How do we handle risk in life?
Human life is intrinsically risky. There are health risks, occupational, recreational and financial risks of every sort which we face daily. It would be fun to address the many aspects of this topic but that would quickly become much too broad for this brief article. So, from an insurance agent’s perspective, I believe it is best to focus on the hazards and risk of fortuitous loss for which people come to see me to help them insure.
This is an attempt to briefly capture my philosophy when explaining the need for insurance and encouraging a more informed approach to help my client purchase their insurance thoughtfully.
We have to consider when we need it, how much to buy and how broad should coverage be to make us feel protected. That is often a subjective choice. One individual’s appetite for risk may vary greatly from another person who doesn’t want to lose anything -but doesn’t mind spending premium dollars. Insurance is basically exchanging a known (premium cost) for the unknown (loss).
A lender expects you to have insurance. In order to obtain a loan for a house or an auto, you must protect the asset they hold as collateral. Insurance is essential to lending because it assures their asset will continue to exist, or its value covered despite a loss occurring.
So, lenders will want your insurance to include replacement cost coverage, in the case of your home, and to include Collision and Other than Collision coverage for your auto. Failing to do so can cause them to put in place Force Placed or Single Interest insurance upon you. The cost is high and is added to your loan payment but this only compensates them for their loan balance, it does not indemnify you for the rest of the value or equity you own.
When there is no lender demanding what and how your things are insured, you have the freedom to choose whether and how much you may insure against property and casualty losses. With the exception that the state requires you to maintain minimum liability insurance on your vehicles.
Here are four simple words I like to use to explain the basic concepts you use to help us determine what insurance to buy in order to manage financial risk in your life.
The term is TRAP as in “We need to TRAP the risk of loss.” They are:
- Transfer – Give the risk to someone else in exchange for a known premium.
- Retain – Keep or accept the risk as something you are willing to incur.
- Avoid – To not buy, own, rent or do a thing so that you are not exposed to the potential loss.
- Protect – Take actions to help reduce or avoid the risk of loss happening.
If you are interested in exploring a further academic expansion on these concepts, I recommend you try this Google search for a start.
We transfer a loss that we cannot afford not to insure.
From my perspective as your agent, I want you to balance the coverage you can enjoy at the time of a loss against a customer’s main objective of keeping the bottom line or premium as low as possible. I like to draw their eyes up from the total premium line and have them focus on the limits and limitations of coverage to include what perils are insured in the policy.
Insuring a home includes having an adequate amount of coverage to meet the minimum cost to rebuild a home following a loss, sometimes referred to as replacement cost. Raising this limit also raises the cost of insurance but weighed against having insufficient money to rebuild after a storm or fire, these few dollars do not matter at all.
And by agreeing to accept a higher deductible in exchange for annual reduction in premium, an insured can save up to offset that higher deductible should a loss occur.
On the other hand, the damages you cause to property and to persons from an auto accident can be very large and unknown at the time of a policy purchase. So having as high a limit of liability as you can comfortably afford is a wise way to buy auto insurance which has a high frequency and potential for severe loss amounts.
Imagine having a neighbor’s child enter your yard and be injured by your dog, or hurt on your swing set, or drown in your pool. Having high limits of liability have much greater meaning at that time. All these ideas reflect the value of Transferring the risk.
We may retain a loss that we can afford to absorb.
A deductible is a preset loss amount you will retain should a loss occur. If you have the ability to accept a higher deductible, you are agreeing to meet more of the first dollars spent on the loss, sometimes a small loss is less than your deductible so there is no reason to make a claim. Being claim free and carrying a higher deductible certainly saves premium.
Another example of retaining a loss is when a farmer opts to not buy insurance on an old barn or tractor that to him is still usable but not worth covering in insurance. He could afford to lose it and not replace it.
Consider when a woman decides to not purchase special jewelry coverage (called a Floater) for her wedding ring which would cover her ring for its full value from loss, damage or even for losing a stone. Since this type of insurance is costly, she may depend on her years of experience in wearing it carefully and not absent-mindedly leaving it different places where it can be lost.
When something is too risky or expensive, we may avoid it altogether.
Even though it can be insured, we may choose not to buy a jet ski or motorcycle. One may feel he is too accident prone or careless to do or have certain things so it makes sense not to even try. By owning a home located inland rather than right on the coast or next to a river, we save a lot of insuring cost by not being exposed to higher risk.
Even when we choose these cost saving measures, we can still protect ourselves from loss.
Adding automatic security lights or cameras, locking our doors, watching out for trespassers, and hiding or keeping our guns and valuables in a safe place all add to loss avoidance. In truth we often employ this action even when we are transferring or retaining risk, because not having the accident or loss happen in the first place is naturally always the preferable outcome.
You are already unconsciously utilizing these decision tools and loss protection measures in your daily life and in your insurance purchasing decision. Through better understanding and managing this balance with your needs more practically you may save money and choose to accept more risk or manage it through other means.
My goal in educating my clients is to have them understand the role their insurance plays; and what their policy limits and exclusions will provide following a loss so that their expectations are met and may be realistic. Often the reason people are disappointed is because they carried unrealistic expectations and were surprised to learn that their coverage fell short of what they expected. Being forewarned is forearmed and satisfied in the outcome.