CHAPTER 7
The Gift of Certainty
AUTO, HOME, AND LIABILITY INSURANCE
“Fifteen minutes could save you 15 percent or more on your car insurance.”
“Quote in six minutes. You could save $550 on car insurance.”
“Get more and pay less.”
Various advertisements
You’re involved in a car accident. It’s your fault. The person driving the car you hit is injured. He visits with an attorney who runs late-night commercials in between People’s Court reruns. They decide to sue you. They win and are awarded $950,000. Who pays that bill? The insurance company? Hopefully. You? Possibly. If insurance, which one of those different types of coverage tells you how much they’ll pay? “Gee, I hope that when I saved 15 percent in 15 minutes I didn’t reduce that particular coverage.”
You’ve seen the commercial claiming to save you 15 percent on your auto insurance if you’re willing to spend 15 minutes. I’ve talked to several people who liked that idea, spent their 15 minutes, and, indeed, saved 15 percent or more on their car insurance. What is not promised by the unnamed insurance company, which incidentally is also represented by an oversized lizard and a couple of prehistoric humans, is whether new converts can be guaranteed to maintain or improve on their auto insurance pricing and still have good coverage. In other words, they may be spending less . . . for less.
It is not my intent to demonize the above-referenced company. You may very well have your auto insurance with them and be properly insured for a reasonable rate. But inside the insurance realm economic bias is so ever-present that we must be very careful to understand what coverage we own for the stated price. Too many have spent 15 to save 15, or followed through on some other tempting sales pitch, only to find their auto coverage would leave them financially exposed in the case that it was needed. Another “forward thinking” company has recently invited television viewers to choose the price they would like to pay for their car insurance and allow the company to build a customized policy around the spending restrictions. I’m going to make another suggestion specific to your home, auto, and liability insurance: First determine the coverage that you need, and then shop around for apples-to-apples quotes to see who will offer you the best price.
Timeless Truth
My grandfather, who is the source of much of the wisdom I talk and write about, gave me a lesson and some words that apply to our exploration into the mysteries of insurance.
I was a small boy, and we were doing some type of woodworking project. I was rushing through one of the steps in the process, and he asked a question that remains with me today. “If you don’t have time to do it right, when are you going to have time to do it over?”
The unfortunate thing about insurance coverage is that, by the time you find out you didn’t do it right, you can’t do it over. You are risking everything that you and your family have worked and sacrificed to create, on a moment-by-moment basis. If you’re going to take the time to build and create wealth, it’s worth a few minutes to make sure you adequately protect it.
When you look at the economics of insurance, your primary goal should be protection, not saving premium dollars. People will continue to advertise and push cheaper premiums at you, simply because it’s hard for you and me to know when we think we’re making a comparison, and we’re really looking at apples and oranges.
All premiums are not created equal in part because all coverage is not created equal.
Just as you invest your money, make a commitment to invest some time and acquire the expertise through your own knowledge or a financial planner so you and your family can truly be protected.
Jim Stovall
Home and auto insurance are often the most neglected risk management tools because they’re so often commoditized. It is seen as insurance we are legally required to own if we wish to drive a car or own a home, and so people spend 15 to 60 minutes calling a couple of folks—or the guy at church who mailed them a fridge magnet—and not paying a second’s notice to the details of the policy. Let me show you why it’s so important to understand your auto insurance.
Our at-fault driver mentioned previously, who is on the hook for $950,000, needs to look at his auto and liability insurance to see if he is covered for this loss. The vast majority of the hundreds of auto insurance declaration pages I have reviewed do not provide adequate coverage to insure against a $950,000 loss.
If you shopped your car insurance recently, you may recall the agent mentioning something about “fifty, one hundred,” or “one hundred, three hundred,” or “two-fifty, five hundred.” The type of coverage that would pick up the tab for the lawsuit would be bodily injury liability. Typically, that coverage is quoted listing two successive numbers. The first number is how much liability protection you have per person. The second is the amount that covers you per occurrence.
The chances are good that you have $100,000 of bodily injury liability coverage per person and $300,000 per occurrence. In our hypothetical accident and lawsuit, becuse there was only one person in the car you hit, your liability coverage is going to top out at $100,000. I hope you have an extra $850,000 lying around somewhere, because that’s your responsibility!
Many people intent on saving a few bucks on their premiums opted for a number even lower than that—maybe $50,000 and $100,000 or $25,000 and $50,000. Indeed the minimum insurance amount in most states is $25,000/$50,000. Save in the short term, you may, but it could cost you a fortune. Since we covered the risk manager’s approach to an automobile accident in Chapter 5, we’ll immediately delve into the various types of auto and home insurance coverage.
The primary types of coverage listed on most auto insurance declaration pages are the following, along with some suggestions for coverage limits; but since insurance is regulated by the state and every person’s situation is different, it is important that you review these with an independent planner individually:
- Bodily injury liability: This is the example we used above. The key word here is liability. You did something nonmalicious that was nonetheless due to your own negligence, and you’re now liable for the damage, pain, and suffering caused. Consider having minimum coverage of $250,000 or $500,000 per person and $500,000 per occurrence. (But, you say, even $500,000 isn’t going to take care of that $950,000 bill. Read on.)
- Property damage: This coverage pays for damage done to another vehicle or other immovable object you moved. Consider having minimum coverage of $100,000 per accident.
- Medical payments: Medical payments and its cousin, personal injury protection (PIP), help compensate an injured party for that which may not be otherwise covered by health insurance. For this reason, this limit can be lower. Consider having a minimum of $2,500 per person.
- Uninsured/Underinsured motorists bodily injury and property: Yes, it’s true. You need to insure yourself for injury that may be caused to you or a passenger by a negligent driver who is uninsured or underinsured. As much as that may bother you, the risk is too significant to abstain. Statistics vary greatly by state, but states report anywhere from four percent to over 30 percent rates of uninsured drivers. Statistics for the underinsured in some states indicate that over half of insured drivers have less-than-adequate coverage. Consider having minimum coverage of $250,000 or $500,000 per person and $500,000 per accident, and $100,000 per accident for property damage. (And be careful. If you’re in that category of premium savers who pay very little because you have $25,000/$50,000 for bodily injury liability, you’re one of the underinsured!)
So if you can’t skimp on these coverage amounts in order to get your premium down, what can you do? If you have sufficient emergency reserves, the prudent risk manager would utilize the risk assumption technique by having higher deductibles. The deductible is the amount you are responsible to pay in the case that you suffer or inflict damage before the insurance company starts to pitch in. You will pay less in premium annually if you have a $1,000 deductible than you will with a deductible of $100. If you can only afford to pay $100 or $250 in the case of an accident, your deductible should be $100 or $250. But, if you have sufficient emergency reserves, increasing your deductible to $1,000 or $2,000 should save you money on your premiums. Prior to making a change to increase your deductible, however, ensure the difference in premium is meaningful enough to make it worth the change.
The most common words denoting different deductibles on your auto insurance declaration pages are collision and comprehensive. The easiest way to remember the difference between the two is that collision coverage applies when you have one—a collision. Comprehensive is utilized when just about anything else happens. Your car was vandalized or caught in a hail storm—comprehensive. You have an accident—collision. You’re driving down a nice country road and a deer leaps from the bushes and lands on your car while you are in your lane—comprehensive. You’re driving down the same road and the same deer jumps out a bit sooner, giving you time to swerve, but you veer off the road and hit a tree—collision!
Ultimate Advice
“Life . . . is the ultimate teacher.” That wisdom, delivered to Jason Stevens post mortem by his great uncle, Red, could not be more true. But sometimes we allow that concept to excuse willful ignorance. We don’t have to learn every lesson the hard way, and frequently the presumption that our home and auto insurance represent nothing more than a commodity with a price tag leads us to spend less time on that decision than is optimal . . . often to our detriment. The truth is that what you don’t know can hurt you. You’d be doing yourself a huge favor if you kept a list as you read through this book of those things you don’t know. If it’s an area of interest for you, educate yourself; if not, seek the advice of a trustworthy professional who can guide you.
I still haven’t told you how you’re going to cover the rest of that lawsuit without digging into your personal savings, but that’s because I must first tell you about homeowner’s and renter’s insurance. The primary homeowner’s coverage varieties of which you must be aware are the following:
- Dwelling: Dwelling coverage insures your home, not your homestead. If a tree in your yard falls on your family room, dwelling coverage will pay to fix your house. If that tree falls in the other direction and lands in the middle of your beautiful yard, your standard homeowner’s policy will pay approximately zero dollars to help with the cleanup. In most policies, your land is simply not covered.
What if the same tree falls, landing on your neighbor’s house? She rings the doorbell to let you know that your tree fell on her house in the middle of the night. You suggest she inform her homeowner’s agent, as it is her policy that will handle this damage. What if the tree fell on your neighbor’s car? You got it—her comprehensive auto coverage. Consider covering at least 80 percent of the cost to rebuild your house from scratch—not 80 percent of the value of your dwelling and land combined. In many policies, if your dwelling coverage represents a number less than 80 percent of the true replacement cost of your home, you may be required to pay a proportionate amount of any damages to your home, so it is important to regularly update your dwelling coverage to reflect changes in your home’s value.
- Other structures: Since we’ve established that dwelling coverage only covers the dwelling, other structures will give you some coverage for a detached garage, shed, or . . . outhouse (I guess). This coverage will usually be determined as a multiple of the dwelling coverage.
- Personal property: Dwelling covers the actual structure; other structures covers the other structures. Personal property covers your stuff—everything inside of your house. This coverage is also usually determined as a multiple of your dwelling coverage, but be wary of the exclusions and caps in your policy. There are typically limits placed on the individual value of jewelry, collectibles, guns, and cash. An individual rider is necessary, and recommended, for articles in your house with individual values above the policy limits. Remember these two important things about your personal property coverage:
1. Actual cash value coverage of your personal property will only pay for the depreciated value of your home’s contents. Consider requesting full replacement value coverage that will replace damaged or stolen items with a brand new comparable item.
2. You are responsible to inform the insurance company of your household inventory in the case of a loss. The last time you want to try to remember the details of your property and contents is right after your house burns to the ground. Consider conducting an inventory of your home’s contents with a video camera or online software designed for that purpose. If you use a video camera, describe the contents audibly as you are taping, and then remember to store your tape outside of your home. What You Own™ (www.whatyouown.org) and Know Your Stuff™ (www.knowyourstuff.com) are free home inventory software products designed to make this process as simple and effective as possible. You can go room-by-room offering descriptions and including pictures, receipts, and appraisals.
- Personal liability: This is the coverage that protects you financially if the neighbor’s kid falls down your stairs and the neighbor sues you. Interestingly, personal liability coverage also follows you and your family outside of your house. If your son, visiting a friend, drops the ancient urn holding great-great-great-grandma’s ashes, the personal liability coverage attached to your homeowner’s policy may cover the resulting damages. Consider maintaining a minimum of $300,000 of personal liability insurance coverage.
Renter’s insurance is very similar to homeowner’s insurance with the obvious exception of the dwelling. You don’t own it and are not required to insure it; however, it is very important that renters do not assume they don’t need coverage because they don’t own the building. The property and liability insurance is still vital. Your clothing alone is something that most couldn’t afford to replace, not to mention all of your other household items. And remember, the liability insurance follows you even when you’re not in your own apartment or home.
Excess Liability (Umbrella) Insurance
So, I still haven’t answered the $950,000 question. How do you cover the cost of the lost lawsuit in excess of your underlying liability coverage? The answer is supplemental liability or umbrella insurance. In addition to the liability provided by your home and auto insurance, we must recognize that, while living in the most litigious society on the planet, we may well be faced with a liability suit above the $300,000 or $500,000 policy limits, the balance of which we’d be responsible to pay. An umbrella policy guards you from those litigious clouds that may rain down on your home or auto worlds.
Supplemental liability coverage is typically purchased in increments of $1,000,000. Therefore, if you had the car accident that was your fault and the lawsuit awarded to your victim was outside the parameters of your bodily injury liability protection with your auto policy, your supplemental liability policy would pick up the difference. So, in our story, if you only had $100,000 of bodily injury liability protection, the umbrella would cover the remaining $850,000. Know, however, that most insurers will require you to increase your underlying auto coverage to $250,000/$500,000 in order to give you umbrella protection.
The old rule of thumb was that you only needed an umbrella for up to the value of the assets that you own, but this is one instance where I recommend that virtually everyone purchase at least a $1 million umbrella policy because the cost is so low. The last time I looked into it, the premium quoted was under $250 per year, possibly as low as $150. Remember that a lawsuit you can’t pay today may garnish your wages until it is paid off. So, unless your future wages are a luxury you can do without, consider the umbrella. If your net worth is in excess of a million dollars, consider purchasing additional umbrella coverage in increments of $1,000,000.
Economic Bias Alert!
One of the most fascinating examples of economic bias in this book is that of the home and auto insurance agent. While most salespeople have an incentive to sell more, some home and auto agents have an economic bias to sell less!
An auto agent sells policies for which you and I pay premiums. Those premiums go into a virtual bucket, and throughout the course of the year, claims are paid out of that bucket. If the agency takes in more premiums than they pay out claims in a year, they have a profit; if the reverse, a loss. Most agencies are incentivized to keep that number in the black with the award of a persistency bonus—a cut of the profit.
This is the reason I once had an insurance agent advise me not to purchase an umbrella policy that I wanted to buy. The agent would only take in $200 in premium for the year, but the claims risk potential was $1,000,000! Many insurance agencies, then, have an economic bias to sell you less than you actually need. Good agents do not engage in these practices, but you should be aware of the possibility to make certain that you’re adequately insured.
Price is not the only factor in determining which insurer you use. The company with which you do business does matter. Do your homework to determine which companies in your area have the best service and claims records. Your geographic location will be a major factor in determining which company will offer the best coverage for the lowest price, but don’t forget the importance of a good service and claims record as well.
Some companies will automatically cancel you after only a single claim, and it’s not worth it to save money to go with one of them because once you’ve been cancelled, it’s hard to find new coverage. Several highly-rated companies now offer “First Time Accident Forgiveness,” ensuring you won’t be cancelled or have a rate increase after one incident, and while that is in part a clever marketing campaign, it can also be a valuable benefit.
Consider quoting with the “15-in-15” company and the “forward thinking” bunch, but also quote other national and regional companies that may have more favorable rates in your area. Some companies offer participating policies. These companies may return some of the premium to their policyholders in profitable years, and mutual insurers will offer policyholders company stock if they ever go public. If you’ve ever been connected with the military, the organization exclusively serving current and retired military is known for offering some of the lowest rates and best service.
Timely Application
Home and Auto Insurance Audit
In order to know if your home and auto insurance policies are providing you with the appropriate levels of coverage, you’ll want to collect the declaration pages for all of your home, auto, condo, and renter policies. The Application Exercise online will provide a chart to fill in your various coverage limits next to our recommended minimum limits.
After you’ve tailored your desired limits with the help of an independent planner who does not accept commissions or referral fees for the sale of insurance, you can use the Application Exercise to shop your coverage with several carriers.
Visit www.ultimatefinancialplan.com to find a template to use in creating your own Home and Auto Insurance Audit.
Tim Maurer
Building wealth and planning your financial future without protecting your family and your assets through appropriate insurance is like trying to fill up the bathtub with the drain open.
Bad things inevitably happen to good people. You want to take every step possible to make sure these bad things don’t happen to those you care about, but if you do become one of those unfortunate statistics, proper insurance can be the difference between your dreams coming true and a nightmare.