If you’re like most people, buying insurance gives you that feeling of throwing money away. “Everything’s going to be OK, I’m not paying for something I’m never going to use.” Or, “let me get the cheapest stuff out there because I’m never going to use it.”
We totally get that and are here to help you understand two important components of insurance.
- You can either retain a risk or transfer a risk.
- When you buy insurance, you shouldn’t be picking numbers out of the air. The appropriate coverage can be proven and obtained arithmetically (with a calculator).
To retain risk means to take it on yourself. To insure yourself. For example, if you don’t have homeowner’s insurance and your house burns down, you will have to pay out of your own pocket to rebuild.
To transfer risk means to make it someone else’s problem. Using the same example, when you buy homeowners insurance, you transfer the risk of the house burning down over to an insurance company. You pay a premium each year to transfer this risk, and if the house burns down, they are the ones that replace it.
The retain vs transfer risk comparison can be made across many areas – future income, sickness, injury, cars, boats, houses & lawsuits.
We don’t have to be emotional about it. We can use some simple math and analysis to determine the most cost-effective ways to transfer risks, or even retain them responsibly.
One more thought:
These types of decisions around risk are usually made in the moment, not taking into account other aspects of your finances. When done appropriately, insurance decisions are made IN THE CONTEXT OF YOUR ENTIRE FINANCIAL PICTURE. Considering insurance salespeople typically don’t deal with any other aspects of personal finance, this is tough to be aware of and achieve.
Imagine if you were highly educated on risk transfer, cost-effective insurance ownership, and had it all integrated with the rest of your planning? Now that would be a massive shift.