Understanding Insurance: What Not to Buy

Aflac Duck

Not every insurance product on the market today is a good buy — in fact, some of them are downright crazy.

Having good insurance is an important part of building a stable financial life. It can help to make you financially whole in case a disaster claims your car or your home; help pay for expensive medical care that you couldn’t afford on your own; and even provide for your family should you pass away unexpectedly. But there are other insurance products out there that don’t provide these kinds of important coverages, and those are the ones to avoid.

So, how do you know what is a good insurance policy and what is not? You have to judge on a case-by-case basis, but here’s a general rule of thumb: Insurance is all about protecting ourselves from risk, so you should only buy insurance to guard against a risk that you can’t afford to absorb by yourself.

Here are some examples of insurance products that probably aren’t worth carrying.

1) Supplemental Insurance

There’s a certain noisy duck on TV these days that does a lot of advertising for a company that sells supplemental insurance products. His pitch can sound pretty good, offering insurance that will pay your bills in case you have an extended sickness or injury. This is known as supplemental insurance — it’s coverage that goes beyond normal health insurance. Many companies that sell supplemental disability insurance also sell supplemental dental, vision and other insurance plans.

The problem with these plans is that they’re usually based on fear, and they’re usually a bad deal. I once looked into buying dental insurance from this company, but the annual premiums on the insurance plan added up to much more than I actually paid in dental bills. The other supplemental coverages that they offer range from unnecessary to downright morbid — like cancer insurance. The marketing uses scare tactics to make you think that you’re taking a big risk by not buying their products. But the truth is that the risks are low and the expense is high.

Instead of buying supplemental insurance, you should keep a strong enough emergency fund to cover things like dental bills or unexpected illnesses that keep you away from work for extended periods.

2) Insurance on Loans

If you have a mortgage on your home or a loan on your car, you may get solicited from time to time to buy a special kind of insurance that will pay off your debt in case of certain disasters. It’s common for mortgage companies to try to sell you a policy that will pay off the balance of your home loan if you die early, or for car companies to offer an insurance that will pay off your auto loan in case of an accident. Both of these sound like comforting possibilities; the problem, though, is that they’re both far too expensive.

If you’re worried about paying off your home loan in case you die, you’re much better off by carrying good term life insurance. Make sure that you buy enough coverage to pay off your mortgage balance and still leave your money plenty to live on. Adding $100,000-$200,000 to a life insurance policy is much cheaper than buying a payoff insurance from your mortgage company. The same holds true on auto loans — your auto insurance is already going to pay off your loan if you total your car, so you don’t need a second insurance to do that.

Besides, what are you doing buying cars on debt, anyway?

3) Insurance mixed with Investment

Some of my insurance agent friends will disagree with me on this, but it doesn’t change my point of view: You shouldn’t get involved with whole life, universal life, or any other product that mixes up insurance with investing.

Don’t get me wrong: Life insurance and investing are both good things, and they both need to be part of your financial life. But there’s no reason to mix up insurance with savings — they both have their own purposes, and they’re both best achieved through their own channels.

Many companies sell life insurance policies that accumulate cash value over time, or even include investments that grow in value as the stock market rises. The theory on these is that if you die after term on your life policy is up, there is a cash value left over on the policy, and that cash is distributed to your estate. But that’s not free money — it’s extra money that you’ve paid to the insurance company to save or invest for you. And if you do happen to die during the term of your insurance coverage, you don’t get any of that cash.

Here’s the truth: Whole and universal life policies tend to by overpriced. You’re much better off buying a simple, affordable term life insurance policy — it will cost you less, and leave you more money to invest on your own in an IRA or mutual fund. Keep your insurance and investment plans separate.

4) Extended Warranties

This may seem odd in a discussion about insurance, but the extended warranties that electronics stores and other retailers offer on big-ticket items is really just an insurance policy. If you buy the extended warranty, you’re taking out a policy against the risk of your item breaking within a certain number of years. If you buy the coverage and something bad happens, the company will fix it.

The problem here, like with all of the other examples in this article, is that this coverage is dramatically overpriced. Extended warranties are one of the biggest profit centers for electronics retailers, which explains why they are always trying to sell them to you. And the likelihood that you’ll actually use the coverage is very small. Over the course of your lifetime, you’ll be much better off by paying for repairs on a couple of items than by purchasing extended warranties on every piece of electronic equipment you buy.

Extended warranties, like  most of the other items in the article, are also unnecessary because they go beyond the basic role of insurance in your life. We buy insurance to cover the cost of risk that we can’t absorb by ourselves. But if your $500 TV breaks, you can afford to fix it or replace it yourself.

Do yourself a favor — use insurance only to protect against things that are truly disastrous, and use savings and consumer savvy to handle all of the smaller things in life.


Photo by Kowarski. Used under Creative Commons License.

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