What Is Insurance?

What is insurance anyways? Basically it’s a way to use the power of a large group of people to prevent unlikely large expenses from bankrupting you. For example:

• 10,000 people all own a car that costs $30000 to replace. They buy a new car once every 10 years and budget for that expense by saving $3000 a year.
• Every year 5 people will crash their car and total it – meaning they need a new car
• For each of those 5 people $30,000 is a lot of money that they won’t be able to come up with. If this happened they would have no car, and no way to get to work, or school.
• So, all 10,000 people put $20 a year into an “insurance fund”. 
  • Every year this fund has $200,000 in it.
  • Every year those 5 people take $30000 each out of the fund to buy their new car.
  • This leaves $50,000 in the fund every year to pay for expenses like managing the money, making sure people really crashed their cars, etc. And to pay for an extra car occasionally when 6 people need a new car.
• So, now each person can eliminate the 1 in 2000 risk of needing a new car by spending $20 a year on insurance.

One thing to keep in mind with all insurance, is that there is often a lot of “small print”. These are caveats in your insurance that typically lower the cost of payouts from your insurer. For example, if you total your 2014 Audi A3 that you bought new for $30k, your car insurance will not buy you a new 2020 Audi A3 that now costs $35k. They will buy you (or pay you to buy) a used 2014 Audi A3 in similar condition to your own car, for more like $8k!

Types of Insurance

There are many different types of insurance. In this discussion we will not include Health or Disability insurance, which you do need, but which you may get from your parents or from your workplace. Other than those two, you really only need to worry about a few types of insurance, namely:

Renters or Home Insurance

1. If you rent, the owner of the house or apartment will only have insurance for the structure. They will not have insurance that covers your belongings.
2. If you rent your home, say at college, then you should have Renters insurance. This covers the cost to replace all your belongings in case of theft or fire or damage – like the apartment above you flooding and damaging all your gear.
3. You should also have liability coverage with that renters insurance. That means that if you are the one to leave the bathtub running, that you have insurance to fix the apartment and replace all the belongings of the person living below you!
4. One of the easiest things to do is to take a picture of everything as you unpack it in your new place. Ideally take a picture of the whole thing as well as a close up of the make and model. Then when there is a fire or other damage you have a record of everything you owned. (make sure these pictures are on a cloud storage device or the picture are stored with a parent, do not keep them at your own residence. 
   • This insurance will cost $10-$15 a month for standard coverage.
   • Read: https://www.themuse.com/advice/do-you-really-need-renters-insurance

Car Insurance

Car (or auto) insurance is mandatory in most states and covers costs for three main items:

• Liability
  • Bodily injury covers costs associated with injuries or death caused by you in an accident. 
• Medical
  • Covers the cost of any medical bills for other people injured in a crash caused by you
• Property
  • Typically covers damage to other peoples cars or property that you cause then driving. For example, in a car crash you may end up hitting someone’s house, and have to pay to repair that.

There are other options that are not usually mandatory but that you should have:

• Collision
  • Covers you for the cost of damage to your car in a car crash where you are at fault
• Comprehensive
  • Covers you for theft of your vehicle and damage caused by floods, etc.

Car insurance can be very expensive, especially for young drivers. Research ways to lower your insurance with your insurance provider. Typical suggestions include:

• Ask for higher deductibles.This is the amount you pay out of pocket for an accident before the insurance company starts paying.
• Buy and drive an older car that costs less to replace
• Buy and drive a car that has a smaller engine and therefore has less risk of getting in an accident
• Get your auto insurance from your parents – adding policies to an existing insurance policy is usually less costly than creating a new one.
• Maintain a high credit score
• Keep good grades
• Take a defensive driving course

Life Insurance

Life insurance pays out a lump sum of cash on your death. The cost of life insurance is based primarily on the following:

• Your age; younger =cheaper
• Your health; lower BMI, non-smoker, non-drinker, blood pressure, etc. means lower fees.
• How much of a lump sum payment you need; a higher payout means higher monthly fees 

There are really only three reasons you need life insurance. For 99% of you none of these will apply.

• If you have a spouse or partner that does not or cannot work
  • This lump sum will pay for all their costs, potentially for life, such as mortgage, car, food, clothing etc. Or it will give them enough time to find a job and lower their costs (move to smaller house, buy a cheaper more efficient car, etc)
• If you have a kid or kids or someone else that is dependent on your income
  • The lump sum will pay for their education and living expenses till they are 18 or graduate college.
• If you have a lot of investments already (401K, IRA, stocks and bonds, 529, etc) and want to use life insurance as an investment vehicle
  • Many life insurance vehicles have tax advantages that make sense if you have already invested adequately in all other investment vehicles.