Insurance is the subject we all love to hate. But the fact is, some insurance is absolutely necessary. You should never look at insurance as a way to save or invest. Insurance does not make you money. Insurance costs you money, to protect the things (assets) that actually do make you money. For example, your home is an asset. The insurance you carry on your home protects that asset in case of a loss.
There are three components of insurance cost – the premium, the deductible, and the co-pay.
- The Premium is how much the insurance costs each month or each year to keep in force.
- The Deductible is the amount that you are responsible for paying before any insurance benefits kick in.
- The Co-pay is the amount you are responsible for after the deductible has been met. With health insurance it is common to see a deductible like $1000 and a co-pay figure like 80/20. That means you are responsible for 20% of the cost after you pay the first $1000. Many types of insurances (other than health insurance) have a zero co-pay, meaning that after the deductible has been met, the insurance covers 100%.
The ultimate goal of your personal financial plan is to build wealth. Your most powerful wealth-building tool is your income. So we don’t want all of your income going to insurance companies in the form of high premiums! It is therefore NOT in your best interest to have an insurance policy that features “zero out of pocket expense” if there is an insurable event. It is best if you take on some of the risk by having a strong Emergency Fund.
Here’s an example. Let’s say your automotive insurance costs $400 a month and has a $250 deductible. That means that if you have an accident, all you have to pay is $250 out of pocket. Sounds like a great deal, right? Except for the fact that you are paying $400 a month, every single month, for that “feature”. Instead, see how much your monthly premiums would decrease if you raise your deductible to $1000. Now, as an example, you might cut your monthly premium in half to $200 a month. Yes, IF you have an accident you will be on the hook for the first $1000 – which you will have as part of your Financial Plan in your Emergency Fund – but your monthly cost is now only $200 every month, saving you $2400 a year whether you have an accident or not.
Another way to lower your cost of insurance premiums is to raise the co-pay amount (maybe consider a 70/30 policy with health insurance). With health insurance you might also consider a Very High Deductible plan such as a Health Savings Plan, where your deductible is upwards of $5000, and after that your insurance pays 100%. This is actually a great plan in two cases – if you are very healthy and almost never go to the doctor, or if you are chronically ill and will blow through $5000 no matter what plan you have – and it is not great at all if you are kinda in the middle. If you do choose an HSA plan, make sure you have an adequate Emergency Fund to cover 100% of the deductible.