A University of Alabama Law School Clinical Program funded in part by West Alabama Regional Commission

Insurance

The idea of insurance has been around for a long time; perhaps since as early as 4000 B.C. Insurance is an excellent product when used for its intended purpose; to spread risk.

The role of an insurance company is not to assume risk, but to spread it among many people so that business can flourish. It would be hard for commerce to exist without insurance, or for individuals to own homes, drive cars or enjoy basic health coverage without it.

Whether fire, auto, life or health insurance, the idea is for many people exposed to catastrophic financial loss to contribute a relatively small amount to a pool of funds that will be used to pay for large losses experienced by some of them.

Out of a thousand automobile drivers only a few will have a ruinously expensive accident, but any one of them might. If all of those drivers pay comparatively small annual amounts to an automobile insurance company, the company will then have a pool of funds to cover the losses of those few who actually experience accidents that they could not cover on their own - and the others will be able to drive with some assurance that they are “covered”.

Insurance companies should not be gamblers or charities or wealth factories for top management. If an insurance company miscalculates its financial exposure and charges each insured too little, it will not collect a large enough money pool to cover actual losses. If it collects enough but pays out carelessly or too generously, it will run out of money, with the same bad result.

On the other hand, if a company charges premiums that are too high relative to the real risks, or is too stingy with payouts, it will - or should -eventually lose the confidence of a well-informed insurance-buying public.

Self-insure as much as you can to lower premiums. If each automobile driver insists on being insured for the smallest loss (“first dollar coverage”) such as a scratch on a door, premiums will have to increase for everyone. The greater the chance of a loss occurring, the greater the cost of insuring against it. Larger deductibles save premium dollars that can be put in interest-bearing accounts to cover any small losses (or used for other needs if no loss occurs). There will probably be a significant difference in premiums for the same coverage with a $1,000 deductible rather than a $500 deductible.

With auto insurance, two other ways to save money are to shop around and to be a safe driver. Call several companies before you buy, and keep in mind that the best drivers get the best rates. Also consider the financial stability of the company you deal with. The lowest rate may not be the best coverage.

Insurance is not primarily an investment or a savings program. The primary purpose of insurance is to cover risk. The greater the risk, the greater the need for insurance. The lower the risk, the less the need for insurance. Of course there are some good insurance products designed for special situations, such as insurance trusts to cover estate taxes at the death of a wealthy person. There are other insurance products that have “investment features”. Consider these only after real risks are covered.

Life insurance.

The same principles that apply to auto and home insurance apply to life insurance: the purpose is to cover the risk of unaffordable loss.

Young parents with child care expenses, a home mortgage, car payments and the ongoing costs of raising a family need life insurance that would replace breadwinner salaries.

Middle-aged parents with homes almost paid for but with children facing college costs need life insurance, but perhaps less of it.

Children do not “need” life insurance; they do not have mortgages or cars to pay for or anyone to educate, and the chance that a child will become unable to qualify for insurance before adulthood is negligible.

Few older persons need life insurance. Mortgages and loans are paid, families are grown and self-supporting. The costs of life insurance eventually become too high with age to be reasonably related to any risk of financial disaster caused by death of a spouse.

Funeral expenses, health, auto and home maintenance costs can be planned for more effectively by other means than through high- premium life insurance policies.

Small-dollar “whole life” policies.

Many Alabama seniors buy whole life insurance policies for face values of less than $5,000. For a long time such policies have been used to “save” for burial expenses. These policies are the most expensive form of life insurance. The cash value lags far behind the premium payments, and premiums must be paid until death or until very old age. It is common for Alabama policyholders to pay hundreds or even thousands of dollars more in premiums than the face values of their policies.

Term insurance is more economical insurance, but it accrues no cash value. A person could be insured for a much larger amount at a lower cost when younger, and put the difference in premiums into a savings account, so that money will be available at the time of need. Term insurance generally ends at age 65 or 70, but by that time the insured/saver could have a nice nest egg. This requires a lot of discipline, but if an individual would faithfully put the same amount of money into the bank that he would pay in premiums, and not tap into it when cash is short, over a period of time there would be enough to pay the costs of final disposition.

Health insurance. The topic of health insurance is addressed in another article on this web site, but in that connection remember that the more likely it is that something will occur, the closer the cost of insurance will have to be to the actual loss in order for the insurance company to have a pool of funds to cover those costs.

Many insurance companies actively market “health and accident” or “life and accident” policies. Some of these policies are designed in a way that is confusing and they appear to promise more than an insured is ever likely to collect. While many people do have accidents each year, very few die from any accident other than auto accidents, for which there is other coverage. There are better ways to use your insurance dollars. There is a reason why these policies do not cost much compared with most insurance: They are not worth much, because there is little risk that the company will have to pay out. Such policies are big money-makers for the companies but poor buys for the consumer.

Consumer advocates consider “dread disease” policies a poor buy, especially for seniors. They duplicate Medicare, and often pay only in narrow circumstances that are unlikely to occur. Some states do not permit sale of such policies. If purchased at all these purchases should probably be with “extra” insurance dollars, after your real risks are covered adequately.

Medicare, Medigap and other health insurance, and Long Term Care Insurance are other important topics on this web site.

Resources

Every library and many other locations provide free copies of the Consumer Information Catalog, published periodically, which offers free and low-cost publications on many subjects, including different types of insurance. For copies of the booklet call toll free: 1-888-878-3256, or visit the Consumer Information Center web site at www.pueblo.gsa.gov .

The National Consumer Law Center (www.nclc.org) and AARP (www.aarp.org) offer on-line and print articles on many topics, including insurance, that may be helpful.

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