Why Insurance is a Scam
Insurance. Some of it is required by law, some of it is optional. But is it really necessary or worth it? We’ll explain why insurance and warranties might be some of the most well-known scams, and how companies get away with it.
Across the world, people insure some crazy things, like famous singers insuring their voices or Heidi Klum insuring her legs. However, the most common types of insurance we carry are auto insurance, homeowners insurance, and life insurance.
Do you really need it?
Some things, like your home or car, insurance is required to own them (assuming you have a mortgage). Car insurance is required by law to pay for an accident you might cause.
Types of Insurance
There are a few different kinds of insurance. In auto insurance, you’ll hear the terms collision or comprehensive insurance. Collision insurance is less expensive as it only covers the other car in an accident that you cause. We’ll explain more below.
Collision insurance is used whenever you cause an accident. For example, if you rear-end the vehicle in front of you, it is your fault and you must pay to fix the other car. If you didn't have insurance, you would be forced to pay out of pocket for the repair costs. This explains why it is required by law. If you did not have the cash to cover the out of pocket repairs for the other owner's vehicle, they would be left with a wrecked vehicle that was not their fault. Therefore, insurance is required to pay for damages you may cause.
Comprehensive auto insurance is required by car loans but is optional for those without a loan. Comprehensive coverage pays for damage to your own car that is caused by you. Using the previous example, your collision insurance would pay to fix the other owner's car, but not your own, leaving you in the dust if your vehicle has significant damage. If you had comprehensive insurance, you could make a claim to get your car fixed while only paying your deductible. This is the difference between collision and comprehensive auto insurance.
Many people will choose to pay for comprehensive insurance for newer vehicles because, in theory, they would cost more to repair or replace if significant damage occurred whereas an older, less valuable vehicle would only cost a few thousand dollars to replace.
Our advice? Depending on your financial situation and insurance costs, it might be worth paying for comprehensive insurance for a car worth more than $10,000. Otherwise, you’re probably wasting your money and can opt for less expensive collision insurance.
If you have a mortgage, you are required to have homeowners insurance. Just think, if your house was to burn down, you most likely wouldn’t have the funds to rebuild a house, therefore insurance is required.
Homeowner's insurance costs depend on many factors, including the build, square footage, and roof type of the home. Because it is rarer to have a homeowner's insurance claim, the cost is typically less or similar to auto insurance. This might be surprising because it costs a lot more to replace a home than it does a vehicle, but it’s all based on statistics.
What to consider with homeowners insurance
When purchasing homeowners insurance, you will be asked many questions. Your answers will determine not only the cost of your insurance but also what is covered. Here are a few things you should consider when purchasing homeowners insurance:
- External building structures such as sheds, detached garages, fences, and more
- Personal property
Home warranties are often pitched by your realtor or mortgage broker when purchasing a new home. They typically cover things like major appliances such as refrigerators, HVAC, and ovens. It’s best to look for what they don’t cover, rather than what they do. Oftentimes you can find items that you think are covered only to be not covered in the fine print.
Another flaw of these warranties are the “service charges”. These charges, typically costing $75 or more can add up and are not refundable. For example, if you have a problem with your dishwasher and want to get it looked at, it will cost $75 even if there is nothing wrong, or it costs less than $50 to fix.
It’s also worth noting that home warranty companies aren’t going to hire the “A” team when it comes to their service technicians. They notoriously outsource their technicians to cheaper options that are late to appointments and try to avoid fixing problems as much as possible. Be careful when it comes to home warranties.
No-one likes to think of life insurance, but depending on your income, it could be beneficial for your family in the case of an emergency. Life insurance is structured to help your spouse and family (whoever your primary beneficiary is) in the case of a sudden death. Many times, families will purchase life insurance if there is a primary income dependent on one member of the family. Similar to auto insurance, there are different kinds of life insurance. We’ll dive into the most common below!
Term Life Insurance
Term life insurance is structured so that your insurance is available during a certain term. For example, if you purchase 15-year term life insurance, your coverage would last for 15 years. After that, you no longer would have coverage. Because term life insurance is not indefinite, it is often less expensive than whole life insurance.
Whole Life Insurance
Whole life insurance is as it sounds, for the rest of your life. If the person covered is to pass away, the beneficiary will receive a certain amount, outlined in your coverage details. As expected, because whole life insurance if indefinite, it is more expensive than term life insurance.
Whole life insurance can be complex at times, you can read more about whole life insurance here.
Other Insurance & Warranties
We cringe at the thought that people pay monthly for insurance on things like mobile phones, A/V systems, or other small appliances. This might simply be one of the biggest cash throwaways. Below are some of the most common insurance and warranty purchases:
- Car Warranty
- Phone Insurance
- Extended laptop warranties
What is a deductible?
You’ll hear the term “deductible” a lot when it comes to insurance. A deductible is an amount you must pay out of pocket before insurance will pay for the remaining balance required to meet the policy. For example, if you are involved in an accident and you have a $1,000 deductible, you would be required to pay $1,000 on your claim and your insurance company will pay the remaining balance to repair the car according to your policy.
The Theory Behind Insurance
In its simplest form, insurance and warranties are all about statistics. That’s why insurance companies are one of the top hirers of Actuaries (those use mathematics, statistics, and financial theory to analyze the financial costs of risk and uncertainty).
Whenever you pay for your insurance, that money goes into a large pool. Whenever a claim is made, that money comes from the pool generated by the income from everyone who has paid for insurance. Insurance companies make a profit by being left with an overage.
Actuaries are able to accurately predict the average cost of insurance per person. They will take that amount, and add a percentage on top in order to make a profit. The law of averages will keep them profiting over long periods.
Time to think… If insurance companies continually make money, that means the statistics are in favor of not paying for it. In other words, it’s more likely that your total claims will be less than the amount you pay for it. So why do we continue to buy into insurance and warranties?
This comes down to psychology and individual financial situations. We all think of the “what ifs”, and that’s reasonable. If your home were to burn down in a fire, you would be left with a financial mess. For that reason, we recommend always having homeowners insurance, whether it’s required or not. Insurance companies have the ability to easily pay for a home rebuild because of the sheer amount of income they produce, while individuals do not.
What should I get insurance for?
In this section, we’ll help you decide what insurance is worth it and what insurance is a waste. We recommend getting insurance for items that you could not replace with half of your annual income. For example, if you could not afford to purchase a home with one-half years of income, it’s probably wise to purchase homeowner's insurance to keep yourself covered. Below we give our most recommended insurance purchases and our least recommended
- Homeowners Insurance
- Auto Insurance
- Term Life Insurance
- Home Warranty
- Extended Car Warranty
- Mobile Phone Insurance
Many times insurance is required, and other times it can be worth it. But some times, it can be a flat out dumb decision. Phone insurance, home warranties, and car warranties can cost thousands of dollars for something you may never use. Insurance companies rake in the cash while distributing small amounts in the form of claims. This is why most insurance and warranties could be considered scams. Always do your research and know exactly what you’re getting before committing to any policy. Whatever your decision is, it’s important to know the premiums and deductibles you must pay before your insurance will kick in. This will help guide your decision making and decide whether it is worth it or not in order to help you keep more money in your pocket.