What Should I Insure?

Insurance poor is a bad idea. So is poor because I had too little or none. There is a way to think about it.

Future unknown losses fall into four categories. The defining elements are the cost of the loss and the probability of the loss occurring. Each of the categories has an implicit insurance strategy. The combinations are:

Low cost / low probability. Things like: Left my umbrella at the restaurant, ripped my shirt, damaged a rental DVD. Tactic: self insure

Low cost / high probability. Things like dental care, dents in your car. Tactic: Manage the costs. If you insure, have a significant deductible. Self insure the small stuff because all insurers have overhead to recover. On average the insurance premium is about $1.25 per $ of claim. Use a meaningful sized deductible.

High cost / High probability. Things like sending a ship full of product into a war zone, life insurance for someone with pancreatic cancer. No insurance will be available except possibly at a prohibitive price. Tactic: fuggedaboutit or better, avoid the risk.

High cost, low probability. The only area where real insurance exists. Things like life insurance for healthy people, most liability insurance and fire insurance, medical insurance for huge drug claims. Tactic: Define the loss you cannot afford and cover it.

Most people who fail to insure wisely share mistakes. The most common are to

  • overvalue the loss or
  • over estimate the probability of loss
  • or misunderstand the policy.

An accidental death would be unfortunate and costly but very rare. It looks like you get a big payout and a small premium. Most of the time the premium is multiples of its real value to you. I once had a client with a $1,000,000 “personal catastrophe” policy. The premium was less than $300 per year. Upon examination we discovered that the only likely claim would be if he were trampled to death by a rabid yak while mountain climbing in Tibet. Even then, he might only be able to stop paying premiums.

Accidental death is not as common as you would think. If an event that causes death is “reasonably foreseeable” then it is not an accident. Playing Russian Roulette for example. Walking on a bridge parapet. Climbing a high tree. Being stupid is generally not a covered condition.

Workers Compensation is an example of overestimating the probability. Only a tiny fraction of disabilities occur on the job. I have seen statistics that say as few as 1 in 30. In most cases, premiums are lower than individual disability insurance but not 1/30. You are a lot more likely to be in a car accident or fall off your roof or have a heart attack or get cancer than you are to be hurt at work.

Insurance is merely a financial tool. Figure out what you need done, figure out what insurance does, compare the value of the loss to the price to avoid it and get on with it.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. don.s@protectorsgroup.com