Today’s post is inspired by a recent experience with home insurance.
Earlier this week, I was looking online at a price comparison website to purchase a buildings and contents insurance policy for my house.
One of the options I was asked was whether I would like a high excess (£500) or a low excess (£50), should I ever need to make a claim.1For readers not in the UK, an excess is the same as a deductible and is the amount you need to pay out of your own pocket before you can file a claim with your insurance company.
For the seemingly small difference of £450 between the low excess and the high excess, the disparity in the overall cost of the insurance policy was over £250 (the cheapest policy was £177 with the high excess, and £446 with the low excess).
That’s a lot of money, especially since you could invest that same yearly figure in a low cost index fund for 15 years and net yourself a cool £8,544.68.
That’s right, over £8,500 in savings simply for choosing a lower excess. Now that’s a money saving method we can get behind.
It’s even more mind-blowing when you consider that home insurance is just one type of insurance that you purchase every year.
When you add in the cost of insurance for your car, life, gadgets, valuables and anything else you choose to insure, these figures can snowball into the hundreds of thousands over an extended period of time.
But wait. If I choose a higher excess, then I have to pay out more when I claim. That can’t be good.
You make a valid point. But relax young money saver. The Lawyer On A Mission has you covered.
What’s important to understand is that insurance companies make their money using statistics. They employ some of the cleverest and brainiest mathematicians in the world to create complicated predictive models of how much they will need to pay out in insurance claims each year.
They then set the price of your policy and your excess so that, on average, they can pay your claims, cover the cost of their employees and other running costs, and still make a pretty profit on top.
Even if they experience a record number of claims in a certain year, they will still factor in enough headroom in the price of your insurance policy so that they can continue running as a profitable business when claim volumes return to normal levels.
This means that whatever you are paying for your insurance policy, you are not getting nearly as much of a return as you are putting in.
Think about it. If purchasing your insurance policy actually saved you money on average, then the insurance companies would have to pay out more than they receive through selling the policies.
In short, they would lose money. And I don’t know about you, but I don’t see a whole load of insurance companies going bust at the moment.
But what if my phone breaks, or the boiler goes on the blink, or my washing machine dies. I’ll need insurance then, right?
The truth is, insurance companies play on those little niggling feelings of fear, uncertainty and doubt that crop up in the back of your mind.
If you see an option to insure your washing machine or extend the warranty on your laptop, you start thinking of all the ways that your washing machine could fail or your laptop could break.
Human beings are masters at imaging these negative outcomes. In fact, it’s been hardwired into our brains through evolution.
In the days of primitive humankind, those of us who envisaged bad times ahead were usually the ones sensible enough to plan for the future. We therefore out-survived our more carefree contemporaries who failed to prepare for the imminent danger.
Luckily, society has evolved since then, and we don’t have to worry about being ambushed by a sabre tooth tiger or being eaten by a lion in the savannah.
However, those neurological pathways in our brains which cause us to overestimate the probability of negative outcomes still exist.
It is these exact fears that insurance companies tap into to make us buy all sorts of insurance products that we don’t actually need.
These fears are amplified during times of global crisis. You know, like a worldwide pandemic or a war in Eastern Europe.
The more doubt you have over the certainty of your future, the more likely you are to seek some form of guarantee that if things go wrong, someone will help you pick up the pieces.
The answer? Insurance of course, to cover every possible circumstance.
So how do I overcome my chimp brain and stop being so afraid all the time!?
The reality is that you can’t really overcome your evolutionary make-up. It’s been that way for millions of years and will probably continue to be so for millions more.
However, by being rational and realising that, statistically, the chances of these negative events happening is actually far lower than your brain tells you, you can make better decisions about which types of insurance you need.
Now obviously, you can’t just avoid getting any insurance. Sometimes you are obligated to purchase it legally. Or you might choose to get it where you literally cannot afford the consequences if the worst does happen (e.g. a house fire).
However, for the vast majority of other types of insurance, you can rest easy in the knowledge that statistically speaking, you are better off not buying the insurance in the first place and sticking the savings in a safe and diversified investment fund instead.
And for the insurance that you do have to buy, increase the damn excess and invest the savings from that. The only thing you’re doing by lowering your excess and paying more for your policy is feeding into the insurance companies’ profits.
Even if you do have to make a claim with your higher excess, then at that point the odds are reversed. Now you’re in the driving seat. To use my example, if my house does burn down, I’ll be paying a £500 excess in exchange for several hundreds of thousands of pounds to rebuild my home.
That’s an astonishing rate of return and a very good bit of business. What’s more, you’ll probably be able to pay the higher excess with the profits you make from your investment. Isn’t that neat?
Learn To Play The Odds
When it comes to insurance, let the maths do the talking. Get insurance policies where you need to, avoid them where you don’t, and invest the savings that you make.
Knowing you’re not covered may even inspire some positive behaviour changes.
By avoiding that unnecessary dental insurance policy, you’ll be incentivised to brush your teeth for longer to keep your dentist pleased and your teeth operation-free.
You’ll have a larger bank balance and a brighter smile. Now doesn’t that sound good?
I’ll see you in the next one.
Disclaimer: I am not a professional financial advisor, so nothing you read on this blog should be taken as investment or financial advice. Instead, this platform uses my own lived experience and publicly known factual information to produce articles for research and entertainment purposes. Please seek your own independent investment advice from a professional advisor before making financial or investment decisions. Thank you!