too little. It’s easy to pay far too much for insurance if you’re buying from the wrong company. A complete guide to buying insurance would fill several volumes of books. I can, however, give you three simple rules for making these large and critical purchases.
Rule 1: Don’t buy too much or too little insurance
Understand that insurance companies price their products to make a profit. If they make money, you will, on average, lose money — or at least make less money than you would had you invested it rather than bought the insurance policies. Let’s look at two extreme examples.
Unnecessary insurance: Let’s say you buy a $1,000 LED high-definition TV that has a one-year warranty. The store offers you an extended warranty to protect your purchase for three additional years for $250. Now your cost is $1,250. In most cases, I would recommend skipping this insurance and saving the $250. If the TV broke even one day after the one-year warranty expired, that TV is now older technology and could be bought for about $750. This means you are out a maximum of $500 since you saved $250 by not buying the extended warranty and could buy the replacement for $750. That is a loss that you could bear (I hope) and would not be catastrophic.
The same thing goes for auto insurance for some people. You want and need liability insurance. If you injure someone, that could cost you hundreds of thousands of dollars or more. But if you have an older car and a sizable nest egg, you may be better off skipping collision and comprehensive (such as hail damage). In fact, if I had a $3,000 fender bender and a $1,000 deductible, I probably wouldn’t submit a claim if I wasn’t required to. That’s because the insurance company might raise my premiums to more than cover the $2,000 claim.
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