Conventional insurance policies provide protection from catastrophic events that would normally bankrupt a business or family. Instead, the insurance company absorbs the risk of this loss and pays a claim when the event against which an individual or business is insured occurs. Without conventional insurance, you would need to insure for these risks yourself. Before attempting such a feat, you should understand the advantages and disadvantages of conventional insurance.
Advantage: Decreased Risk
Conventional insurance transfers risk away from you and onto the insurance company from which you purchase a policy. This transference decreases the probability that you'll experience serious financial trouble due to a catastrophic or other unexpected event. Life insurance, for example, decreases the risk that your family won't be able to pay ordinary expenses if you die before you save enough money to pay all your outstanding debts. Health insurance decreases the risk that you'll need to pay for significant medical treatment out of your own pocket.
Advantage: Increased Potential
Conventional insurance allows you to spend more time and money engaging in activities you could not otherwise pursue. A company with liability insurance can use more revenue to expand and grow the business, since a smaller reserve of cash is needed to pay potential claims, legal expenses and other costs associated with legal action by an outside party.
Paying premiums is one disadvantage of conventional insurance. Premiums may increase over time and you must pay them, whether you file a claim or not. If you hold a policy for 20 years yet never file a claim, the premiums paid over that time period represent a cost you can never recover.
Underwriting may pose a challenge in certain situations. Underwriting is the process an insurance company uses to determine the risk it takes and then quantifies that risk in dollars. Underwriting often involves a health exam for life insurance, but underwriting may also involve analysis such as examining driving records and history for automobile insurance. Perhaps you're not in the best of health and need life insurance. You might also possess a poor driving record, yet you still need automobile insurance. Under either of these circumstances, you could end up paying a higher premium than usual. You could opt to forgo insurance in both of these instances and keep the money you pay out in premiums for yourself. You would most likely want to invest this money in the event you needed to fix your car or make it available for your family when you die. While retaining your premiums in cash poses a risk -- since you may not accumulate funds as quickly as an insurance company does -- paying high premiums can sometimes feel like you're overpaying for insurance.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
- "Life Insurance"; Kenneth Black, Jr., Harold D. Skipper, Jr.; 1994
- "Actuarial Aspects Of Individual Life Insurance And Annuity Contracts"; Albert E. Easton, Timothy F. Harris; 1999
- "Ernst & Young's Personal Financial Planning Guide, 5th Edition"; Martin Nissenbaum, Barbara J. Raasch, Charles L. Ratner; 2004