Dear Young Friend,
We haven't talked much about insurance and risk. Before we wrap up our conversations, I wanted to share some thoughts on this.
Karen
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Here's a question for all my twenty-something friends: What do you worry about?
What kinds of things should you be worrying about?
The trick is paying attention to the concerns that really deserve it. That's one of the not-so-exciting things about becoming an adult: thinking about the risks we face and taking responsibility for handling them.
Every situation poses some type of risk.
Maybe you're taking a road trip with your BFF. There's always the risk of an auto accident or car trouble. There's a chance that you'll pick a bad restaurant along the way and have a lousy meal. There's a risk that you'll get stuck if your go off-roading with your 10-year old sedan.
Say you're getting married and you've got your heart set on a garden wedding. There's a risk that it will rain. There's a risk that your fiancé and you will break up before the big day. There's a risk that at least one bridesmaid won't like her dress, and there's always a chance that your engagement ring will be lost or stolen.
Ways to deal with risk
You have four basic choices:
Bear the risk: If it happens, deal with it.
Transfer the risk: Make it someone else's problem. Usually, this means buying insurance so the insurance company else has to cough up if bad things happen. (Of course, you'll still be on the hook for the deductible.)
Reduce or control the risk: take steps to reduce the likelihood that the bad thing will happen, or to control the amount of damage.
Remove the risk: Avoid it! Make choices that rule out any possibility that it could happen.
How to Decide
Choose your strategy based on how big the risk is – how much it could cost, or how much the damage could be – and how likely it is to happen. Some events could have huge consequences: your apartment building burns down. Others would be minor financial inconveniences: your hair dryer dies. Some are fairly likely to happen (being in a fender-bender), while others are a fairly remote possibility (being struck by lightning).
Some rules of thumb may help.
Bear the small risks. For example, take a pass on the extended warranty on the TV that cost $200 and the trip insurance for your $300 airplane ticket.
Insure the things that pose a significant financial risk. Purchase medical insurance, choose high liability coverage on your auto insurance policy, pay for the disability insurance offered by your employer, and buy life insurance if you have young children. Without those, an accident or serious illness could leave your bankrupt and your children at the mercy of someone else to pay the cost of raising them.
Think about how much you can afford to lose. With many types of insurance, you decide how much you'll have to pay yourself before the insurance kicks in. That's your deductible. If you can handle a $1000 deductible on your auto insurance policy, you'll pay a lot less for your insurance. But before you choose that large of a deductible, be sure that you'll keep $1000 in your emergency fund or that you'll have plenty of credit available on your credit card.
Back to the road trip and the garden wedding…
Let's use the two scenarios we started with and look at how we might handle the risks.
The road trip with your BFF:
- Auto accident: Transfer most of the risk by purchasing auto insurance. Reduce the likelihood of an accident by watching your speed, stopping when you get sleepy, and not texting while driving. Control the amount of damage by wearing your seat belt.
- Car trouble: Reduce the likelihood by having regular oil changes and having the car checked before the big trip. Reduce the cost and inconvenience by having enough money to pay for repairs.
- Picking a bad restaurant along the way: Bear the risk – take the chance. Reduce the likelihood by checking online reviews. Or avoid it by carrying your own food in a cooler.
- Getting stuck if your go off-roading in your 10-year old sedan: Remove the risk. Skip the off-roading and stay on the paved roads.
The garden wedding:
- It might rain. Control the risk by arranging for a covered area you can use if the weather doesn't cooperate.
- Your fiancé and you could break up before the big day: As far as I know, there's no insurance policy available for this one, so bearing the risk is the obvious answer. But you might take steps to reduce the chances it will happen, such as having frank discussions about finances, children, faith, etc. or having a long engagement.
- At least one bridesmaid won't like the bridesmaid's dress you picked out: Remove the risk. Pick the color and let each one pick her own style.
- Your engagement ring is lost or stolen: Transfer the risk with insurance. Your renters or homeowners insurance will provide limited coverage for jewelry. To cover the full value, you could add a rider to your policy or purchase a floater policy specifically for the ring. You can reduce the likelihood of loss by having the ring sized to fit properly and always putting it in the same secure place if you take it off.
In life there will always be risks; you get to decide which ones are worth worrying about. Weigh the costs of insurance against the possibility you might have to pay if something bad happens. Spend time and effort to manage risks, or allow nature to take its course. It's your choice!
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This post continues a series based on conversations with a young friend of mine about the financial decisions and challenges of being an independent young adult in today's world. You can find other posts in the series by clicking Organizing Finances in the Category list on the right side of this page. ~Karen