Insurance – Do You Have Too Much or Not Enough?

For many people, insurance is not a fun or exciting topic. We often mindlessly renew our existing policies and spend little time thinking about whether we have the right policies or coverage. As a result, we may have unnecessary insurance in some areas and not enough coverage in other areas.

Why should having too much insurance be a concern? While insurance serves an important function for protecting against large losses, it is not a good deal for small potential losses that you can afford. The reason for this is that insurance premiums are designed to cover not only the policyholder’s statistical share of potential claims but also the insurance company’s overhead, selling expenses, and profit. In most cases, you can do without the following insurance policies that cover relatively small potential losses:

  • Extended warranties
  • Cell phone insurance
  • Travel insurance
  • Credit card insurance
  • Comprehensive and collision coverage for older cars with low replacement value

Another way to eliminate coverage for small potential losses and reduce your premiums is to choose policy deductibles that are as high as you can afford. Is your auto insurance policy deductible $500? Unless you are accident prone or your auto lender requires a low deductible, why not increase the deductible to $2,000 if you can afford such a loss?

Why do people buy insurance for small losses? I believe it is because of two behavioral finance tendencies: (1) fear of regret and (2) assigning probabilities based on the ease of imagining the event or finding examples. It is easy to see how someone who has always had comprehensive and collision coverage could fear having his car stolen right after dropping comprehensive and collision coverage on his 15-year-old car worth $1,500 (fear of regret). Also, some people may overestimate the probability of something happening because it is so easy to imagine (e.g., misplacing one’s cell phone or getting sick right before a planned vacation).

So, what are some areas where you might have not enough insurance? First, consider the reason for insurance. The purpose of insurance is to protect you from large financial losses that you cannot afford. Most people have heard of auto insurance, homeowners’ insurance, health insurance, disability insurance, and life insurance, but there are other types of insurance that are also important. One is renters’ insurance, which is designed for those who rent their residence. An apartment renter might say, “I don’t need renters’ insurance because the things in my apartment aren’t worth much.” Renters’ insurance covers much more than the contents of your apartment. It covers your liability from bodily injury or property damage that occurs either at home or anywhere outside your home. If you are sued for this type of liability, the insurance company will provide a legal defense at their expense, even if the lawsuit is groundless. The sum of a liability judgment and attorney’s fees could become a very large loss. Of course, the details of policy terms will vary with the insurance company, but you can see the importance of having renters’ insurance.

Another important type of insurance policy is a personal umbrella liability policy, which covers your liability from bodily injury or property damage that exceeds the limits of your underlying auto, homeowners’, or renters’ policies. Some umbrella policies also cover events that may not be covered by underlying homeowners’ or renters’ insurance, such as personal injury from false arrest, slander, or libel. Although the chances of anyone filing an umbrella claim may be very small, an umbrella policy, by definition, protects you from catastrophic financial liability. Umbrella insurance is especially important if you have a sizeable net worth. Umbrella premiums are often modest, and umbrella policies are offered by many insurance companies that offer auto, homeowners’, and renters’ insurance.

Also, take a look at the liability limits of your insurance policies. Did you get a low $50,000 liability limit on your auto policy when you were a poor college student and never change it? If so, this is a good time to reassess all of your liability limits. If you have an umbrella liability policy, you can just set the liability limits on your underlying auto, homeowners’, and renters’ policies at the minimum amounts required by the umbrella policy since the umbrella policy will cover any excess liability (up to the limits of the umbrella policy).

Finally, be aware of policy exclusions. For example, homeowners’ insurance policies typically do not cover damage from earthquakes or floods unless you get add-on coverage specifically for these perils.