Insurance is one method of dealing with risk. You can sometimes change the way you do things to manage risks rather than purchase insurance. Once you decide that a certain risk has the potential for being very expensive or causing you financial hardship, you may want to consider transferring that risk to others. You purchase an insurance policy to transfer risk.
There are four insurance strategies that could be used to manage risks.
- You can self-insure and assume the risk yourself. This often works for smaller risks that have a low probability of happening. Higher probability risks or risks that put large amounts of your assets in jeopardy are not good candidates for this insurance method.
- You could under-insure where you pay a portion of the loss out of your assets (checking, savings, equity in your home, withdrawing a portion of your retirement etc.) and the insurance company pays a portion of the loss. (Note: This is a very expensive way to manage risks.)
- Purchase an adequate amount of insurance where the insurance company pays for the entire loss (minus your deductible if any).
- Or you could “Over Insure” and purchase much more insurance than you think you will need.
These are some insurance principles to consider.
- If you transfer more risk to the insurance company, you will pay more in premium. The opposite is also true.
- You can reduce your premium by assuming a portion of the risk. The best way to do that is to have a higher deductible. This is a reasonably good method of reducing premium, because a deductible is a relatively small loss compared to a large liability loss. And it is a known fixed amount such as $1000 for a collision deductible.
- You want the insurance company to assume the potentially large risks and you should take care of the smaller risks. Your largest risks are in the liability area where there are potential losses in the thousands and hundreds of thousands of dollars. Concentrate your premium dollars on those coverages where you get the biggest bang for your buck.
- The risk you represent to the insurance company affects the premium you will pay. For example, safe drivers pay less than drivers with numerous accidents and speeding tickets.
A recap:
- Insurance is a method of transferring and managing risk.
- Adequate insurance coverage can protect your assets.
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