Two truths seem to hold when it comes to insurance:
- People like being insured, and
- People don’t like paying insurance premiums.
People often make decisions on managing risk based upon these two factors alone. The trouble with this is that often people end up with too much or too little insurance, or the wrong type of insurance altogether.
A better way could be using something I call the 3 ‘A’s of risk management: Avoid, Assume, Assign. Let’s walk through each of them.
Where it is possible, this is the cleanest, easiest way to handle risk. Simply avoiding situations that bring on unwanted risk is a perfectly good way at insuring against loss. Don’t want to face a large risk of losing a limb to an alligator? Don’t wrestle alligators!
A lot of the time, though, risk avoidance is either not desirable or not practicable. I, for example, like to teach people how to fly airplanes. In my case, I’m NOT going to avoid of some of the risks inherent to flying, because I WANT to teach people to fly. Obviously, many steps are taken along the way to mitigate risks, but complete avoidance is not a palatable option to me.
Similarly, some risks cannot be avoided because they are pretty much completely out of our control. Becoming disabled or ill are substantial risks that, while we might take steps (seat belts, hand washing, etc) to avoid, are ultimately out of our hands.
Each day, we assume risks. More often than not, we do not pay much attention to these instances for two reasons:
- We can afford the consequences, and
- The consequences aren’t particularly dire.
The risk of a paper cut doesn’t stop me from filing the paperwork I need to submit on my job. The risk that I don’t get the very best deal out there on garden-fresh tomatoes because I stopped shopping early. The risk that I hit a traffic jam and am late to a meeting. These are all risks that, for most of us, fall firmly into the ‘Assume’ category all the time.
Risks that we can’t totally avoid, but that we also can’t afford to assume, fall into the ‘Assign’ category. How we assign risk can vary. Driving home from work has a low level of risk, but driving home from a 3-martini lunch carries with it much more dire consequences. Assigning the risk (in this case, the risk of driving) to someone else (like an Uber) makes a lot of sense in this situation.
We can also share with large numbers of people. This is another way of assigning risk. The most frequent way of ‘pooling risk’ is through insurance.
EFFECTIVE USE OF THE THREE ‘A’s
When making decisions about insurance, it’s important to make sure you have considered all three – Avoid, Assume, Assign – in your process. When you think about risks using this framework, which of these three pitfalls can you relate to?
- Assigning risks you could assume
You may win or lose at a blackjack table if you play one hand. If you play hundreds of hands, though (assuming you are not cheating), eventually the casino will start to win. That’s how the odds are structured, and after enough cycles, a random sequence will approach its average expected outcome. Just like casinos, or ANY other company, for that matter, Insurance companies need to make money.
I’ve been offered purchase protection on a $10 phone plug. It seems this type of insurance is available on everything conceivable, but at the end of the day, the risk of a phone charging plug going bad is something I’m willing to take my chances on (i.e. ASSUME the risk). And it’s not a big deal if I pay the extra $2 to have my charging cord protected. But adding insurance on things I don’t really need to insure is, over the long-term (remember, hundreds of hands…) going to cost me more money.
Similarly, when thinking through deductibles on property and casualty policies, this is something to consider. An auto policy with a $250 collision deductible will likely cost significantly more than a policy with a $1,000 deductible. If I have adequate cash reserves that I can cover that $1,000 rather easily, I’ll probably make back that $1,000 in a relatively short amount of time with the money I’ve saved by going with the higher deductible.
One place I see a lot of ‘assumable’ risk being ‘assigned’ is in healthcare policies. In today’s healthcare marketplace, comprehensive policies that cover every doctor’s visit with little to no deductible are extremely expensive. Removing the liability for the smaller claims from the insurance company by assuming them yourself will likely save you some money. This is especially true in situations where employers offer ‘high-deductible’ plans coupled with an HSA, or Health Savings Account. Some employers even contribute to the employee’s HSA plan when they enroll in these, and the vast majority of cases we review result in employees doing MUCH better over the long run by taking the higher deductible plan and assuming the cost of the smaller stuff (and with the HSA, benefiting mightily from a tax standpoint).
- Assuming risks you could avoid
Actually, I find people usually do a good job at this. That said, some reminders always come in handy;
- Put your cell phone in the glove compartment when you drive
- Buckle up
- Don’t consume unrefrigerated shellfish
- Assuming risks you could assign
We see this a lot. Some of the biggest risks we see left unassigned are:
- Loss of income due to disability: If you make $50,000 per year, and have 20 years left until retirement, the value of your future income is approximately $1 Million dollars. That’s a risk that most people can’t afford to assume, yet most folks are either woefully unaware of what they have for disability insurance, or they have none at all.
- Loss of income due to death: Another area rife with mystery is the world of life insurance. It is complex and wrought with people who end up underinsured (because they haven’t calculated the actual value of the income they need to replace), or mis-insured (like someone who buys a whole life policy when they only need to protect their income during their working years).
- Costs associated with Long-Term Care: Many people still mistakenly feel that Medicare provides for the cost of nursing home or in-home custodial care. It doesn’t. Paying out-of-pocket for such care can cost hundreds of thousands of dollars.
- Umbrella Liability: Once you’ve been sued for millions of dollars, it’s too late to cover this risk. But adding a couple million in general liability coverage to your auto and homeowners policy is affordable and transfers this risk to the insurance company.
So don’t sweat it when it comes to making insurance decisions. Follow the 3 ‘A’s (or just give us a call) and you’ll be well on your way to ensuring your risks are correctly managed!