Insurance: the one investment in your life that you don’t want to have pay out

“Getting insurance is YOUR responsibility to your family and your loved ones. You may hate it but it is your responsibility”– Jeremiah Say *

“Why would you pay for something that you really don’t want to have happen?” – My son when talking about buying insurance

Welcome to the latest post in my journey to build financial literacy for young adults and their families. In today’s post, we will discuss insurance and why it’s important. This will be a two-part post as insurance is a very important subject and there are lots of insurance types. This post will discuss why insurance is necessary and focus on those types which are legally required. The next post will dive into insurance types which are not legally required but serve important purposes nonetheless. Depending on your life circumstances, a number of those insurances are worthwhile to buy.

What is the purpose of insurance?

In life, there is lots of uncertainty. Sometimes bad events happen which, beyond the human suffering they cause, also have large financial implications. This is where insurance comes in. The fundamental purpose of insurance is to manage risk. The Insurance Institute explains that “its aim is to reduce financial uncertainty and make accidental loss manageable. It does this [by] substituting payment of a small, known fee—an insurance premium—to a professional insurer in exchange for the assumption of the risk [of] a large loss, and a promise to pay in the event of such a loss.”** Put in simpler terms, the purpose of insurance is to help you prevent bad events from causing catastrophic financial damage.

Now, many people think that insurance is a waste of money. The types of events that insurance is meant to protect against are typically low probability. And actually, in a perfect world, you would never experience the bad event and don’t get a payout from your insurance plan. In that sense, you have spent money on the insurance premiums for no return. However, in addition to the financial safety net, insurance also provides a very important psychological benefit as it provides you the proverbial “ability to sleep well at night”. This is because low probability does not mean no probability. If one of those rare events does occur, insurance helps prevent your finances from catastrophe. The psychological benefit alone of knowing you have a safety net is worth a lot of money - I definitely sleep a lot better knowing there is a fallback for me and the people to whom I am responsible in case one of these bad events happen.

What types of insurance are there?

There are many types of insurances which you will need to look at and consider buying. I divide them into three categories and will cover the first in today’s post:

• Legally required: Usually health insurance and auto insurance, although this may differ by state or country
• Discretionary yet required: these are required in certain instances. For example, if you have bought a home with a mortgage the bank will require home insurance. If you have a limited amount of equity in the house, the bank will also require mortgage insurance
• Discretionary but not required: there are many insurances which are not required, but will make sense based on your life circumstances. For example, if you have a spouse or children, you will most likely want life insurance

Legally required insurances are, as the name describes, required by law. In the US, there are two types of insurance which are legally required:

Health insurance

This type of insurance is “a contract that requires an insurer to pay some or all of a person's healthcare costs in exchange for a premium. More specifically, health insurance typically pays for medical, surgical, prescription drug, and sometimes dental expenses incurred by the insured.”***

Most people get their insurance through their employer benefits. However, a large number of others have to buy it themselves either through private health insurance providers or through government programs such as Medicare, Medicaid or the Veterans Administration.

In a world where the number one cause of US bankruptcies (~62% of bankruptcies; https://www.thebalance.com/medical-bankruptcy-statistics-4154729#) is medical issues, having health insurance is a must. In addition, since the launch of the Affordable Care Act (“Obamacare”) program, health insurance is a legal requirement although the penalty for not having insurance has been gutted. Some states do also require health insurance and have a meaningful penalty if you do not have it. Regardless of the legal requirements for having insurance and the extensiveness of penalties for not meeting this requirement, having health insurance is in my view a must. Something as simple as breaking a bone when playing a sport can lead to huge monetary costs which insurance will help you manage.

Auto insurance

This insurance is “a contract between you and the insurance company that protects you against financial loss in the event of an accident or theft. In exchange for your paying a premium, the insurance company agrees to pay your losses as outlined in your policy. Auto insurance provides coverage for:

• Property – such as damage to or theft of your car
• Liability – your legal responsibility to others for bodily injury or property damage
• Medical – the cost of treating injuries, rehabilitation and sometimes lost wages and funeral expenses”

Most states in the US require auto insurance with a typical minimum requirement of property and liability coverage. Each state is different so make sure that you get the details of what is required in your location and ensure that you have at least the minimum legal requirement. The penalty for driving without insurance can be significant so going without this insurance if you drive is not a risk worth taking.

This completes today’s summary of the purpose of insurance and a description of legally-required insurances. The practical steps you can start taking from today’s post are:

1. Audit the insurances that you have either every year or when you have a change in life circumstance such as getting married or having a child
2. Ensure that you have all legally-required insurances to at least the minimum required levels where you live
3. For discretionary insurances (which will be covered in the next post), determine who you currently have a financial responsibility to as mentioned in the opening quote: family (spouse, children, parents) as well other entities such as the bank if you have a mortgage or locally-required business insurance if you have your own business
4. Map your insurance to each person or entity to whom you are responsible. If there is one which doesn’t have an insurance that ties to them, identify which insurance you need to add

Thank you again for joining me on my journey to build financial literacy for young adults and their families. If you have found this post interesting and have friends and family who would benefit from it, please share the post with them. If you are interested in reading more of my posts, please consider becoming a subscriber by clicking the button on the right. You can always access all the posts I have published on my author page at https://vocal.media/authors/sudhir-sahay. If you have any questions on today’s topic or if there are any topics you’re interested in my broaching in future posts, please let me know. I can be reached at [email protected].

* Jeremiah Say as quoted in https://graciousquotes.com/insurance-quotes/

** Insurance 101; Insurance Information Institute, https://www.iii.org/article/insurance-101

*** Health Insurance Guide, Investopedia, https://www.investopedia.com/terms/h/healthinsurance.asp

**** What is Auto Insurance; Insurance Information Institute, https://www.iii