No one really enjoys spending money on insurance, and most people don’t really like talking or thinking about it. It’s one of those things we pay for and hope we never need to use.
The purpose of insurance is risk management. When you buy insurance, you transfer the risk from your own bank account to the insurance company. Think of your insurance policies as a means to cover those large, unexpected expenses that have the potential to ruin your financial future.
Here are some basic terms and definitions you should know.
Premium
This is the money you pay the insurance company for the policy. Premiums are typically paid monthly, quarterly, or annually. It’s often worth considering paying the premium once a year if that results in a substantial discount for you. I’ve seen discounts as high as 20% if you pay the whole year’s premium upfront instead of making monthly payments.
Deductible
The deductible is the amount you must pay before your insurance company pays its portion. For example, suppose your auto insurance policy has a $1,000 deductible. If you have a wreck that results in $5,000 worth of damage to your car, you will pay $1,000 toward the repair and the insurance pays the remaining $4,000.
You can usually save money on your premium by going with a higher deductible. This is one of the ways a fully-funded emergency fund can pay big dividends for you,
Copay/Copayment
When dealing with health insurance, your copay is an amount you need to pay each time you use a specific type of service, such as an office visit. Copayments don’t normally count toward your deductible.
Liability
This type of insurance covers other people’s expenses when you are at fault for an incident that caused either their injury or damage to their property.
Declarations
This is your proof of insurance. It contains information such as effective dates of the policy, premium, deductible, copay, liability limits, amount of coverage, etc.
Claim
A claim is your request for payment or reimbursem*nt from your insurance company. For example, if you’re involved in a car wreck you’d contact your auto insurance company to file a claim. You’d provide info about yourself, the wreck, and the contact info for anyone else involved. Your insurance company then processes the info you provided and follows up with you on the next steps to provide payment or reimbursem*nt for your damages.
Now that you know these terms, that will help you better understand these basic types of insurance.
If you have a car you need auto insurance to protect you, your property, and others. In many areas, it’s required by law. Premiums vary based on your deductible, your age, the type and age of your car, driving history, where you live, and the type of insurance you buy.
The three most basic types of auto insurance you need to know about are liability, comprehensive, and collision coverage.
Liability
This covers other people’s expenses when an incident is your fault. I normally recommend a minimum of $500,000 in liability coverage for property damage and bodily injury. This protects you from bankruptcy in case of a major event.
This looks a little confusing when you see it on your insurance coverage limits as "$250,000/$500,000/$250,000" or "250/500/250." When you see this, it means:
$250,000 of coverage for bodily injury (per person)
$500,000 of coverage for bodily injury (per accident)
$250,000 of coverage for property damage (per accident)
Comprehensive
This coverage serves to repair or replace your car if it is stolen or damaged by a fire, storm, falling tree branches, or other natural disasters. It’s normally optional coverage.
Collision
This covers your vehicle if you’re in a wreck with another vehicle, object, or even yourself, regardless of who is at fault. Remember the other driver’s liability insurance only covers your expenses if the other driver is at fault. And that’s only if they have enough liability insurance to cover you.
Most homeowner’s insurance policies include several types of coverage that are designed to protect you financially when disaster strikes. Here are the most common coverages:
Dwelling
Most homeowner’s policies include dwelling coverage, which covers the cost to repair or rebuild due to damage caused by events like fire, wind, hail, lightning, theft, and vandalism.
Other Structures
If you have a detached garage, tool shed, or other similar structure on your property, your home insurance probably covers any damage done to them. Most policies will cover around 10% of the amount of insurance you have on the structure of your house.
Personal Property
Personal property coverage within your home insurance policy typically protects the possessions inside your home like clothes, furniture, and electronics. Jewelry, art, and antiques are included as well, but there’s usually a dollar limit attached to higher-end items.
Personal Liability
Personal liability insurance covers you against any lawsuits for bodily injury or property damage in your home. This coverage pays for legal representation if you’re sued, and could also cover damages that you’re found responsible for paying.
Additional Living Expense
This coverage helps you cover the costs of living away from home if you can’t live there due to damage from an insured disaster. Covered expenses usually include hotel bills, restaurant meals, pet care and moving expenses. It’s designed to help you pay for costs you incur (beyond your normal living expenses) while your home is being rebuilt.
If you’re renting a place to live that you don’t own, like an apartment, be sure you have renter’s insurance. Your landlord’s insurance does not cover your belongings. Their insurance only pays to rebuild what belongs to them, the building. Your property is your responsibility. Renter’s insurance usually comes in three types of coverage:
Personal Property
This covers the cost to repair or replace items like electronics, clothing, furniture, etc.
Liability
This covers repairs if you accidentally damage another person’s property or their medical bills if you’re at fault for their injuries.
Additional Living Expenses
This covers living expenses if you’re at fault for damage that makes the space you rent uninhabitable.
Everyone needs health insurance. Even when you think you’re healthy and fit, medical emergencies can happen when you least expect them and send your finances down the tubes. For example, HealthCare.gov says the average cost of a three-day hospital stay is around $30,000.
Once you have a well-established emergency fund, you can raise your deductibles on health insurance to reduce your expenses on premiums. Health Savings Accounts are also an attractive way to save for health care costs since you can save this money tax-free.
The purpose of life insurance is to replace your income if and when you die. If you have a family that depends on you for income, they will lose that income once you die. Even if you’re single, you’ll need a basic amount to cover your burial expenses and any remaining debts so that burden doesn’t land on your family.
I almost always recommend term life insurance. It is usually the most cost-effective way to provide for this very important coverage.
Beware of whole life or cash value insurance. This product tries to merge savings and insurance, and it’s super-expensive compared to term life insurance. You will do much better to separate your insurance and savings decisions.
Retailers love to sell insurance on phones, tablets, computers, etc. When you have your emergency fund in place, you can cover the cost of replacing or repairing these sorts of items yourself. No need for expensive extended warranties.
This is obviously very basic information, but I hope it’s helpful and encouraging to you to get the right insurance coverage in place for your health, home, auto, and life.
Thinking through all the financial decisions that need to be made can be overwhelming. If you could use some help learning to live within your means, building up your emergency fund, and getting the right insurance coverage in place, book a free consultation. I don’t sell insurance or any other financial products, but we will work together to build out your plan and then work the plan together. It’ll make a difference!
