Three Things You Should Insure
Insurance is often a necessity, an expensive necessity. Car insurance costs an average of $1,718 per year for full coverage, health insurance can cost over $1,000 per month depending on your age and circumstances, and home insurance averages around $2,000 per year. Protecting what you have, from your possessions to your health, is getting more and more expensive— and not all insurance is worth it .
This doesn’t mean insurance is a scam: no matter how high those premiums may seem, when your insurance claim is paid out, it could save you from financial disaster. Flood insurance on my house is quite expensive, but when there was a flood a few years ago, the insurance payout saved our asses and allowed us to do things like rebuild and replace the house. But sometimes it makes more sense to insure yourself rather than pay for a policy.
Self-insurance
Self-insurance is a simple concept: Instead of purchasing a policy from an insurer, you protect yourself from future problems by setting aside money yourself to cover the costs involved. For example, if you’ve paid off your mortgage and no longer want to pay homeowners’ insurance premiums, you can set aside enough money to cover the potential costs of repairing or replacing your home after a future disaster.
You’re already self-insuring without realizing it: everything you own that isn’t covered by your insurance policy is essentially self-insuring. If you bought an expensive TV yesterday and it wasn’t explicitly covered by insurance, if it were stolen tomorrow, you’ll have to pay out of pocket to replace it. This is self-insurance. You can insure yourself against anything to a greater or lesser extent. If you don’t have health insurance, you insure yourself. If you are required to insure your car, but prefer not to pay for collision or theft coverage, you insure these aspects of your car yourself.
The main benefit of self-insurance is that you can save the money you would normally spend on insurance premiums and let it accumulate, preferably somewhere in an interest-earning account. If there’s a problem, you have the money to fix it . If you never get into trouble, that money will still be yours, unlike the premiums on a policy that was never paid out.
When is it worth getting insurance?
Self-insurance is tempting because in theory you keep your money, but you also have a plan to deal with unexpected problems. But unless you have significant liquid funds, it’s only a good idea in some specific scenarios. For example, let’s say your flood insurance premiums cost $1,000 per year. You give up your policy and instead put the money into an investment where you earn an average return of 10% and after 10 years you have about $16,000 . Amazing! The bad news is that the average reimbursement paid by the National Flood Insurance Program is over $66,000 , meaning you could be out $50,000 if your home floods. In this case, paying the annual premium will be a much better deal, as long as you never have to make a claim, which is a bit of a gamble.
This means that there are two main scenarios in which self-insurance makes sense: when the cost of replacement or payment for services is within your means (for example, you have $66,000 that you earn somewhere and earn interest that you can put aside for the damage flood), or when the item you are insuring is not worth that much, so the cost of insurance is unprofitable.
There are a few specific scenarios in which you should definitely consider self-insurance:
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Car insurance. Most states require you to have liability insurance, but more comprehensive coverage is usually up to you. If your car is old and not worth much, and/or you have the ability to do the repairs yourself, choosing self-insured car insurance may make sense.
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Jewelry. Just like with a car, the value of most jewelry drops sharply the moment you buy it, making insuring it a bad deal in most cases. Most homeowners insurance covers jewelry for a very limited amount —between $1,500 and $2,000—so unless your jewelry is worth much more, it makes sense to simply insure it yourself.
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Life insurance. The sole purpose of life insurance is to ensure that your family is not left penniless if you die unexpectedly. If you have accumulated significant assets that provide income without a salary, or your family simply won’t need your income (for example, because your children are grown and your spouse has access to shared retirement savings), then life insurance is probably unnecessary expenses and self-insurance is a better idea.
One thing to consider in these scenarios is that the portion of the “significant assets” with which you can cover unexpected losses without insurance must be liquid assets. For example, if your net worth is tied up in real estate or a business, self-insurance may require you to sell those assets, which can be an unpleasant experience. But if you have liquid assets and know you can cover the costs of negative events, self-insurance can be a viable option that can save you a lot of money over time.