We have one simple rule that helps us make decisions about insurance:
Insurance is meant only to protect from financial catastrophe.
This is our guideline in determining what our deductibles should be. For example, most auto insurance policies have a choice of deductibles ranging from $250 to $1,000. “Financial Catastrophe” means something unique to everyone and every situation. If we were to have an accident tonight, we could cover $1,000 in repairs using cash from our wedding savings account. It would be painful, but it would not come near to qualifying as a financial catastrophe. So our auto deductible is $1,000. This helps save us money on the cost of our policy.
Many people make the mistake of thinking that insurance is meant to protect you from feeling the minor consequences of a loss. In the case of an auto accident, everyone would rather pay a $250 deductible than a $1,000 deductible. Paying $1,000 to have a bumper fixed feels rotten, but it is better than paying for more insurance coverage than you actually need.
A true financial catastrophe means losing the ability to pay for basic needs, such as housing, food, and your minimum debt service. A financial catastrophe isn’t just taking money out of savings or having to trim expenses to bare bones for a short period of time.
What magnitude of loss would be a financial catastrophe for you? Do your insurance deductibles align accurately with your needs?