A Common Insurance Planning Mistake – Rey Arellano, CFP®
Although often overlooked, insurance planning is a fundamental aspect of being financially sound. Usually, people do not like to talk about insurance because it involves losing something, i.e., wrecking your car, an injury preventing you from working, or the loss of your property. However, being underinsured (or in some cases over insured) could be a costly mistake that can easily be avoided with proper planning. The following is an example of how analyzing a policy led us to saving clients’ money and making sure they were properly insured.
Comprehensive vs Liability Auto Insurance
People usually get comprehensive coverage when they first insure a new car. They renew their policies without ever checking to see if the car being covered is worth the extra coverage. Over time, the amount people pay for comprehensive coverage no longer makes financial sense.
A general rule of thumb on when to drop comprehensive coverage and only carry liability insurance is when the replacement value of the car is less than ten times the annual premium one would pay for that coverage. For example, if your car is worth $5,000 and you are paying $540 a year for comprehensive coverage, consider dropping that coverage. If a person were to file a claim, they would have to pay a deductible, usually in the range of $250-$1,000. Although insurance companies have made it very easy to renew auto policies, their automatic renewal procedures might cost you.
Earlier in the year, we had two clients for whom we did an insurance review (we have changed their names for privacy reasons). Tom had a 2009 Honda CRV worth close to $8000. Ann had a 1998 Honda Civic worth $500. They both had comprehensive coverage on the cars, with an annual cost of $266 for the CRV and $185 for the Civic. The deductibles on the policy were $1,000 for each car; that is what Tom and Ann would have to pay if they filed a claim.
Per our rule of thumb, Tom’s CRV is still valuable enough to have comprehensive coverage ($266 x 10 is less than $8,000). However, Ann’s Civic is not ($185 x 10 is more than $500). Additionally, if Ann were to file a claim on her Civic, her insurance company would only pay for the replacement value of the car, minus the deductible. Meaning, if Ann totaled her car, the insurance company wouldn’t pay anything because the $500 replacement value is lower than the deductible. The $185 Ann is paying for her comprehensive coverage is only going into the insurance company’s coffers because there is no benefit even if Ann filed a claim!
It is no surprise these scenarios occur often. However, by analyzing a policy, we can help clients determine if they are properly covered and if they can save money.