Understanding the Benefits of Benefits by Byron Moore

  • September 10, 2014

futurehardtopredict-featuredimage

Question: My wife and I are really trying to cut back and get a budget going. I’m looking at all the money I’m shelling out for insurance and I’m saying we’ve got to cut back. We just can’t afford all that. But what kind should we cut first?

 

Answer: Whenever someone raises the twin topics of insurance and affordability, a little red flag goes up in my little brain.

 

It’s not that you can’t spend too much on insurance – you surely can. But in 99% of the cases I see, the problem is not affordability, but effectiveness. Will the coverage you have actually DO what you want it to DO when the car wrecks, or the house burns or when the doctor has a negative report to give? The question you should be asking is, “What coverage can our family afford NOT to have?”

 

On that note, allow me to broaden the discussion a bit to the larger topic of financial benefits (which is what insurance is). Most of us trade money for financial benefits. But because we don’t know how to think about them, we don’t have a common sense frame of reference to inform us of when we are getting a good value and when we’re not.

 

The definition of the word “benefit” is “an advantage or profit gained from something.” So any “financial benefit” you buy ought to result in a distinct advantage or profit to you. You should be better off by having it, not worse off.

 

Let’s say you own a house worth $250,000 and you pay $1,500 a year for homeowners insurance. As long as you own the house without a mortgage, you could skip the homeowners insurance and keep the $1,500. You could save up the replacement cost of your house in…166 years! OK, maybe skipping the homeowners insurance isn’t such a great idea after all.

 

By giving the insurance company your $1,500 each year, you are transferring the risk of experiencing a $250,000 loss. The insurance company can do something you simply cannot – spread out the risk that any single house will burn among hundreds or thousands or other homes in similar situations as yours. The clear benefit you receive is risk transfer.

 

But the various forms of “catastrophe insurance” are not the only financial benefits available.