02.07 How Do I Protect My Stuff?

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Objectives

After completing this lesson, you will be able to:

understand how insurance policies work

recognize that people make decisions about insurance coverage based on several factors, including their willingness to accept risk

understand that individuals may be required to carry insurance under certain conditions

recognize government programs that help protect people from economic hardship

understand the different types of insurance available

understand that behavior can influence insurance rates

calculate payments on insurance claims

compare different insurance options and fees

What Is Insurance?

Say hello to Jason. Jason recently had great success saving for and purchasing his first car. Unfortunately, his good fortune has since run out, so he is also learning about insurance. It all started with those explosion-happy planet crashers he had befriended … more on that later.

If we could predict the future, the insurance industry would not exist. It's impossible to know what accidents, health problems, or natural disasters could affect our families or property. Therefore, many of us take out insurance to protect ourselves from potential losses. People vary in their willingness to accept risk. Yet most are willing to pay a smallpremium now in order to avoid a possible larger loss later. By signing a contract, or insurance policy, with an insurance company, people are able to transfer the risk of loss to the company.

Insurance companies collect premiums from their customers on a regular basis, usually monthly, semi-annually, or annually. They create a pool or collection of funds with the payments. When one of the customers, known as apolicyholder, suffers a loss, he or she is paid out of the collected funds.

Insurance companies are profitable because they base their prices on the odds of a certain event occurring and adjust their prices to reflect those odds. Those at higher risk will pay more because the company knows that they are more likely to have a future claim. Another reason the companies are successful is that people tend to overestimate the chance of something bad happening. Often this is because they have heard or seen a recent example of such an event.

Soon after Jason bought his car, offers for "extended warranties" arrived in the mail. These warranties are available for other large purchases, as well as for appliances and electronics. They are a type of insurance. Consumers often wonder if it's worth the money to add this protection to what is already an expensive price tag. Note that these items usually have some kind of basic warranty from the manufacturer. Examine these three examples of products and their extended warranty options. Select a product to view pricing and warranty information.

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Insurance—Extended Warranties—Text Version

For which types of products would an extended warranty be worth purchasing? Read the information for the example appliance, electronic device, and automobile to decide.

Dishwasher

Original Price: $5502-year Extended Warranty Price: $90Average Cost to Fix: $150

In this case, the average cost to fix a broken dishwasher is more than the cost of the extended warranty. However, only a very small percentage of dishwashers that break do so within the first three years. Additionally, the product comes with a manufacturer's warranty that covers defects for the first year. Is the extended warranty worth the price?

Smartphone

Original Price: $200Replacement Value: $6002-year Extended Warranty Price: $100Cost Per Incident: $49

Most of the time people don't pay full price for a smartphone because they get a deal through their wireless carrier. However, the phone that originally cost $200 may be $600 to replace. An extended

warranty is much cheaper than a new phone, but it's important to consider what it covers. These warranties usually cover defects in workmanship and repairs if the phone is damaged. They often do not cover the most common problems with smartphones, like loss and theft.

New Car

Original Price: $15,000Average Extended Warranty Price: $1200Average Warranty-Covered Repairs: $850

Many of those who buy extended warranty coverage on their vehicles do so at the time of purchase, rolling the cost into their auto loan. This means that they will pay interest on the price of the warranty. The repairs covered under an extended warranty average $350 less than the cost of the warranty itself. Many of those who purchase the warranty do so to give themselves peace of mind because they know that some car repairs, however rare, can cost thousands of dollars.

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Instead of purchasing extended warranties or other types of insurance, some people prefer to accept the risk of something happening to their property. They might "self-insure" by setting aside money, usually in a savings account, on a regular basis. This money can then be used to repair or replace damaged property. However, few of these folks save enough for a large loss. Just ask Jason, whose alien nitrous boosters wrapped his car around a tree. His $100 per month savings barely made a dent in his $25,000 hospital bill.

When borrowing money for a large purchase like a house, lenders often require borrowers to carry insurance as part of an agreement with the lender. The house is collateral for the home loan, or mortgage. If the house were damaged in a storm, for example, the insurance would protect the bank's investment by covering the loss.

02.07 How Do I Protect My Stuff?

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Automobile

Automobile insurance is required by the government. However, those state laws only outline the minimum amount of coverage needed. Vehicle owners often choose policies that exceed the state requirements to better protect themselves in the case of an accident.

The following are different types of coverage that may be part of an auto insurance policy:

Bodily Injury Liability—pays for medical expenses, pain and suffering, and lost wages of another person hurt in an auto accident for which you are at fault or liable; also covers legal defense and court costs

Property Damage Liability—pays for vehicle or property like a fence, garage, etc. damaged in an auto accident for which you are at fault or liable; also covers legal defense and court costs

Collision—pays for losses to your car when in a collision with another vehicle or object

Comprehensive—pays for losses to your car in a non-collision situation, such as damage caused by theft, wind, or hail

Medical Coverage—pays for medical expenses of driver and passengers, regardless of fault

Uninsured/ Underinsured Motorist—pays for losses to your car when accident is caused by a driver who has no or insufficient liability insurance

Rental Reimbursement—pays for rental car if your vehicle is damaged in an accident

GAP Insurance—pays for fees associated with damage to a car when the amount still owed on the car is greater than its value

As with most insurance policies, there are different factors that determine the amount of coverage an individual chooses and how much the policy costs. Review the factors below:

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Factors in Cost of Auto Insurance—Text Version

Levels of Coverages

For each type of coverage in your policy, you must decide how much coverage you want. Ask yourself how much money you could afford to pay in the event of an accident. For example, say you have the minimum $10,000 liability coverage. Then you cause an accident that cost $30,000 in damages. Would you be able to pay the remaining $20,000? If not, it might be worth it to increase the level of coverage. This would, of course, increase the monthly premium. Yet it would greatly spread out the financial impact of a potential loss, instead of taking a big hit all at once.

Deductibles

A deductible is a set amount of money that the insured must pay out of pocket, meaning pay themselves, before the insurance coverage will apply. For example, suppose you have a $500 deductible. A windstorm causes a branch to fall on your car, resulting in $3,500 in damages. You are responsible for $500 of the loss, while the insurance company pays the remaining $3,000.

With auto insurance, the deductible is a per-accident cost. In other words, if you had another claim two months later, you would need to pay the $500 deductible again.

A higher deductible reduces your monthly insurance premium. Similarly, a lower deductible increases your premium. It's up to you to weigh the pros and cons of these choices for your individual needs.

Personal Circumstances

An insurance agent gathers a great deal of information from you before being able to tell you how much your coverage will cost. Personal circumstances, including age, driving record, your credit score, and even where you live, can influence your rates.

Discounts

Insurance companies typically offer premium discounts for a variety of things, including those for owners of a car with air bags, antilock brakes, or an antitheft device, families who own more than one car on the same policy, and drivers who maintain their policy with the same company for a long time.

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An insurance agent can inform you of how changes in these factors will affect your premiums. Try these questions to check your understanding of these factors.

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Try This!—Text Version

1. Jack has an auto insurance policy with $10,000 in collision coverage and a $250 deductible. He gets in an accident that causes $8,500 in damages to his car. If the claim is approved, how much will Jack's auto insurance company pay for repairs?

A. $10,000

B. $9,750

C. $8,500

D. $8,250

2. Mackenzie received a used car as a high school graduation gift from her parents. She's purchased an insurance policy, but her premium is pretty high. Which of the following actions is likely to lower her monthly premium?

A. Increasing her collision coverage

B. Increasing her deductible

C. Increasing her bodily injury liability

D. Increasing her comprehensive coverage

3. D'Andre paid an annual premium of $600 in liability protection, including bodily injury of up to $300,000 and property damage of up to $100,000. He never "needed" this coverage until 13 years into his driving experience, when he ran a red light and caused an accident with another driver. The other driver made a claim of $58,000 in medical costs and $5,000 in auto damage. D'Andre's insurance company paid the $63,000 claim in full. How much had D'Andre invested in his automobile policy in order to be protected from this large financial blow?

A. $2,600

B. $7,800

C. $63,000

D. $337,000

Check Answers

1. Jack has an auto insurance policy with $10,000 in collision coverage and a $250 deductible. He gets in an accident that causes $8,500 in damages to his car. If the claim is approved, how much will Jack's auto insurance company pay for repairs? D. $8,250—The insurance company will pay the balance of the loss after Jack's deductible. $8,500 – $250 = $8,250

2. Mackenzie received a used car as a high school graduation gift from her parents. She's purchased an insurance policy, but her premium is pretty high. Which of the following actions is likely to lower her monthly premium? B. Increasing her deductible—You've got it! By increasing the her deductible, Mackenzie would be paying more if there was a claim against her policy, but she would also be saving more each month because the company would reduce her premium.

3. D'Andre paid an annual premium of $600 in liability protection, including bodily injury of up to $300,000 and property damage of up to $100,000. He never "needed" this coverage until 13 years into his driving experience, when he ran a red light and caused an accident with another driver. The other driver made a claim of $58,000 in medical costs and $5,000 in auto damage. D'Andre's insurance company paid the $63,000 claim in full. How much had D'Andre invested in his automobile policy in order to be protected from this large financial blow?B. $7,800—D'Andre had invested $600 per year for 13 years up to that point, which means he

had paid $7,800 thus far. This is a great example of the advantage of insurance. His $7,800 investment saved him from a lump sum of $63,000 financial loss.

Homeowner's Insurance

Jason's woes with the aliens began at home. Homeowner's insurance, or HOI, is insurance for private homes. Like automobile insurance, it is a type of property and casualty insurance. There are two main components of a homeowner's insurance policy: property and liability.

This type of coverage … Pays for …

Property Loss of or damage to home, property, and/or belongings in the event of things like fire, a storm, or theft

Liability Loss or damage caused by accidents that may occur to others while in your home or on your property, like your dog biting the mailman or your friend falling onto a glass table

In Jason's case, the aliens accidentally firebombed his apartment complex. (They were at the wrong planet.) If Jason had known about renter's insurance, he could have made a claim on the destruction of his furniture, clothes, and other belongings.

Image of a boy's messy room

You can personalize a homeowner's insurance policy in many ways. The company will write the policy to clarify all circumstances and items that are covered, as well as those that are not. For example, the insured person may want to specify riders. These are special items added to and covered by the policy, like an antique coin collection or a valuable piece of jewelry. An HOI policy may also have exclusions. These are events or circumstances not covered. For example, a typical HOI does not cover damage caused by floods or termites. However, individuals can purchase separate flood insurance or termite damage insurance. If the home is in an area that is at risk for these events, purchasing a policy to mitigate the risk may be a wise investment.

The premium for homeowner's insurance varies according to many factors, including:

Assessed Value—The more valuable the insured home, the higher the cost of the policy.

Deductible—Just like with auto insurance, the higher the deductible, the lower the premium, and vice versa. The homeowner pays the deductible once per claim.

Riders—The more valuable the items added to the policy, the higher the rates.

Other Factors—Examples of other factors considered are geographic location (for example, does the homeowner live near water), distance to a fire station or fire hydrant, crime rates in the neighborhood, age of the home, overall condition of the home's construction, and the existence of a sprinkler system.

Health Insurance

Like other types of insurance, health insurance helps mitigate a risk. In this case, the risk is incurring medical expenses. However, health insurance is different from automobile or homeowner's insurance because it doesn't just cover the costs of a single unpredictable event, like the medical care for a broken leg. (A single health event like this one might include an emergency room visit, X-rays, surgery, medicine, and so on.) Health insurance also typically covers routine doctor visits, preventive care, and prescription drugs. Most plans also include some level of coverage for mental health, chiropractic, dental, and vision care. Those may exist as separate plans.

People usually obtain health insurance through employer-sponsored plans. When signing on for a health insurance policy, individuals usually have some choices to make. These include the types and levels of coverage they will obtain for themselves and their family members. Because there are so many possible configurations of component parts, options are usually presented as pre-packaged "plans" to choose from. Each plan specifies the details of coverage and costs. Larger companies are often able to offer more plan choices and pay a larger portion of the premium. Recent studies show American companies pay the majority of the premium, though the specific portion varies widely. For example, one person might pay 18%, while another might pay 39% of the premium.

Many factors have an impact on the overall cost of individual health care. A few are shown here:

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Insurance—Factors that Affect Health Care Cost—Text Version

Amount of Coverage

The more options you choose, such as dental and vision coverage, the higher your premium will be. Some plans allow you to choose levels of coverage. For example, one plan may allow for an annual maximum dental benefit of $2,000, while another plan may have no maximum as long as the procedures are necessary and the claims are properly documented. The higher the level of coverage for the component parts of the plan, the higher the premium.

Deductibles

Like automobile and homeowner's insurance, some health insurance plans come with deductibles. One difference to note is that the deductible associated with health insurance policies is usually annual, not per incident. For example, a $500 deductible for medical care means that the insured must pay out of pocket for all doctor's visits or procedures until the deductible is met. Then all costs are paid by the insurance company for the remainder of the year. When the new year begins, the $500 deductible is in effect again. Like all insurance policies, the lower the deductible, the higher the premium.

Co-payments

A co-payment, or co-pay for short, is an out of pocket fee paid for individual services each time that service is rendered. For example, one health care policy may include a $10 co-pay for each doctor visit, a $20 co pay for each emergency room visit, and an $8 co-pay for each prescription filled. Typically, lower co-pays translate to higher premiums.

Coinsurance

Coinsurance is another way that individuals and insurance companies share the cost of health care. Not all health insurance plans have coinsurance. Often, it is specified for a particular component. An example of this would be a 15% coinsurance for hospital stays. This means, whatever the total cost of a hospital visit, the patient is responsible for 15% of the bill, and the insurance company pays the remaining 85%. The lower the percentage of coinsurance, the higher the premium.

Exclusions

As with other types of insurance, there are some things health insurance policies do not cover at all. An example might be elective surgery or teeth whitening. Such medical services would be the full financial responsibility of the policyholder. Whatever the exclusions, they are specified in the written policy along with all the other details of coverage. It is the responsibility of the insured to be familiar with his or her plan and know how to find information regarding coverage. Health care plans are complex and can be

intimidating and confusing. But there is always assistance available through the customer service department of the insurance carrier. Do not be afraid to access that help.

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Disability

Disability insurance provides income for those who are insured and unable to work due to injury or illness. This type of coverage provides insurance for your paycheck. It helps you to still have money coming in even if you cannot work. Employers may provide disability insurance as part of their group coverage or offer it as a voluntary policy. That means you can choose whether to buy it or not. In some cases, an employer may pay for basic coverage and give employees the option to buy a more comprehensive plan. Most plans pay between 40 and 80 percent of your gross salary, but the details of the coverage depend on the type of plan purchased.

Did You Know?

Sometimes people with insurance will take more risks with their health or property because they know that they have a certain amount of protection. To help deter this mindset, insurance companies use features like deductibles and copayments as a way to share the cost of a loss with the policyholder. This helps reduce the cost of a potential claim for the company.

Those who can show that they pose less risk of loss generally benefit from lower insurance premiums. For example, an insurance company views those who have passed a safe driving course as less likely to get in an accident, because of their training. Thus, the company might lower their auto insurance premiums. Health insurance premiums are often less expensive for people who don't smoke. Non-smokers have less risk for developing diseases and conditions related to smoking.

Life Insurance

The purpose of life insurance is to provide financial support to family members, or other beneficiaries, at the time of your death. Individuals pay a premium to an insurance company for their coverage. The insurance company then pays a death benefit, usually a lump sum, to the designated beneficiaries (often a spouse and/or children).

There are two main types of life insurance, term and whole.

Term Life Insurance

Coverage only for a specified term, or number of years, such as 5, 10, or 25

Lower premium than whole

Often chose as a way to support children in case of parent's death during children's dependent years

"Protection policy"

Whole Life Insurance

Permanent, remains in effect until death, no matter how many years

Higher premium than term

Often chose as part of a long-term investment strategy, because the policy builds cash value

"Investment policy"

The cost of a life insurance policy, like all insurance types, is determined by many factors, including the:

Health of Insured—Information about personal health status, family health history, and lifestyle choices is used to determine if the insurance company will provide coverage and at what rate.

Type of Policy—The next consideration is the kind of policy you want or need. Are you looking for a way to ensure the financial security of your children from age 0 to 20 in the event of your death during that time? Then term life insurance may be a cost effective option. Or are you looking for a long-term investment opportunity, in which a loved one will be well provided for, even at a ripe old age? Then a whole life insurance policy may be an option to explore.

The premium for whole is many times higher than the premium for term with the same death benefit. This is because of fund management costs and cash value accumulation. Fund management costs refer to the cost of paying people who work for the insurance company to sell policies, collect and account for premiums, and handle claims. Cash value refers to the total dollar value of the premiums a person has paid for a policy.

Amount of Coverage—The final question when starting a life insurance policy is how much you want the death benefit to be; $100,000? $500,000? $1,000,000? This is not an easy question to answer. Yet a few other questions may help guide you to that decision.

What would be the financial burden on your family if you were to die tomorrow?

Are you the primary income earner?

Do you have other savings, investments, and resources your spouse, children, or elderly parents could live on without your income?

What would be the financial needs of the beneficiaries?

Would they need to cover your funeral costs and medical bills?

Would they need to pay an ongoing mortgage and other monthly bills?

Would they need money for the kids' college and spouse's retirement?

1. Based on the information provided below, which individual has the least current need for term

life insurance?

Name Age Family Status Financial Situation

Ashley 26 Single; no children $1,000 credit card debt; $1500 car loan; $3000 in savings

Marcus 30 Married; no children $5000 credit card debt; $150,000 mortgage; working spouse; $10,000 in savings

Julie 45 Married; 3 children (ages 10, 13, 15)

$20,000 car loans, $300,000 mortgage; non-working spouse; $30,000 stocks and bonds; $15,000 savings

Luis 65 Widowed; 1 child (age 35)

$2000 car loan; owns house; $200,000 retirement account; responsible for disabled son

2.

A. Ashley—Since Ashley is not married and has no children, she does not need term life

insurance to provide for anyone after she is gone. While she could buy a policy and

designate a beneficiary, her current age and lifestyle indicate that another type of

investment would be a better choice. 

3. For prescription drug coverage with his family health care plan, Vincent has four options. 

Option A: $70 monthly premium and $15 co-pay per prescription

Option B: $90 monthly premium and $10 co-pay per prescription

Option C: $100 monthly premium and $8 co-pay per prescription

Option D: $120 monthly premium and $4 co-pay per prescription

Based on Vincent's records, his family fills an average of 3 prescriptions per month. Which would

be Vincent's best (cheapest) option?

A. Option A—You're right!

Option A is $70 + $15 x 3 = $115

Option B is $90 + $10 x 3 = $120

Option C is $100 + $8 x 3 = $124

Option D is $120 + $4 x 3 = $132

Even though Option A has the highest co-pay amount per prescription, it is still the

cheapest option because Vincent's family is only filling an average of 3 prescriptions per

month. 

4. For prescription drug coverage with his family health care plan, Vincent has four options. 

Remember Vincent from the last question? His family is now filling an average of 12

prescriptions per month. Should Vincent change his prescription insurance plan? If so, to which

option?

Option A: $70 monthly premium and $15 co-pay per prescription

Option B: $90 monthly premium and $10 co-pay per prescription

Option C: $100 monthly premium and $8 co-pay per prescription

Option D: $120 monthly premium and $4 co-pay per prescription

D. Option D—You've got it!

Option A is $70 + $15 x 12 = $250

Option B is $90 + $10 x 12 = $210

Option C is $100 + $8 x 12 = $196

Option D is $120 + $4 x 12 = $168 

With more prescriptions filled per month, the high monthly premium of Option D actually

contributes to the lowest total cost because of the low co-pay.

5. Sarah is comparing auto insurance options. She is 18 years old and has had one parking ticket,

but no accidents. Her car is worth about $8,000. Sarah has about $1,000 set aside for

emergency or unforeseen expenses. Which would be the best option for her?

Deductible CoverageSix-Month Premium

Option A $2,000 $5,000 collision, $5,000 comprehensive, no rental car coverage

$700

Option B $1,000 $10,000 collision, $10,000 comprehensive, rental car coverage

$900

Option C $500 $20,000 collision, $20,000 comprehensive, rental car coverage

$1,200

6. Option B—Option A would not cover the value of Sarah's car in the event of a total loss,

nor could she afford the deductible. Option C contains more coverage than she truly

needs at a significantly higher premium. Option B is the best for Sarah's needs.

7. Shane is thinking about purchasing his first home. He was approved by the bank for a mortgage.

Shane found a small home near the beach for a price of $110,000, within his approved mortgage

amount. He likes that the home is on a hill and not in a flood zone. Before making an offer on the

house, he called a few insurance companies to see how much it would cost to insure the home.

The bank requires wind damage coverage. Which of the following plans meets Shane's needs

and provides the greatest value for the least expense?

Deductible Coverage Annual Premium

Option A

$500 per claim/$1,000 per claim for mold, flood, or wind damage claim

$150,000 home, $75,000 contents, same coverage no matter type of claim

$4,685

Option B

$2,000 per claim $100,000 home, $50,000 contents, no wind or flood coverage

$3,627

Option C

$1,000 per claim, requires separate wind damage policy with its own $1,000 deductible

$120,000 home, $60,000 contents, no flood coverage, separate wind rider with same coverage amounts

$1,833 for base HOI, $2,245 for separate wind damage policy

8. Option C—For Shane, Option C is best. Option A is the most expensive plan and, while

comprehensive, has more coverage than he needs. Option B seems a bit shy of the

coverage Shane needs for the house. Yet the coverage he chooses should not be for the

price of the house, but rather for the cost of replacing it. Even then, Option B does not

provide the required wind damage coverage. It is not truly an option at all, despite the

lowest price tag. By separating the basic home policy from the wind damage coverage,

Option C provides Shane the coverage he needs for the best price available.