Insurance is the boring part of money until the one bad day it isn't. In my 20s I wanted every dollar invested, and insurance felt like money thrown away. The way I think about it now: insurance isn't for the small stuff. It's for the few events that could undo years of saving in a single month.
The rule I use: insure what I couldn't afford to pay myself, and self-fund everything else.
A few words first
- Premium: what the policy costs each month or year, whether or not it's used.
- Deductible: what gets paid out of pocket before the insurance starts paying.
- Copay: a flat fee for a visit or prescription, like $30 for a doctor visit.
- Coinsurance: the share of a bill paid after the deductible is met. With 20% coinsurance, a $1,000 bill costs $200 and the plan pays $800.
- Out-of-pocket maximum: the most a health plan can make someone pay in a year. After that, the plan pays 100% of covered care.
- Network: the doctors and hospitals a plan has agreed prices with. Going out of network usually costs more, or isn't covered at all.
- Liability: money owed to someone else for damage or injury that was my fault.
- Coverage limit: the most a policy will pay for a claim. Anything above it is on me.
The four that matter
- Health insurance. A hospital stay or surgery without coverage can run into the tens of thousands. Under the ACA (Affordable Care Act), anyone can stay on a parent's plan until 26. After that it's an employer plan or the Marketplace. More on plan types and HSAs in The HSA: The Retirement Account Nobody Talks About.
- Auto liability. If I cause an accident, I'm on the hook for the other driver's car and medical bills. State minimums are often low enough that one serious accident blows past them, and higher limits usually cost little extra.
- Renters insurance. It covers my belongings if there's a fire or break-in, and my liability if someone gets hurt in my apartment. It's usually one of the cheapest policies there is.
- Disability insurance. It replaces part of my paycheck if illness or injury stops me from working. Short-term disability covers a few weeks or months. Long-term disability can last years. Social Security estimates that more than 1 in 4 of today's 20-year-olds will be disabled before reaching full retirement age. Many employers offer long-term disability as an optional benefit, often at a low cost.
The one that can wait: life insurance
Life insurance replaces income for people who depend on it. Single with no kids, there usually isn't anyone. That changes with a spouse, a shared mortgage or children.
There are two main kinds. Term life covers a set number of years, like 20 or 30, and is the cheaper of the two for the same payout. Whole life lasts for life and builds a cash value, and it costs far more for the same payout. I have term. Many planners and consumer groups argue whole life isn't worth it for most people who just need to replace income. Agents also typically earn a bigger first-year commission on whole life than on term, which is worth knowing when someone is pitching it. More in Term Life Insurance.
What I'd skip
Insurance companies price every policy to make a profit. On average, the customer pays in more than they get back. That trade is worth it for a loss that would wreck me, like a lawsuit or a hospital stay. It's a bad trade for a loss I could cover from savings, like a cracked phone screen.
So I skip these:
- Extended warranties on electronics and appliances. The repair they cover is usually small, and many items fail inside the manufacturer's warranty or long after the extended one runs out.
- Rental car insurance, when my auto policy or credit card already covers rentals.
- Flight and trip insurance on cheap or refundable trips.
- Whole life sold as an investment. I keep insurance and investing separate.
The money I'd have spent on these stays in my emergency fund, and the rest gets invested. That's self-funding: over a lifetime, I pay for the small stuff myself and keep the profit the insurer would have made. Skipping $150 a year of warranties and add-ons and investing it instead comes to about $30,000 over 40 years at 7% after inflation.
Keeping the cost down
- Raise the deductibles once the emergency fund can cover them. A higher deductible means a lower premium.
- Spend the savings on higher limits. This is what I do. I pay a little more for high liability limits on my auto and home coverage, and I offset that cost with a high deductible. The small claims come out of my savings. The big one, the lawsuit that could reach my assets, is what the coverage is for.
- Bundle auto and renters with one insurer for a discount.
- Shop the policies every year or two. Rates drift up for loyal customers.
- Use the benefits package. Employer disability and life coverage is often cheap or free. More in Benefits Packages Decoded.
Later: umbrella insurance
An umbrella policy adds extra liability coverage on top of auto and home or renters policies, often $1 million or more. It's rarely a priority at 22. It belongs on the list once savings and net worth start to build, because that's what a lawsuit would go after.