Your Financial Future:
The Basics About Insurance
For a PDF version of this Fact Sheet, click here.
These days, it is possible to buy insurance for just about every aspect of your life and property. It can be very hard to distinguish what is necessary to keep you safe financially from what might be a waste of your money. This fact sheet will help you sort through the insurance options available to find what you really need. But first, a quick run-through of how insurance payments work:
- The amount you pay for any type of insurance is called a premium. These vary largely, so it is important to shop around by comparing quotes and contacting insurance companies directly.
- Your premiums are directly related to another amount, called your deductible. This is the amount per year you are required to pay before your insurance company helps pay for anything. For example, let’s say that you get into a car accident that causes $2,500 in damages. If your deductible is $500, you are required to shell out $500 of your own money to pay for the damages before your insurance company will pay for the other $2,000 in damages.
- Generally, the higher your deductible, the lower your premiums, so it is often smarter to get the highest deductible you can afford to pay. However, you should evaluate your own tendencies because if you find yourself frequently paying for routine costs, it may not make sense for you to pick a high deductible, as you will end up footing a bigger bill on services.
- Health insurance policies will also often require you to make a co-payment (or co-pay), which is a flat amount that you pay for every doctor’s visit or to receive a medication. You may even have to pay coinsurance after you’ve met the deductible, which is a percentage of the health care costs. For example, if your coinsurance rate is 80/20, your insurance company pays 80% of your medical expenses while you’re responsible for the remaining 20%.
- Check the credentials of the insurer with your state insurance department to ensure you’re protected if they become bankrupt, as well as the qualifications of an agent if you use one.
You need health insurance, even if you are young and healthy. If you get into an accident, you could be hit with thousands of dollars in medical bills that will quickly put you in financial trouble. If you are lucky, your employer offers health insurance, otherwise you may have to get coverage on your own. If so, do your research to find a reasonably-priced plan that focuses on covering any major medical problems. Your plan should cover at least 80% of hospital and surgery bills once you meet your deductible, any prescriptions you need, and at least a $1-$2 million maximum lifetime benefit (the amount the company is willing to pay over your lifetime). Some cheaper alternatives to buying an individual policy are state-run options, your parents’ plan, a group plan, or temporary coverage.
If you are young, it may be too early to start paying premiums on long-term care insurance, which covers a broad range of health and support services for people who have chronic illnesses or disabilities. Instead, to cover you in case you get injured and can’t work, look into getting disability insurance through your employer or individually.
What can I get from my employer?
The type and amount of insurance employees get varies widely, so it is crucial to read the information your employer provides on their health, life, disability, and other insurance policies. If you have any questions about your coverage, make an appointment with the person in charge of benefits at your company to get your questions answered.
Types of Employer-Sponsored Plans
Flexible Benefits Plan: This type of plan is also sometimes called a “flex plan” or “cafeteria plan.” It allows you to choose what benefits you want and often includes choices about noninsurance benefits such as paid time off, legal services, or 401(k) contributions. With this type of plan, your employer gives you a fixed number of “credits” to spend on benefits. These decisions will often be based on family status. If you don’t have children, you may spend your credits on better health insurance and forego a life insurance plan. Similarly, if you are covered under your spouse’s health insurance plan, you may want to put your credits towards disability.
Flexible Spending Accounts (FSAs): These are tax-favored accounts in which you can set aside a fixed amount of your own money taken from your paycheck to pay for specific medical expenses that are not covered by health insurance. The advantage of these accounts is that you deposit money on a before-tax basis, and it never gets taxed. Rules on what expenditures can be made with money from an FSA account often vary from company to company, but some unified rules can be found in Publication 502 at www.irs.gov.
One Benefit of FSAs: The accounts are prefunded, meaning that you get the whole sum of what you agree to deposit from your monthly paychecks all at the beginning of the year.
One Drawback of FSAs: If you do not use the money you put into the account for the year, you will lose it, so make sure you put in only as much as you’re sure you will spend.
This type of insurance protects you if you encounter any serious, long-term illness or injury over the course of your working life, regardless of whether or not the condition results from your job. For women, pregnancy can be considered a short-term disability, so this type of insurance can be very valuable to your financial security if you are planning on having a family. Disability insurance, however, is not the same as workers compensation, which is only available to you if you are injured on the job or as a result of your job.
There are three types of protection:
- Auto liability coverage: Protects you from damages to others or to property while you are driving.
- Medical payments coverage: Covers your medical bills if you are injured in an accident.
- Collision and comprehensive coverage: Covers physical damage to your car.
Additionally, some drivers buy underinsured or uninsured motorists coverage. This protects you if you ever get in an accident with or are hurt by a driver who has too little or no insurance.
This protects your home and a certain monetary amount of its contents against natural disasters and theft. It can also cover damages that visitors do to your home, damages that you do to others’ homes, as well as medical costs for someone injured in your home. How do you know how much to buy? Use the guidelines below to help decide:
- The Home Itself: Make sure you have enough insurance to cover the full amount it would cost to rebuild your home, called the “building cost per square foot.” A local insurance agent or builders association should provide you with this information for free. If you multiply this number by the number of square feet in your home, you should get an estimate of the rebuilding cost.
- Personal Property Insurance: A typical policy will insure your personal property up to a value of 50% to 70% of your home structure rebuilding cost. For an extra cost, you can get a higher value of personal property coverage if you see it as necessary, or cater your policy to have a higher limit for certain types of belongings. When assessing the value of your belongings, remember to think about replacement costs. The cost of buying comparable items to replace your current belongings is the important number.
- Liability Protection: You should have a rough idea of how much you need to protect yourself against any accidents that may happen inside and outside your home. The amount should exceed the value of all your major assets, including your retirement savings and investments.
Your Options For Homeowner’s Insurance:
- HO-2: Also known as “broad coverage,” it provides the three protections outlined above in 17 listed perils. For example, it covers damages from fire, hail, vandalism, theft, etc.
- HO-3: Also known as “special coverage,” it covers your home from all 17 perils listed in the HO-2 policy, as well as any other peril not specified in the policy (excluding flood and earthquake damage). Get this if you can, as its coverage is much broader and it is not much more expensive.
- HO-4: This is tenants or renters insurance. Most young people are renters, so this type of homeowner’s insurance is important to consider. It covers the cost of belongings lost in a fire, storm, or theft. Renters insurance can also cover the liability associated with accidents that occur on the property that you are renting.
- HO-6: If you live in a co-op or condo, this policy will protect your personal property and the unit you own but not the entire common property.
- Catastrophe Insurance: Most homeowner’s insurance policies do not cover flood damage. Some people in flood-prone or other areas in which natural disasters are common choose to purchase flood insurance from the federal government. This is fairly inexpensive but is very valuable if your home is destroyed or damaged by catastrophic disasters. Find out if your home is in an at-risk area on http://www.floodsmart.gov/, or go to http://www.earthquakeauthority.com/ if you are in an earthquake-prone area to look into earthquake insurance.
Depending on your family status, you may not need life insurance. Its main purpose is to protect others that rely on your income, so you should only buy it if others are financially reliant on you. If you do have kids or a spouse that could not handle basic living expenses without you, here are the types of life insurance to consider:
- Term Life Insurance: This is life insurance that you purchase for a set period at a time, usually 30 years. It can generally be renewed when the term runs out, and it can also be converted into a permanent plan. If you die, your beneficiaries receive something called a “death benefit” from your insurance company. For young people, premiums are usually pretty low, around $150 per year, and do not increase very drastically over time. Even if you do not have a family to support, you may want to consider term life insurance to avoid financially burdening your parents with your outstanding debts and burial costs in the event of your death.
- Permanent Life Insurance: Also known as a “cash value policy,” these policies are much more expensive and usually do not make sense for young people to buy. Life insurance agents will try to get you to buy these plans rather than term life insurance, but it is in your interest to purchase the former. The premiums you will be charged on a permanent plan are very high.
Many insurance companies provide different types of insurance. If you already have one type of insurance (like car insurance), your company may give you a discount for also purchasing other types of insurance through them (like renters insurance). Check with your insurance provider to see if they offer this.
Insurance companies are regulated on the state level so each state has different laws regarding insurance. If you think that your insurance company is violating the law or engaging in unfair practices, you can file a claim with your state’s Department of Insurance. For more information on insurance regulations in your specific state, visit http://www.naic.org/state_web_map.htm.