Be Your Own Insurance Company

Understand Risk

This past weekend was a very busy one at the Root of Good household.  We were hosting play dates, lunches, and dinners for a few friends at our house throughout the weekend.  Add to that a birthday party on Sunday at a nature preserve (with hiking after the cake-eating), and watching fireworks at the State Fair.

The weekend started early on Friday.  Around lunch time the kids were released from school around noon so their teachers can participate in a half day of intensive training on new instructional methods and techniques.  I call B.S.  I really think it was a pretext and all the teachers sat around commiserating with each other while taking tequila shots and singing drunken karaoke over the intercom.  That’s what I would do if I were a teacher, which partially explains why I’m not a teacher.

After school, I walked home with my two daughters as well as about 10 other elementary school kids who belonged to an assortment of other parents.  Two of those 10 other kids were headed to our house (along with my two daughters) for an afternoon play date.  The other 8?  They went to their respective houses without anyone running them over or abducting them in a big creepy white work van.

Some might argue that the parents of those eight other children are guilty of child abuse.  If I were those allegedly negligent parents’ criminal defense attorney, I would argue they are actually very astute statisticians who know how to ignore the media hype over child abductions by strangers (a little more info on avoiding media hype here).  The best statistic I could find was in this eleven year old report that says there were around 115 children kidnapped by strangers in 1999.  For reference, there were 72,000,000 children in the US in 1999.  In other words, 99.99984% of children walking home from school made it home just fine.  Put another way, for every abducted kid, there are 626,086 other kids that are completely safe from getting kidnapped by strangers.  They will live another year to take their shot at the “abduction lottery” the next year.  As my kids say, “Stranger Danger!”.

The odds are so firmly stacked in favor of NOT getting abducted, that parents could arguably be called negligent for NOT allowing their kids to enjoy the outdoors and get some much needed exercise while walking home from school with their friends.  But I don’t want to judge, since I almost always walk with my kids to and from school.

To put the risk of a kid being abducted into perspective, it is roughly as likely to happen as it is to die in a car crash over the long Thanksgiving holiday weekend.  The odds of dying in a car crash over Thanksgiving are 1 out of 697,917 (for a period of 5 days), just slightly less likely than being abducted by a stranger (1 out of 626,087 over the course of an entire year).

Would anyone really be deterred from visiting grandma’s for her delicious turkey, stuffing, and gravy over a piddly 1 out of 697,917 chance of dying on the trip?  Of course not!  We all take risks every day, even when there are serious consequences due to our choices.  The odds of a negative outcome may be tiny, but the result of a negative outcome can be fatal.  In spite of the known dangers, we willingly take on risks.

I don’t have reams of annual statistics on child abductions over the last half century, but I would imagine that child abduction rates have remained relatively constant or even declined over the decades.  There were crazy, messed up, despicable, sick people in the 60’s, the 70’s, the 80’s, the 90’s, the 2000’s, and today.  There were no good old days of 100% safety and security, just the good old days when TV’s only had 3 stations and they were in black and white.  You didn’t hear about child abductions because they were so rare.  Today we have 24-7 news cycles and internet headlines and facebook newsfeeds to keep us informed of the 0.00016% of children that are abducted every year.  Rapidly evolving technologies accelerate the rate of information dissemination.  Bad people doing bad things haven’t changed their ways.

Mr. Money Mustache (a fellow blogger) talks a bit about how much we focus on the risk of something really bad happening, when in reality the odds of that bad event occurring are nearly zero.  It’s a good read and helps put things in the right perspective.  I would call Mr. Money Mustache and myself an optimist, but I think we are both just slightly above average at math and statistics.


Analyze Risk

Thinking critically about risk and putting particular risks in perspective can help you navigate every day life.  The insurance industry exists to help people and businesses manage risk.  It’s a trillion dollar industry in the US alone, and employs over 2 million people.  This also means there are huge amounts of money being spent on insurance company operations, overhead and profit.

Why such a large insurance industry?  People don’t like risk.  The unpredictable nature of random events bugs us.  Insurance steps in to spread the risk to a large number of people.  If you are insured against a particular risk, you share that risk with all the other insureds, so your risk of significant loss is limited.

Many of us have experience with life insurance, health insurance, auto insurance, and home or renter’s insurance.  The truth is that insurance is offered all over the place:

  • extended warranties on electronics and appliances
  • travel insurance
  • vacation rental insurance
  • Roadside assistance

With the major types of insurance like home, auto, and health insurance, the Root of Good household tries to keep our premiums as low as possible by having a high deductible and only covering risks we want to protect against.

For health insurance, a high deductible plan has served us well during most years.  We did switch to more comprehensive coverage for a few years to save us money on the delivery of our children.  I’m not worried about a $100 doctor’s visit or a small $1,000-2,000 procedure.  I’m worried about a catastrophic medical emergency that could cost tens or hundreds of thousands of dollars.  I really consider health insurance to be asset insurance, since a major medical issue probably wouldn’t bankrupt us, but it would seriously deplete our assets.

For auto insurance, we also kept the deductible high.  A $1,000 deductible isn’t a problem when you have plenty of money in the bank to cover unexpected expenses.  Insurance acts as a forced savings account for many.  Instead of handing over more money to the insurance company each year to cover insurance we don’t need, we just pocket the savings.  We also got rid of the comprehensive and collision coverage once the cars weren’t worth that much ($3,000-$4,000 value seems like a good level).  If one of our cars were stolen, vandalized, or destroyed, a $3,000 hit to our net worth isn’t that severe.  We would just buy a new(er) car or get our busted up car fixed.

On our home policy, we set the deductible at $2,500.  In ten years owning our current home, we have not filed a single claim.  We look at home insurance as something that would be used primarily in the case of major catastrophes.  If our house burned to the ground or we suffered a direct hit from a tornado, the insurance would come in handy.  If a thunderstorm knocks a few shingles loose, we aren’t filing a claim.

Extended warranties seem to provide peace of mind.  At a steep cost.  I took a quick peek at the website to see the going rate for “peace of mind” these days.  I found a nice 50″ TV similar to the one we bought a few years ago.  The extended warranty for a 50″ TV is 18% of the purchase price if you opt for two years of protection.  For a five year extended warranty, you will pay 31% of the TV’s purchase price.  Do 31% of TV’s really die within 5 years?  We haven’t experienced failures this frequently, and we usually buy just about the cheapest tech toys we can find!

We occasionally rent a house at the beach for family vacations.  They always offer “vacation rental insurance” to cover your rental costs in the event of family illness or death, or in the event of a hurricane or tropical storm (they infrequently hit the east coast of the USA).  Without doing any research or analysis, it seems like a good deal to pay an extra 7% of your rental cost for this valuable insurance.  But it isn’t that simple.

The extended warranties and vacation rental insurance contracts are worded very carefully against the consumer.  Pick up one of these contracts some time and dig through the fine print (because that sounds like so much freaking fun!).

The Best Buy extended warranty contract says you may have to pay a diagnostic fee to the technician to determine whether the repair falls under the terms of the extended warranty.  They will refund the diagnostic fee if the problem is under the warranty.  Otherwise you’ll have a busted TV and a bill for $100.  I can’t think of a time when any extended warranties would have worked in our favor.  Eventually something of ours will die just outside the manufacturer’s warranty, and we will be on the hook for repair or replacement.

Vacation rental insurance wouldn’t have helped us avoid this tropical storm. I’m glad we didn’t waste money on it!

On the vacation rental insurance contract, “illness” and “death in the family” are defined very narrowly to make it difficult to use the insurance policy.  Hurricanes only trigger the insurance coverage if your rental house is under a mandatory evacuation for at least four days during your seven day stay.

Situations where the insurance pays you nothing: A mandatory evacuation lasting less than four days.  A mandatory evacuation of a few days at the beginning of your stay or a few days at the end of your stay. Merely a voluntary evacuation (not mandatory), and a hurricane or tropical storm makes landfall a few hundred miles away and makes the ocean extremely turbulent and dangerous, floods the roads near your house, and you lose power to your house for half the stay.  Those scenarios are more likely than the only scenario actually covered by the insurance (four day mandatory evacuation).

In other words, the insurance is almost useless to protect you against the biggest risk you face – loss of use of the rental house when a big tropical system makes life on the coast really crappy.  In all our years of renting houses at the beach, we have never experienced a situation even close to triggering the terms of the vacation rental insurance policy.


Embrace Risk, Self Insure

We embrace risk by self insuring for small risks that we can absorb without significantly impacting our finances.  By self insuring all of our small risks, we save a huge amount of money on reduced or avoided insurance premiums.  Occasionally we have slightly higher out of pocket costs to cover an incident, but it all averages out in our favor over time.

Here is roughly what we save each year by keeping deductibles high and forgoing various types of consumer insurance:

Health insurance: $2,000

Home insurance: $400

Auto insurance: $200

Extended warranties: $250

Vacation Rental Insurance: $100

Roadside assistance: $50          

TOTAL: $3,000

Understanding risk can save you a bunch of money.  The past decade of buying too much insurance would have cost us $30,000.  We have definitely paid out of pocket for a few things over the years that we could have insured against, but nowhere near $30,000 (probably $3,000).  Most of that $30,000 is sitting in our investment accounts and is probably closer to $40,000 or $45,000 since amounts saved ten years ago have more than doubled in the last decade.

Some might be reading all this and think “yeah, but Root of Good is rich and we aren’t.  We can’t afford to pay a thousand or two out of pocket if something really bad happens.”  You can’t afford not to self insure.  Save a few thousand extra dollars in your savings account and call it “self insurance money”, “rainy day fund”, or some other useful name.  Then you can save thousands of dollars every year by right-sizing your insurance purchases.


Closing Thoughts

My philosophy on insurance is that it should cover catastrophic risks primarily.  We do pay extra for higher coverage amounts for liability insurance on the home and auto policies.  The additional coverage is incredibly cheap (around $100-200 per year for hundreds of thousands of dollars of additional liability insurance).  I strongly hope it will continue being a complete waste of money while protecting us against the exact kind of risks that would destroy our assets and would cause a major change in lifestyle for us.

To save money by self insuring, you have to be mentally okay with losing out occasionally when bad stuff happens.  Imagine paying $500 for a new TV or computer and having the device die the day after the manufacturer’s warranty expires.  You face a $200 repair bill (but you avoided an $80 extended warranty).  Does it feel okay losing $120 (the net cost after discounting the extended warranty price)?  If not, you should keep wasting money on insurance since it buys you peace of mind.



Readers, do you think you have just the right amount of insurance, or are there areas where you need more or less?