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Rule of Thumb on Insurances To Avoid

Posted By Jim On 09/20/2010 @ 7:19 am In Insurance | 17 Comments

Here’s the rule of thumb I use on whether or not an insurance policy is worth getting – if they are willing to sell you insurance without knowing anything about you, don’t buy it.

Think about how much information you have to provide if you’re buying any kind of “traditional insurance.” With life insurance, you have to submit yourself to a physical. For auto insurance you have to offer up your car’s history, your credit history and your driving history, which is being tracked by a third party. For homeowners insurance, you have to provide a history of claims on your home (don’t worry, it’s tracked by a third party), your own credit history, and home details.

When you buy travel or trip cancellation insurance [3], they don’t need anything except your money. When you buy cell phone insurance, they don’t need anything except your money. Extended warranties? Just send in a check.

The reason why these insurance policies don’t care about you, and only about your cash, is because the profit margin on these policies is astronomical. They make so much money off travel insurance and extended warranties that they don’t care how risky you are or how likely you are to use it. They just know that any random Joe off the street is going to generate a profit. The only way they can be assured of that is if their profit margins are high enough.

If you’ve ever looked at the business model of an insurance company, it’s fairly simple. You collect premiums, invest the “float,” and then hope that the gains off the float offset the claims payouts. You expect to pay back all of the premiums in the form of claims in an average year. In a “good” claims year, you pay back less and in a “bad” year you pay back more than the premiums you’ve collected (hopefully less than the gains from your investments). [This is based on reading Berkshire Hathaway annual reports [4], which are remarkably fun to read]

Insurance companies manage risk by analyzing and scrutinizing who they insure. When they don’t do either, you know they must be making money hand over fist at your expense.

What do you think about my rule of thumb? Makes sense? Totally off base? Please let me know!


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[3] trip cancellation insurance: http://wanderlustjourney.com/is-vacation-trip-cancellation-insurance-worth-it/

[4] Berkshire Hathaway annual reports: http://www.berkshirehathaway.com/letters/letters.html

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