March 3, 2009 at 8:00 AM ET
If you're struggling to make ends meet, one obvious place to cut costs is to stop paying for something that gets you nothing. I'll bet you've looked more than once at an insurance bill and asked yourself the simple question: "Why?"
The average American spends more than $2,000 each year on auto, life and homeowners' insurance. And what do you get for that money? Not very much. For example, only about one in 15 drivers makes an auto insurance claim every year.
On the other hand, you probably know better than to question the need for insurance. Even if you've never had an accident, you know your time will likely come. And when it does, it'll be costly. The average auto insurance claim payment is nearly $4,000. Plus, auto insurance is required by law, so you don't really have a choice.
It is not required that you overpay, however, and many people do just that. Here are a few tips you can use to pare down your insurance bills without putting yourself at unnecessary risk. I'll focus on auto insurance, but mix in a few tips about life and homeowners policies as well. And many of the principles apply to any kind of insurance you buy.
It helps to think of insurance as a concept as well as a product. Insurance was designed centuries ago to ease catastrophic losses by individuals by spreading risk over wide pools of contributors. One oft-told story has it that Chinese traders invented insurance by spreading their goods among each others' trading ships, so that no merchant would be wiped out if a single ship was lost at sea.
Notice I used the word "catastrophic." Insurance was never designed to make your life easy, and it's not really designed to make you whole after an accident either. It's designed to prevent you from being wiped out. If you get in a small fender-bender that requires some paint touch-up, you should expect to pay for those losses yourself. Save the insurance for the big event when you really need help.
In practical terms, this means most people are better off keeping deductibles on their policies high. The two most common optional coverages on auto policies are collision and comprehensive – collision covers the cost of repairing your car after accidents that aren't covered by someone else's policy, and comprehensive covers everything else (mainly fire and theft). Since you shouldn't make a claim for a $565 repair, you shouldn't pay for that level of coverage either. Raising the deductibles on your auto insurance policy is probably the single quickest way to save money. How much? Raising the deductible from $200 to $1,000 on comprehensive insurance will save an average of 40 percent or about $100 per year.
As a matter of sound financial planning, you should "self-insure" against the cost of these smaller incidents. That means when you raise your deductible to $1,000, you should simultaneously put $1,000 in an interest-bearing account that's earmarked specifically for small auto-related troubles. This way, when a theft or fire occurs, you can cover the expense relatively painlessly. In the meantime, you have the extra $100 each year – not your insurance company -- and you earn the interest.
There are many consumers who should consider dropping collision and comprehensive coverage altogether. Remember, these insurances are designed to protect you from a catastrophe. If your beloved clunker is only worth $1,800 and has a real replacement value of $1,200, it doesn't make sense to pay for comprehensive coverage with a $1,000 deductible. Many consumers fail to realistically assess the replacement value of their car and the real value of their comprehensive and collision coverage. In 2006, the last year for which figures are available, the National Association of Insurance Commissioners said 77 percent of drivers bought comprehensive coverage and 72 percent bought collision. I know there are more clunkers out there that that. This is why it's so important to reassess your insurance policy every year.
When should you stop paying for collision and comprehensive? It's a personal choice, but here are some rules of thumb: As soon as you get to the point where you wouldn't spend $2,000 to fix your car, drop the extra coverage. Or, if you'd like a more complex formula that's often used, drop coverage when your annual premium multiplied by 5 exceeds the value of your car. If you already have that $1,000 set aside as your own "self-insurance" policy, that money can ease the blow if your car is stolen.
There's no way to skimp on the third main element of most drivers' insurance policies: liability. In fact, many insurance experts think consumers generally buy too little liability coverage. Minimum coverages are specified by each state's insurance regulators. Here's one list of state-by-state requirements.
You will often see liability insurance expressed as a series of three numbers, like this: 25/50/10. That means your state requires $25,000 in coverage for a single person's injury in an accident, $50,000 in coverage for all people who might be hurt, and $10,000 coverage for any property damage. It's important to note that who gets paid by your insurance company after an accident varies based on whether your state is a "tort" state or a "no-fault" state. In tort states, the responsible party's insurance firm pays. In no-fault states, your insurance will pay you no matter whose fault the accident is. So if you skimp on coverage, you might actually be skimping on your own payouts. Twelve states currently have no-fault rules, according to the Insurance Information Institute (click for a list).
How much coverage should you have? Consumer Reports last year recommended 100/300/100 for an average middle-class worker. To be more specific, your coverage should grow with your income and assets. Think like a lawyer for someone you've hit in a car accident. If you have assets in excess of $300,000, someone might sue you for their value. So you should have at least enough liability coverage to protect your assets in case of an accident.
One other thing to look for: Many insurance companies load up policies with unnecessary extras like roadside assistance or rental car reimbursement. While roadside plans from insurers can be a good deal, make sure you aren't covered twice (perhaps by AAA, or your cell phone or your car manufacturer).
Rental car reimbursement can be handy, but it doesn't fit into the category of preventing catastrophe. In this economy, it's probably a luxury you can live without.
Even if you've done all these things to keep your insurance premiums down, you should take the time to get price quotes from competitors once each year. Auto insurers have a secret sauce they use to price policies. It includes arcane and unexpected items like your credit score. The only way to find out if you are paying a fair price is to see what the competition charges. Make sure you compare apples to apples when pricing polices -- same collision deductible, same liability and so on. Some insurers make that difficult, but it's worth the effort.
Other insurance tips
Finally, if you want to switch providers, do a little background check before you do. About half of U.S. states maintain extensive databases of complaints against insurers. The numbers are boiled down to a single rating called a "complaint ratio," which is essentially the number of complaints per customer each company gets. If you are thinking of signing up with a new company, make sure you aren't jumping to a leaky ship by first checking the complaint ratio database on your state's regulators Web site. How do you find that?
Here's a link to a state-by-state listing of insurance commissioners
Once consumers get into a home, they often allow their bank to pay their homeowners' insurance automatically through escrow payments. Then they forget all about it. Big mistake. Homeowners premiums can vary widely and also can be impacted by seeming unrelated items, such as a change in credit score. It's important to get competitive bids for your home insurance at least once every few years. Also, it's really important to avoid filing homeowners claims, and there's evidence that you shouldn't even place a call to your insurer asking about whether or not you should file a claim. Insurers share information on claims through a big database called CLUE -- Comprehensive Loss Underwriting Exchange. Sometimes, insurers make entries simply based on consumer inquiries. Avoid getting into this database at all costs. Handle small home accidents yourself.
And, if you've done anything to make your house safer – such as adding an alarm or helping to pay for a new fire station nearby -- make sure your insurer knows about it.
Life insurance comes in so many flavors that I can't address then all in this column. My colleague Laura Coffey covered most of the basic ways you can save on life insurance in a recent column.
A few points should be stressed. Just like any other kind of insurance, life insurance should be there to prevent a disaster, such as premature death of a family's wage earner. It should not be confused with an investment vehicle. Life insurance policies that are bound up in retirement plans are generally a bad deal, and they are almost always confusing. Keep it simple. Buy what you need to take care of your loved ones if you die. How much do you need? Here's one calculator
The most common mistake people make is ignoring other sources of income available to the surviving spouse, such as Social Security benefits, when making the calculation. You'll need less insurance as life goes by and the kids finish college.
The best way to save money is to be healthy. Life insurers punish smokers with higher premiums. Ditto for those with high blood pressure or heart-related health issues.
The good news is that life insurance rates, overall, are plummeting. Premiums dropped 50 percent from 1994-2007 according to the Insurance Information Institute, thanks to better risk-assessment formulas and, naturally, competition.
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