What is insurance?
Insurance plain and simple is a CYA product (Do not know what this stands for google "what is cya"). Insurance is the answer to Murphy's law, "if anything can go wrong it will." Or, O'Brians law, "Murphy was an optimist."
You want and need protection when really bad stuff happens like your home burns down, someone drive their car into your, you get diagnosed with cancer. ...You get the picture
A quick primer on how insurance works (in laymans terms)
Do I really need to know this information?
Yes!!! It is important that you have a laymans perspective of insurance. I promise to be short, entertaining, and keep the subject at 50,000 feet.
A bunch of rich folks get together and create a business. There business model is for you to pay them a small sum of money in exchange for protection should something very bad happen to you or your stuff. For example, if you own a home you pay homeowners insurance. If you have a mortgage the bank will insist that you have homeowners insurance. Why? Because you owe them money on the house and if the house burns down or falls over, or gets blown away by a tornado they want to get their money.
We will keep working with the home example. As I said a bunch of rich folks with a lot of money got together and figured out how they could continue to make even more money and do so while also doing you "a solid." In other words, you just bought a home for $100,000. One of their representatives comes to your home and says, "hey, if you pay us $1500 a year we will cover the cost of your home should this list of bad things happens to it." This payment is called a premium
Now rich people do not like to lose money. If you think about it insurance is really nothing more than a bet. And it is important that the insurer does not lose his money. So lets expand upon our example a bit. Pretend we are living in a mythical country, we will call it America. For the sake of argument lets further assume, to make things simple that every house costs $100,000. Let's also assume that there are 1 million houses in America, and that last year 100 burned to the ground. At the cost of each house that adds up to $10,000,000.
How does an Insurance Company Price the Cost of Insurance?
Well now, that depends. We know that 100 houses burned down last year. We know the cost of each house is $100,000. We also know that there are 1 million homes. If we can get all one million to buy insurance based on all the statistical data we have we would have to charge $10 per year to break even. Of course we would like to make some profit. Suppose we want to make a 20% profit. To do so we would sell our policies for $12 a year. Acturial science is a big word that insurance companies use. Actuarial science is nothing more than applying trends and statistics to a situation in order to determine the appropriate price for selling you insurance and still being able to make a profit. The more data and statistics one has the easier it is to cover the best while minimizing ones risk and exposure.
If being an Actuary was that simple
Life would be simple if this was our scenario. But, what happens if next year the number of houses that burn down doubles? What happens if a hurricane blows through town and wipes out the town. What happens if the river floods. What happens if a serial arsonist goes on a rampage. What happens if we can only find 100,000 people that want to buy our insurance, and these people live in areas that account for 50% of the homes that burn down or are destroyed each year? There are many factors that go into determining how much insurance costs. If you think about it, insurance is a lot like gambling. The insurance companies want to operate like a casino does. They want to come out at the end of the day with more money. In return, you get some piece of mind. Everyone wins.
And, now for the deductable
In my simple example I only considered total replacement cost of the house. But, what if your plumbing bursts and ruins your carpeting, or your roof blows off in a windstorm. Insurance generally will cover more than full repalcement costs. This is where the deductable comes in. An insurance company will sell you an insurance policy. This policy will list everything that is covered and all the scenarios that you are covered for. The cost of the premiums you will pay will be based upon the cost of the deductable. The rule is, the higher the deductable the lower the cost of the premium.
It is a good idea in my opinion to reduce the cost of you insurance by getting a higher deductable. The savings can be rather significant. Remember, on you end insurance is supposed to cover you from financial hardship or ruin should something extreme happen to you or your assets. Go with the highest deductable you think you can afford should you need to file a claim.
What company should you buy your insurance through?
The simple answer might seem to be the one that offers the lowest prices. But, this is not always the best answer. All insurance companies are more than happy to collect the premiums. But, when you need to file a claim and collect on your insurance are they going to be there to help you or are they going to jerk you around?
When buying insurance it is a good idea to talk to your neighbors. Ask them if they are happy with their insurance? Have they ever had to file a claim? Did the insurance company respond and pay them promptly or did they jerk them around? Bottom line, you want to buy insurance from a company that is going to be there for you when you need them.
We have had Country Companies as our auto and homeowners insurance for almost twenty years now. We had a car accident about 10 years ago (our fault) and they paid the claim promptly. We had a windstorm that blew our dormer roof off. They were there quickly to estimate the damage and quickly pay the claim. If someone came to us tomorrow and offered to insure us at 1/2 the cost of Country Companies I would still stay with them. Why? I have twenty years of dealing with them. When we did need them them were there for us. I have peace of mind with them. I guarantee even though we have filed these two claims (one being a totalled car) they still have made money off of us. This is capitalism as it is meant to be! [Disclosure: I have received nothing whatsoever for this endorsement.]
Whatever insurance company you decide to go with make sure you do some homework. As I said, the best way to start is by talking to your neighbors and co-workers.