I’m a big fan of my clients having better than average knowledge of their insurance situations. Not experts but having a handle on things is very beneficial to them. Very few come to me this way. But I do make an effort to help them understand what they are buying by getting an idea of where their risks are. In the spirit of providing that to anyone who might find this, I’m starting a blog. This article begins with some very basic info about insurance. We’ll get a little more detailed in future articles.
The fact is that life has certain risks that can cause both physical and financial loss. Some we learn to live with. For others, the stakes may be too high to handle it ourselves. It’s these high stakes risks that we would rather not carry ourselves. The potential loss could be financially devastating, so society figured out a way to transfer those risks away from an individual onto a larger group of people who were willing to accept a portion of each other’s risks. Insurance was born.
These risks all have some form of financial component to them for which you do not want to carry yourself. This could be damage to something you own that is costly to repair or replace, or it could be damage to something or someone else for which you are responsible to make whole. Either way, there’s potential financial loss to you and/or someone else.
When you own some kind of valuable property and want to transfer the potential risk of repair or replacement, you purchase insurance on that property. The most common examples of this are home and car insurance, but also can include things like jewelry, tools, machinery, collectibles, or even body parts that are a source of income. There are a variety of ways to cover these things, but there are specific types of policies which provide the most comprehensive coverage for each class of property.
Now, if you own these types of property outright, insuring them is completely up to you. For example, if you own a $20,000 car with no loan against it, and you are fully capable of replacing that car if it was lost, stolen or damaged, and you are comfortable with that potential, then you may see the cost of comprehensive and collision coverage on your auto policy to be a waste of money. However, even if you own your home free and clear, and could cover the cost of rebuilding and refurnishing your home, the cost of an insurance policy may be a small consideration compared to the potential financial risk. Therefore, the insurance policy makes sense.
It’s a financial trade-off. Can I cover the risk and do I want to cover the risk vs the cost of the insurance. Maybe. Maybe not. That’s up to you.
Many of us choose to purchase these things with a loan. When we do this, insurance is probably going to be mandatory. The bank providing the money is almost certainly going to require that we also purchase the insurance to cover damage or loss of the property purchased. And in nearly all of these cases, it’s less costly to you to buy it yourself versus allowing the bank to purchase it for you.
Now, when we purchase these policies, there’s a component to them that requires that you cover the small losses or a first portion of the loss. This is called a deductible. It does a few things. First, it keeps the owner in a position to want to be responsible with the property being covered. If there was no financial responsibility, there’s a decent portion of the population that would ignore common responsibility and treat the property without regard to its value. The deductible also keeps the insurance company from being involved in every little ding or bump. Although the cost of repair would be small, the labor cost associated with a claim adjuster evaluating every small loss would become cost prohibitive. Either of these situations would drive up the cost of insurance making it cost prohibitive to many people.
Now, when we cause damage to something or someone else, we are typically held liable for the financial cost of making them whole. In other words, you break it, you buy it.
When I was a kid, about 7 years old or so, my family took a trip to San Antonio. We were in a shop of some sort, I don’t really remember exactly what it was, but there was this little wooden toy that I thought was really cool, so I began playing with it. I was not the most gentle of 7 year-old boys. I remember my mom using the phrase “like a bull in a china closet.” Anyway, I was having fun and broke it. I remember my dad paying the shop owner a few dollars for it. Small risks such as this are inconvenient, but something we’re willing to live with, so we don’t buy insurance for them. However, other situations drive up the stakes of potential financial loss. So we buy liability insurance to cover those situations.
Liability insurance comes in many forms. The most common is auto liability insurance, then there’s the liability portion of your home insurance, umbrella insurance, commercial general liability insurance, commercial auto liability insurance, commercial umbrella insurance, professional liability insurance, etc, etc, etc.
The basic premise is that there are situations where we could potentially be on the hook for a large amount of money to make someone whole if we cause damage to their property or injury to them. Even when we take great care to do things right and act responsibly, accidents happen and some situations would cost much more than a little wooden toy.
When we purchase these policies, they generally have a clause in them that states the insurance company has both the right and responsibility to defend you. And most (not all) of them do this without considering the amount of coverage you have or charging you for the cost of the defense. For example, you have a $1,000,000 liability policy and are being sued for that amount. The insurance company will defend you, without charging you or your policy for the cost of that defense. Therefore, if the case ends in a judgement against you for the full $1,000,000, your policy pays the judgement and the company pays the lawyers who defended you. That could be a substantial amount more than the judgement.