A Note on How Insurance Companies Make Profits
Insurance companies take a blanket approach to making money. They sell policies to a multitude of customers called policyholders paying to protect against losses. The payments the customers make are called premiums. Generally, the companies will then invest these premiums to bring in more money. If a customer suffers a loss (such as a car accident), the insurance company pays the customer a sum of money (incurred losses to the company). The companies, of course, have expenses to maintain the business as well. So, the companies have to hope that the income from premiums and investing those premiums exceeds the incurred losses and expenses. Note that on average the insurance companies will make money from you.
What kind of insurance do I need? The Experts: Only Policies to Protect Against Financial Ruin
Despite the fact that insurance companies aim to make money from you, it is to your benefit to purchase policies that protect against financial catastrophe. This is one of the most critical personal finance tips. For example, if your home caught fire and you did not have an insurance policy, this would likely spell permanent disaster for your finances. For the big policies that you need, internationally-renowned author Eric Tyson in his best-seller Personal Finance For Dummies breaks them into two categories: insurance on you (life insurance, disability insurance, and health insurance) and insurance for your assets (homeowner’s insurance, flood & earthquake insurance, liability insurance, auto insurance, uninsured/underinsured motorist insurance, and umbrella insurance for your home and vehicle). When wondering, “What insurance do I need?” these are the policies that will protect against financial ruin to research further for your needs.
The Insurance Policies That Will Cost You in the Long-Run (The Mistake to Avoid)
Buying small policies is a losing game. Regarding the purchase of these policies, Eric Tyson writes, “You’re not going to come out ahead in the aggregate-if you did, insurance companies would lose money…on average, insurance companies pay out just 60 cents in benefits on every dollar collected. Many of the following policies pay back even less-around 20 cents…” Some of these “small potato” polices he then lists are: extended warranty and repair plans, home warranty plans, dental insurance, and credit life/credit disability insurance. Over the course of your life, having many small policies will most likely lose you money.
The Bottom Line
What type of insurance do I need? As long as you stick to policies that will protect against large financial disasters and avoid policies on small items, you will be protecting yourself the same way the financial experts do.
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Tyson, Eric. Personal Finance for Dummies. Indianapolis, IN: Wiley Pub., 2006. Print.