Many people view certain types of insurance as a necessity. Health care is a good example of insurance that many people would be loath to go without. Over 90 percent of the U.S. population is covered by health insurance, according to the United States Census. Meanwhile, other insurances — such as extended warranties — are not so universally seen as necessary. There are a few reasons for these lines of thinking.
What Is Insurance?
Insurance as a concept is straightforward. Instead of retaining all the risk of a catastrophic event, I transfer that risk to a pool in exchange for a premium. The pool has the risk of each catastrophe, funded by the premiums for the group. Basically, I'm accepting a small, known cost (my premium) to avoid a higher potential cost for a less likely risk of catastrophe.
What Insurance Do I Need?
Insurance is most appropriate in a scenario where two conditions are met. First, the likelihood of the occurrence should be fairly small — i.e. it is far more likely that the negative event won’t occur than it is that it will.
And second, the cost of the occurrence should be relatively high. In other words, paying for the cost of the negative occurrence individually would be a hardship for most people. Fire insurance on a home is a good example of this type of risk. It’s fairly unlikely to occur, but the cost without insurance would be a problem for most people.
Conversely, it makes no sense to insure things with low value and a high probability of loss, such as a pen running out of ink. This occurs fairly frequently, and the cost of a remedy is quite small. It would cost more for an insurance company to administer a pen-out-of-ink policy than it would just to replace the pen, so insurance would be of no help.
If we humans were all rational beings, we would insure our major risks (such as the loss of a home or car) and keep our minor risks. But alas, we are not rational beings. Some people prefer the guaranteed savings of a small amount by not paying a premium and are willing to accept the risk of a large loss — even one that they clearly can’t afford!
With a few minor exceptions, there are five types of insurance policies you shouldn’t go without.
These policies are life, health, disability, home or renter’s, and auto. Here are the primary reasons you should have them, along with the minor exceptions mentioned above.
1. Life Insurance
The amount and type of life insurance you should have can vary widely based on your circumstances. The purpose of life insurance is mainly twofold. One is to provide resources for your dependents or others when you are no longer here to provide for them. The other is to pay for your funeral and final expenses.
If you have dependents or others who rely upon you for support, you should consider what would happen to them if you were to pass suddenly.
Consider not only living expenses, but also education and other needs or wants that you may wish to fund. Single, childless people often don’t need life insurance for this purpose, no matter what an agent may tell you.
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The other primary purpose of life insurance is to pay for funeral and final expenses. Final expenses are your unpaid bills or other obligations that you leave behind.
For example, you may wish to leave your car to someone you know could use it, but the bank will want it paid off first. Even single people with some assets may wish to carry a small amount of insurance in order to allow for their assets to be transferred to their beneficiaries without debt.
They may also wish to use the insurance proceeds to fund their funeral. It can be a very difficult time for your loved ones, and not having to figure out where those funeral funds are coming from can help relieve a good deal of stress.
2. Health Insurance
Most people already see health insurance as a necessity. We don’t just need it so that we can get a prescription if we get a cold. Insurance would actually work more efficiently — saving all of us money — if it didn’t cover such things.
Rather, health insurance is necessary for big things like getting injured in an accident or having a major health emergency such as a heart attack or a serious disease. Hospital and doctor bills can easily run into tens or hundreds of thousands of dollars. Health insurance is clearly a necessity to cover such events.
3. Disability Insurance
This is one of the most essential — and most overlooked — types of insurance.
A working person’s ability to earn an income is his or her greatest asset.
And workers are more likely to become disabled for at least a year before they turn 65 than they are likely to die before that age.
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Let that sink in. And on top of possibly being out of work, your cost of living goes up when you’re disabled. You may need a wheelchair, ramps, additional childcare… There are all kinds of new expenses.
Even people with sufficient life insurance often don’t have sufficient disability insurance. That said, there is one time when you generally don’t need it: When you’re retired. You have no work income to protect, so you don’t need to spend money on this type of insurance. (But you may need long-term-care insurance!)
4. Home or Renter’s Insurance
The good news is that the clear majority of homeowners in the U.S. carry home insurance. The bad news is that far too many renters don’t. Some people are required by their mortgage lender to have homeowner’s insurance, but even without that, most people seem to recognize the importance of protecting this valuable asset.
Renters, on the other hand, tend to overlook the importance of insurance for their apartments. The value of even modest possessions adds up quickly. Renter’s insurance is quite inexpensive. Consider the cost of losing your possessions compared to the minor cost of this protection.
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5. Auto Insurance
Car insurance is another one that people tend to get without much prodding. They see the importance of protecting an asset that is costly to purchase and that they couldn’t very well afford to go without.
That said, it’s important to review your coverage carefully. If you drive a vehicle that is no longer worth much, it may cost nearly its own value each year for collision coverage.
The Bottom Line on the Types of Insurance You Need
With any kind of insurance, make sure that your deductibles are in-line with your ability to pay them. It seems nice to save money with a high deductible, but that choice will cause you some serious pain if you have an accident, but no savings to pay the deductible.
We insure the things we insure because it makes financial sense to do so. It can also give us peace of mind to know our losses are limited in the event of a catastrophe.
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