We go to work to earn money to protect ourselves from the loss of food, clothing, and shelter.  When we put money in a savings account for emergencies, we are indemnifying ourselves against an unforeseen future loss.  If our refrigerator, heat pump, or dishwasher breaks down for example, we already expect that we will have to pay to repair or replace that loss (unless you have a homeowner’s warranty).  If we do not have money saved for these losses, we might borrow the money we need such as with a credit card.  Hopefully, we save money for retirement to indemnify us against the loss of the ability to earn money.

It is when we are dealing with losses in regard to our homes, cars, health, and life that we look beyond ourselves.  These are losses that would be financially devastating or even impossible to indemnify on our own.  So we purchase insurance from a company that has the wherewithal to indemnify what we cannot.

In regard to insurance, the foundational principle that will save one thousands throughout their life is that devastating loss is the only kind of loss for which insurance should be purchased.  Remember this: insurance is for catastrophes.  This applies to all insurance.  This sounds very simple, but hardly anyone practices it.  When one forgets this principle, they end up paying for maintenance, not insurance.  Insurance companies make a lot of money selling what is essentially a maintenance policy.  If you remember nothing else remember this: insurance is for catastrophes.

There is a human tendency to want to roll off onto someone else or some other entity a responsibility that is solely ours.  This other entity, whether it is the government or a giant corporation, is only too happy to relieve you of your personal responsibility.  When you give them this responsibility, you become dependent on them.

Therefore, based on the principle that insurance is for catastrophic loss, there are four truths to note:

1)      You must distinguish between a loss that is a catastrophe and a loss that is, though painful, merely a financial setback.

2)      You are responsible to insure yourself against financial setbacks and not give that responsibility to anyone else.

3)      No one, no company or human entity, can prevent a catastrophe from happening.

4)      You are responsible to alleviate as much as possible, through means other than yourself (such as insurance), the loss from a catastrophe.

Here’s a shock, I agree.  I agree that one should have the minimal amount of coverage from the insurance company that one needs in order to get by.  However, it is the kind of coverage one purchases for their car that makes a world of difference.

Car insurance is intended to indemnify you from a loss that occurs as a result of something for which you are at fault (we’ll discuss comprehensive and uninsured motorists coverage later).  Think about it.  If your car is damaged as a result of someone else’s negligence, their insurance company will pay for the damage.  Car insurance is all about protecting yourself from your own mistakes.

A car insurance policy is essentially two different kinds of insurance.  The first kind is the insurance that indemnifies you against the loss from damage to your vehicle.  This vehicle damage insurance is divided into two kinds of coverage: Collision and Comprehensive (also called Other than Collision).

Collision insurance is coverage for damage to your vehicle that results from you accidentally colliding with another object such as another car or a light pole in a parking lot.  It is designed to cover the expenses to repair the damage that you caused to your car.  Comprehensive insurance, also called Other Than Collision (because it is not “comprehensive”) is coverage for damage to your vehicle that is from something that is no one’s fault, such as damage that results from hail, a fallen tree branch, or an animal running into your car.

The other kind of insurance on an auto policy is Liability insurance.  This kind of insurance is designed to pay for the expenses that result from physical injuries that occur to any people who are injured because of your driving mistake.  Under the Liability portion of the policy there is also provision for coverage of expenses incurred due to damage you caused to someone else’s property.

Remembering the principle that insurance is for catastrophes, we must now distinguish between these two kinds of car insurance.  Which one is designed to cover a loss that is a painful financial setback, and which kind covers a loss that is a catastrophe?

Looking at the first kind of car insurance, the kind that indemnifies you against the loss from damage to your vehicle, what is the most you would stand to lose if you did not have this insurance?  In a worst case scenario, if you totally damaged your car so that it was beyond repair, you would lose the actual cash value of that vehicle.  Now if it is a brand new Mercedes Benz, and if you are in debt up to your eyeballs, this loss could be financially devastating.  You would have the loss of the money you still owe on the vehicle, plus the loss of replacing it.  But if it was an older vehicle worth only several thousand dollars, the loss would be painful, but not devastating.  Thankfully, this kind of car insurance (Collision insurance) comes with an option that allows you to take some of the burden of insuring your vehicle upon yourself, thus reducing your premiums.

We’ll talk about this special feature in the next article.

But “I can’t afford to pay $1,000 to have my car repaired!” you might say, “That is the reason I have insurance”.  It is the wrong reason.  You will in fact pay the insurance company much more than $1,000 over time to protect you from what is a financial setback, not a catastrophe.

If you were to take the difference in premium you would save from raising your deductible and invest that money in insuring yourself, it wouldn’t be long before you would have $1,000 set aside.   With a $1,000 deductible, the most you would stand to lose in a total loss is $1,000.  This is a painful financial setback, yes, but not financially devastating.

Save $2,500 to insure your vehicle, and a $2,500 deductible reduces your premiums even more dramatically.  Keep saving until you have enough to match the actual cash value of your vehicle and you can drop your Collision Coverage altogether.  You have insured yourself.  By the way, it is never wise to owe the bank more than what your car is worth.  Insurance companies only pay for the value of a car, not the size of the loan.

Now let’s look at the other kind of car insurance, Liability Coverage.  This is the kind that is designed to pay for the expenses that result from physical injuries that occur to any people who are injured because of your driving mistake.

If you are in an accident that is your fault and someone is injured as a result, what kind of expenses might we be talking about?  It depends on the extent of the injury and the number of people who are injured.  With medical expenses as they are today, how much would it take to pay for the care of someone who was paralyzed in an auto accident?  What would the surgical expenses be?  Hospitalization?  Rehabilitation?  How much would it take to pay for the injured person’s loss of work?  We’re not talking about thousands anymore.  We’re talking about potentially hundreds of thousands.  A loss such as this would indeed be a catastrophe.

Unfortunately, Liability Coverage is where people often choose to limit their coverage to their particular state’s minimum requirements.  State limits are often presented like this: $25,000 per person, $50,000 per incident, and $10,000 in property damage.  That means that in an accident, the most your insurance company would pay would be $25,000 for each person you injured not to exceed a total cost of $50,000.  Also, you would be protected for up to $10,000 in damage to the other person’s vehicle.  How many days in the hospital would $25,000 cover?  Not many.  So who pays for the additional hundreds of thousands in medical costs?  You do.

What many don’t realize is that the most expensive part of their car insurance policy is their Collision Coverage—the part that protects you the least.  Liability Protection is inexpensive, yet provides the most coverage against catastrophic loss.  You can increase your coverage to $100,000 per person, $300,000 per incident, and $100,000 for property damage for only a few dollars more per month.

So, to save money right away while increasing your coverage where it really matters, raise your deductible on your Collision Coverage to $1,000 or $2,500.  If you don’t yet feel comfortable going that high, do whatever it takes to save $1,000, and when you get there, raise your deductible.  I know, I know, easier said than done.  But would you rather pay yourself, or forever be paying the insurance company?  $1,000 is an achievable goal and it puts you in control of your coverage.  If your car is older and paid up, drop the Collision coverage altogether and raise your Liability limits as high as possible.

Congratulations, you have now discovered the cheapest and best car insurance on earth.

Some of the factors that go into determining rates are a person’s age, sex, geographical location, occupation, driving habits, lifestyle, driving record, and claims history.  A new feature was added in the early 90’s—credit history.  This factor is very controversial and it is the one that I have heard the most complaints about.

An insurance company is a business whose primary goal is to make a profit.  They are in the business of gambling.  They are gambling that the person they promise to indemnify will not ultimately need their money.  So their goal is to look to indemnify people who are least likely to have a claim.  If they are too restrictive about whom they insure they will not have enough customers to pay enough premiums.  They will not be competitive.  Likewise, if they are too lax about whom they insure, too many claims will be filed and the insurance company will run out of money.

So they gather an enormous amount of statistical data to try to spot trends that will help predict the likelihood that certain kinds of people will file a claim.  In the past, underwriters would just make a judgment call on how prone an individual might be to having an accident.  Obviously, someone who gets a lot of traffic tickets, or who has a history of accidents has demonstrated that they are not a safe bet.  The company will likely lose money on this individual.  But underwriters are only human and could not possibly be as accurate as the company would like.

Imagine, however, if you happened upon an unrelated statistic that paralleled a reality manifested elsewhere.  What if you discovered, for example, that people who ate orange sherbet had a ninety percent chance of buying Nike cross-training shoes.  You would have some very valuable information that would be useful to both Nike and orange sherbet makers.

In the early nineties, a credit reporting agency discovered that people with bad credit also demonstrated a very high likelihood of filing an insurance claim.  This discovery was met with initial skepticism.  In fact, the head statistician at one of the leading property and casualty insurance companies relayed to me how he set out to disprove the connection between credit and claims.  Instead he became so absolutely convinced of its reality that the company changed its entire underwriting guidelines.

So accurate was the comparison, he said, that the company could with certainty determine that a person with bad credit and no accident history was more likely to file a claim than a person who had several accidents and excellent credit.  Companies have since developed their own algorithms based on various credit characteristics.  For instance, it is may not necessarily be a person’s credit score that predicts future claims, but the number of “consumer generated inquiries”.

In science fiction books and movies, there are stories of future behavior being predicted based upon statistics such as a person’s DNA.  As technology advances, we have entered an age of ethical dilemmas as to how far we should go in predicting someone’s future actions.  Credit and claims prediction is still very controversial and is not legal in some states.  However, knowing what you can about how your rates are determined can help you change the circumstances that will help to lower your insurance premiums.

1)      You must distinguish between a loss that is a catastrophe and a loss that is, though painful, merely a financial setback.

Collision Insurance is for a financial setback, not a catastrophe.  If you are in a position in which you need Collision Insurance, start working to get out of that position.  Never owe more for a vehicle than the cost to replace it.

2)      You are responsible to insure yourself against financial setbacks and not give that responsibility to anyone else.

Become the (insert your name here) Insurance Company.  Start saving in small increments by establishing insurance accounts that are there for unexpected financial setbacks.  Stop paying an insurance company to protect you against the loss of something that would not be devastating.

3)      No one, no company or human entity, can prevent a catastrophe from happening.

Prepare yourself for the day when a catastrophe will arrive.  Even if that catastrophe is simply your own death.

4)      You are responsible to alleviate as much as possible, through means other than yourself (such as insurance), the loss from a catastrophe.

Own enough of the right kind of insurance for the right situation.  In regard to car insurance, have lots of Liability Protection and little or no Collision Coverage.  That means either drop Collision altogether or raise your deductible as high as you can tolerate.  You will immediately reduce your premium by doing so.

Other helpful tips:

• Shop for new car and home insurance every three years.  I know that most agents would disagree with this.  They will point out some earned benefit that you would lose such as deductible savings or coverage that is guaranteed not to be dropped.  Or that no other company offers their unique personal service.  None of this is worth a $300 to $500 reduction in annual premium.  Shop anyway.  Companies are always changing leadership and premium formulas.  Someone that was high three years ago might be low now.

• Get out of debt.  Get out of debt.  Get out of debt.

• Do not fill out a credit application for six months prior to shopping for car insurance.  Do not initiate any action that would lead to your credit being checked.

• Have the insurance company representative generate a rate for both you and your spouse.  Sometimes a spouse’s rate is significantly lower.  An onsite agent will most likely do this.  If you are calling a representative sitting in a cubicle in Rhode Island or Connecticut, or getting quotes online, they may not do this without your asking.

• Ask the agent about all the savings features they may offer such as anti-lock brakes, security systems, good grades for students, driving courses, etc…

• Along with adequate Liability Protection, make sure you have adequate Uninsured/Underinsured Motorists Coverage (limits usually match your own Liability limits).  Especially in troubling economic times, many drivers will not have adequate coverage or no coverage at all.  If you are injured by an uninsured driver or by someone who does not have enough coverage (like state minimum limits), this coverage will pay the difference for the damage done to you.  Uninsured/Underinsured Motorists Coverage is also very inexpensive.

• Check out the price of umbrella policies.  Umbrellas add an enormous amount of Liability protection for very little money.