Insurance is a complicated business. Just settle in to read your auto, home or health insurance policy, and you’ll agree. But decades of experience have helped boil down the web of insurance rules and regulations to a relative handful of easy-to-remember principles. Here are five of those principles, along with explanations of what they mean, how to use them and how they can be misused.
1. If you can’t afford the insurance, you can’t afford the car.
“A lot of times, young people see a fancy car they want to buy, but the cost to insure a new car may be more than they can afford,” says Loretta Worters, vice president of the Insurance Information Institute.
This principle advises car shoppers to consider total cost of ownership, including auto insurance, before buying a vehicle. And, in the majority of cases, this principle is worth following. It’s not a foolproof guide to automotive affordability, however. A shopper might be able to handle loan payments and insurance premiums on a given vehicle, but still be unable to afford the vehicle because of particularly high maintenance costs, for instance.
2. Insure for the cost to rebuild, not the real estate value.
This principle deals with home insurance. It refers to the fact that many people shopping for insurance for a home they’ve owned for a while assume they need less coverage if the value of their real estate has gone down.
“The real estate value has nothing to do with the price of homeowner's insurance,” Worters says. “It is the cost to rebuild the property. And construction costs have gone up, not down.”
Of course, this principle applies only when construction costs have, in fact, gone up. These costs do fluctuate from year to year as prices for materials and labor go up and down. For a recently purchased home, it might conceivably be less expensive to rebuild it than it was to build in the first place -- which means it could be prudent and cost-effective to insure the house for less than its initial purchase price.
3. Flooding can happen anytime, anywhere.
“This is something that the National Flood Insurance Program tries to explain to people about the importance of getting flood insurance,” Worters says. “Many people believe it only happens in areas close to a river or after a hurricane, but flooding can happen anytime, anywhere.”
Indeed, the National Flood Insurance Program does offer this warning: “Everyone lives in a flood zone.” The risk isn’t equal everywhere, of course. You can check flood hazard maps to find out what the chances are that your home will wind up underwater.
But being in a low- to moderate-risk flood area doesn’t make you perfectly safe. The National Flood Insurance Program notes that one-fourth of floods occur in such areas, despite the fact they're not in immediate danger from overflowing rivers or flash flooding.
4. Lightning never strikes twice.
Worters denies that this adage originated with the insurance industry.
“It is a known fact that lightning often strikes the same place repeatedly, especially if it is a tall, pointy, isolated object,” she says.
Still, it is not unheard of for consumers to justify not getting home insurance or other insurance on the grounds that they’ve already experienced a loss and surely -- surely! -- fate could not be so unkind as to deliver a second blow.
Of course, even this adage isn’t universal. For instance, you don’t need to keep paying premiums on a life insurance policy for someone who's dead.
5. Buying whole life insurance instead of term life insurance is like buying a house instead of renting a house.
This one comes from Robert Hunter, director of insurance for the Consumer Federation of America. He says it’s more likely to be used to encourage you to get a policy you don’t need than to guide you toward a good decision. The idea behind it is that buying a whole life policy, which is designed to cover you for as long as you’re alive and builds equity in the form of cash, is more like buying a permanent home. On the other hand, getting a term policy, which lasts only for a set period and is meant to cover expenses like a mortgage, is a temporary solution -- sort of like renting.
Hunter’s criticism of the saying is that it masks the real price of the whole life policy and fails to take into account the low price of the term coverage. “It’s like buying a house that costs a lot of money instead of renting a house that costs almost nothing,” he says.
Ultimately, your financial situation and your goals should dictate whether whole life or term life is the best route for you. In essence, the question is this: Do you want to be an owner or a renter?