Knowing how much insurance to buy is one of the harder topics of personal finance. It factors in the future, and all the unknowns that come with the future. On the one hand, insurance protects your wealth from negative events in the future. On the other hand, however, insurance costs you in the present, which in turn, costs you in future earnings on that money. Buy too little insurance, and you leave yourself over-exposed. Buy too much insurance, and you burden yourself with too large of an insurance bill. So where’s the balance? And how much insurance is too much?
Legal Requirements to Hold Insurance
There are several laws requiring you to have various kinds of insurance. These are a good starting point for deciding how much insurance to buy- both because of the reasons the laws were passed and to avoid any penalties for breaking the law.
Most states, for example, require drivers to hold a liability policy. Some states also require a comprehensive policy. Breaking these laws would not only expose you to virtually limitless financial cost in the case of an accident, but would also cost you close to the cost of the premium in the case of getting caught.
More recently, the Affordable Care Act has required all Americans to have health insurance. This insurance must at least meet minimum standards set forth by the law.
Insurance laws are there for a reason. In both the above examples, the insurance requirements are both for the benefit of the insured and of the general public. Both an auto liability policy and health insurance protects holders from catastrophic financial loss. Requiring liability policies also ensures that other drivers are compensated for accidents that were not their fault, while requiring health insurance maintains a more healthy population. These reasons alone are compelling reasons to at least comply with legal insurance requirements. Furthermore, penalties for not complying with the law make it even more prudent to at least insure yourself up to legal minimums.
Contractual Obligations to Hold Insurance
In addition to the law’s requirements regarding insurance, you may be required to hold insurance by a third party. Employment and home ownership are two common situations where this is the case. For example, if employees use their personal vehicles for work, the employer may require employees to have auto liability insurance above legal requirements since the employer may be held responsible in the case of an accident. Likewise, homeowners are typically required by the mortgage lender to insure the house. Since the house and its underlying value are collateral for the mortgage, the lender has an interest in keeping that collateral intact. The bottom line is that whenever you agree to terms, one of the things you should be on the lookout for is insurance requirements.
Insurance Coverage to Fit Your Financial Situation
So is carrying the minimum coverage required by law and contracts enough? It depends on what kind of losses you are willing and able to absorb.
If you have enough cash on hand to replace your car, and are comfortable with this possibility, you probably don’t need comprehensive coverage. And remember, you wouldn’t necessarily have to replace it with a vehicle of the same value. You might be willing to replace your vehicle with a lower cost vehicle until you saved enough for an upgrade. However, if your finances are tight, perhaps because you are paying down debt, you may consider adding extra coverage on your vehicle. This would protect you from having to turn to high interest debt in the even that you did need to replace your vehicle.
Likewise, if you are able to pay for significant medical expenses, you might be best off opting for a High Deductible Health Plan, which still complies with the law, but comes with a lower premium than traditional health plans. However, if a few thousand in medical bills would squeeze you too tight, a traditional plan might be better.
Life insurance should be evaluated the same way. If someone else is depending on your income, to the point that they would be in a financial bind without it, life insurance would be a prudent decision. However, if those dependent on your income have the resources and means that they would be able to recover from the loss of your income, perhaps you don’t need as much life insurance.
Within reason, consider worst case scenarios. If you know how you would recover without insurance, great! If not, insuring yourself protects you from financial catastrophe.
Insuring Yourself For Peace of Mind
From a financial standpoint, the insurance business is like a casino: if you play long enough, the house always wins. However, unlike the casino which gives you the chance at huge wins, insurance gives you a guarantee against huge losses. So while insurance will cost you over the long term, it can buy you peace of mind, which is priceless. Just don’t over insure to the point that the premiums leave you penniless.
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- While I do strive to only write accurate information and dispense valuable advice, I am not a licensed financial adviser. All information is based solely on my personal experience and personal research and should be treated as such. Find out more.