What Types of Insurance do You Need to Buy?
With the ability to buy insurance on just about everything imaginable it can often be difficult to decide which types of insurance you need to buy. Insurance agents often try to sell insurance using emotional examples to help prospective clients understand the necessity of the insurance. One you probably hear all of the time on TV is “what will happen to your family if you were to pass away?” Thinking about things like that can be motivational for those who have not put much thought into buying insurance, but for those who have already decided to buy insurance it is important to recognize that part of the decision of how much insurance to buy and which types of insurance you need is based only partially on emotions and partially on actual need.
What types of insurance do you actually need?
Insurance agents will make you believe that you have a need for every type of insurance under the sun (at least all of the types they are selling), but the bottom line is that insurance needs are based primarily on financial need and your personal risk aversion, both of which will explain below.
Financial need for insurance
Assessing your financial need for insurance is a three step process which begins with looking at how much money you have easy access to (also known as liquid assets; liquid assets include cash in the bank and stocks and bonds in a personal brokerage account that you could easily sell if the need arose). This is the money that you could use to pay for unexpected life events such as a car accident, a pet emergency, or a hospital visit.
Once you have added up your liquid assets and you have a good idea of how much money you could afford to pay in an adverse life situation you can move on to step two: add up the dollar costs of different insurable events.
Insure catastrophic events that would destroy your financial stability
A financially “catastrophic event” is a life event that could potentially wipe out all of your savings and more. The types of insurance you need to cover your financial need are those types of insurance that would save you from having to spend all of your liquid assets on a catastrophic event. Now that you know how much money you have for adverse events and what those adverse events might be you can move on to step three: Select the adverse events that you could not afford to pay for with money you currently have and insure those events.
Life insurance, health insurance, home/fire insurance, and disability insurance are a few examples of types of insurance that cover events that would typically be “catastrophic”. Whether you decide to purchase other types of insurance will largely depend on what level of cost constitutes a catastrophic event for you personally.
Financial need aside, there is still an emotional piece that needs to be factored into your decision as to what types of insurance you will purchase. It may be that even though you have plenty of money to cover damage that you cause to your car or a root canal and crown on a hurt tooth, you like the feeling that you would be covered by insurance as opposed to having to hand over $2,000 immediately. If that is the case then you are highly risk averse (you don’t like taking risk) and there is no shame in buying lots of insurance to make yourself feel safe and secure.
On the opposite end of risk aversion, there are those that don’t mind adapting to adverse events and don’t care much for insurance. For those that are not risk averse (you are not at all afraid to take on financial risks such as the possibility of losing your home to a fire and having to start from the ground up), buying insurance can seem like an unnecessary burden. If you are very financially stable and have sufficient liquid assets (money in the bank) to cover yourself in adverse events then you may be able to pass on many types of insurance.
In the case of low risk aversion, financial need is a trump card. This means that if you don’t have the money to cover unexpected life events you will likely need to purchase many types of insurance to make sure that you are not financially ruined when adverse life events occur, even if you don’t feel the need to.
The types of insurance that you should buy will depend primarily on your financial need and your level of risk aversion (whether you are a financial risk taker or you like to avoid financial risk). While emotions can play a large role in deciding what types of insurance you should buy, remember that your financial need should be the ultimate dictator in your decision; if you don’t have two pennies to rub together you should be scrambling to buy up as much insurance as you can so you are not financially ruined every time life throws you a curve ball. If you are more financially stable then you have more flexibility to decide which types of insurance you want and which types you will avoid.