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Insurance: Buy Only What is Necessary

Insurance is the most widely used method that people use to protect themselves against potential financial losses. According to Webster's Dictionary, insurance is defined as "To guarantee against risk of loss or harm in consideration of a payment proportioned to the risk involved." An important principle behind the purchase of insurance is the "large-loss principle." This means that the size (amount) of a potential loss--rather than its frequency--is the determining factor in purchasing insurance.

In other words, you want to spend the bulk of your insurance premium dollars to protect against risks that can wipe out your assets and/or claim future income for years to come (e.g., a court judgment). Small expenses, such as a dented fender or broken eyeglasses, should be covered through insurance deductibles or emergency fund savings.

Major "large-loss" risks that can greatly affect a family's finances include:

• Loss of income due to disability (illness or accident)
• Loss of a household earner's income
• Destruction of one's home due to fire, flooding, etc.
• Liability losses resulting from a court judgment
• Large hospital and doctor expenses (e.g., expenses for cancer treatment)

On the other hand, certain types of insurance are clearly unnecessary. This includes insurance that duplicates coverage you already have, insurance that covers small losses, and very narrowly defined coverage (e.g., cancer insurance). Below is a list of commonly sold, but unnecessary, types of insurance:

• Term Life Insurance For Children--The purpose of insurance is to protect dependents against the loss of a household earner's income. Children are generally dependents and have a low probability of dying. Therefore, insuring them is totally unnecessary. Some people argue that policy proceeds could be used for a child's funeral or family grief counseling. However, it is likely that college funds, no longer needed, could be tapped, if necessary. As for the argument that children could get sick and be turned down for coverage later as an adult, they could probably still get insurance through an employer group plan.
• Cancer Insurance--Cancer makes headlines but heart disease is actually America's most frequent killer. The bottom line is that no one knows what diseases they may or may not contract. Therefore, comprehensive major medical coverage is needed rather than "dread disease policies" that provide protection only against a specific illness.
• "Double Indemnity" Insurance Riders--This policy feature doubles the face amount of a life insurance policy if a person dies from accidental causes. In reality, most people do not die in accidents. If additional life insurance is needed, it should be purchased as part of a basic policy that provides coverage regardless of the cause of death.
• Hospital Indemnity Policies--These policies provide a specific benefit for each day spent in a hospital. Generally, they pay much less than the amount that a patient is actually charged. Again, a much better alternative is a comprehensive major medical health insurance policy that covers expenses incurred in both a hospital and as an outpatient.
• Flight Insurance--This is life insurance sold in vending machines at airports. Like double indemnity, it is an unwise choice because it shouldn't matter if you die in a plane crash or by natural causes. Instead, life insurance should be purchased based on the needs of a spouse and/or children. In addition, some credit cards (e.g., "gold" bankcards) provide $100,000 of flight insurance coverage for free if you charge your plane ticket.