Don't get trapped by overindulgence, bells and whistles, too many organizations taking their slice of the pie or those prone to fly-by-night. When it comes to insurance, stick with the basics. My father and my first-year college economics professor had the same view on insurance: It's important to insure against what you cannot afford to have happen and a waste of money, time and effort to insure against anything more. The best insurance organizations help you do that and make a fair profit on the value they create. The worst make money at their customers' expense.
My economics professor used an example of 10 farmers who live on the food they produce. Each year one of the farms fails. Without insurance, the family on the failed farm starves to death. The alternate approach is for each farm to put aside 10% of their food each year to help the farm that fails. This way, each farm consumes 90% of its food (or 10% of nine other farms' food) each year and everyone survives.
Since the farmers in this example are collectively self-insured, there's no friction in the system and all the "insurance premiums" go directly to helping those that need it.
Today, there are several different types of insurance organizations:
Cooperatives like Northwestern Mutual have infrastructures to manage their insurance and investing operations but give all their profits to their members in the form of dividends and the like.
Former cooperatives like USAA still very much put their customers first. As one of their vice presidents, Eric Vaith put it: "All employees live by our core values of service, honesty and integrity. These core values are also key influencers for every interaction our employees have with our members."
Some insurance companies like Zurich's Farmers started by insuring a sub-set of the market (like farmers), tailoring products to meet their needs.
Other highly rated companies like Progressive, Allstate and Geico have been investing more heavily in advertising recently, while stalwarts like AIG and The Hartford command high renewal rates and companies like State Farm, Liberty Mutual and Travelers and a host of other, smaller organizations make the field highly competitive.
In any case, as RHR Executive Search's Insurance Industry Leader Lou Hipp explained to me:
"Insurers make money off investments. That is at the core of how insurers are able to keep rates low. By collecting premiums and investing them over a number of years, when it comes time to pay the claim, it is less of a financial blow to the insurer. And in a competitive market, that means better prices for consumers. Lately, we all know that investment returns have not been what they once were, and this has caused tremendous strain on the industry, as they have tried to keep their pricing in check."
Trap #1 - Not insuring what you need to insure. This involves hoping that bad things won't happen to you. Hope is not a plan. There are different implications for different types of insurance: life, health, property and casualty. Some are about what you cannot afford. Some are about what others cannot afford to happen to you.
Trap #2 - Bells and whistles. Some insurance companies have increased their profits by selling insurance polices with lower payouts. In some ways this is all about the actuarial tables and the odds of things happening. If you're a 25-year-old male, you really don't need your own pregnancy covered in your insurance policy. Insure against things that matter at a meaningful level, self-insuring some things and "nuisance risk" by choosing higher deductibles with their related cost savings.
Trap #3 - Slices of the pie. The more people involved in the process, the more of your insurance premiums get sliced away from helping you. Look out for layers of salespeople, management and the like.
Trap #4 - Fly-by-night. Know who's managing the business and ask who's insuring the people insuring you. You don't want your insurance organization to get wiped out by a catastrophic event or bad management over time. This is why it makes so much sense to consult the AM Best ratings or state insurance information before you choose your insurer.
Implications for you
1. Insure what you cannot afford to have happen.
2. Do not waste money insuring against things that you can afford to have happen.
3. Look for minimum friction by those managing your insurance.
4. Make sure the organization that insures you will be able to pay what you need when you need it.