Many people love a good sale, as is evidenced by the popularity of Black Friday, Prime Day, and other big sales retail stores hold throughout the year. White sales, Fourth of July sales, Labor day and Memorial Day sales are just some of the routine sales one can expect to find throughout the year. People like to believe they are getting a deal, and getting something of value for a lesser cost than what it is worth.
Insurance is not that type of product, and that is where a lot of insureds run into trouble. Many perceive that insurance companies are full of money. Part of this perception is due to large jury verdicts where a carrier will be told to pay millions of dollars for a loss, or attorney ads promising large payouts for auto accidents. Insureds look at this and think carriers are loaded with money and that their premiums should be less expensive; carriers have all this money after all, they don't need to be charging what the public perceives as an exorbitant amount of money for coverage.
This fundamental misunderstanding may lead many insureds to try to obtain coverage at lower costs, without realizing that they are shorting themselves for coverages that they need. They fail to realize that by looking for insurance that costs less, they may be getting limits lower than what they actually need, may be setting themselves up for a situation where they are underinsured for their homes and may have to pay a coinsurance penalty if they have a total loss, and may be putting their individual assets at risk if their liability coverage isn't sufficient to cover any injuries or damages to property of another party.
For example, an insured buys a home for $250,000. The premium is $1,200 per year. A few years go by and the insured adds on a screened-in porch, remodels the bathroom, and makes other modifications to the dwelling for a cost of $70,000. The property is now worth $320,000 and the premium should be $1,500. However the insured wants to keep paying his $1,200 a year because he thinks insurance is too expensive in general, and he shops around until he finds an agent who will insure his property for the $250,000 value. The insured is saving only $300 a year. If the insured has a $100,000 loss to his dwelling, because of coinsurance provisions the insured will only receive $78,000, a shortfall of $22,000. At a savings of $300 a year, it would take that insured seventy-three years to save that $22,000 at no interest. The insured is underinsured, and is not being compensated in full for his loss, because he wanted a less expensive premium based on his misperceptions about the insurance industry.
The same thing can happen with automobile insurance. Most states require drivers to carry liability coverage above a certain minimum limit. Most of these minimum limits are extremely low for the potential injuries or damages at risk. The minimums are set low so that everyone can afford at least some coverage, even though it may not be enough. Unfortunately, many people do not think it through.
The state of Ohio requires an insured to carry minimum liability limits of $25,000 per person injured in an auto accident, $50,000 for all persons injured in an auto accident, and $25,000 for damage to property of others in any one accident. Statistics vary, but the average cost of a death is $1,400,000, while disabling injuries range from $78,900 to $98,400 per person. Nondisabling injuries can range from $8,900 to $28,500, depending on severity. This exceeds the minimum limits of Ohio and most of the rest of the states.
The average cost of damages to a vehicle range from $3,231 to $4,600 for minor damages. However if a vehicle is totaled, it's important to know that the average selling price of a used vehicle is $21,000 and the average cost of a new vehicle was $37,851 as of January 2020. Most vehicles on the road are an average of twelve years old. It's estimated that vehicles depreciate by 15-25 percent every year for the first five years. So what does this mean so far as policy limits? If an insured hits someone in an older vehicle, then the minimum physical damage limits may be enough if only one older vehicle is involved; however, if multiple vehicles are involved, or if a newer vehicle is involved, then the minimum limits will not be enough. An insured can't guarantee that he'll only have accidents with only one older vehicle. While most vehicles on the road are older, there are plenty of newer vehicles on the road as well.
In a serious accident, an insured may be looking at injuries and physical damage costs into tens of thousands of dollars above the state minimum limits. Without sufficient policy limits, then the insured's personal assets, including his home, may be at risk in order to pay the injured party. Again, the difference in premiums is not going to be enough for the insured to save that money so that he has a pile of cash from which to pay potential losses. Even if the insured did put the difference in premium in the bank, it would take decades for the insured to accumulate the amount of money needed to cover him for a substantial loss.
While there are many more small insurance losses than large ones, an insured can never be certain that the only loss she'll have is a small one. It doesn't take long for medical bills to go over $20,000 for an auto accident, leaving an insured who purchased only minimum limits on the hook for the rest.
The reason for insurance is so that when a larger accident happens, either to an insured's property or when the insured is driving his vehicle that there are enough funds to pay for any property damage and injuries leaving the insured's personal assets intact. Insured's buying coverage based on price are doing themselves a large disservice; they may be exposing themselves to financial hardship if they don't have the funds available to pick up where their insurance leaves off in event of a large claim.
Another fact that insureds may be unaware of is that insurance companies are required to have a certain amount of their funds placed 'in reserve'. The amount of funds a carrier has on reserves has a lot to do with how stable that company is financially. Let's say the insurer writes insurance for a lot of homes in a specific area. If a catastrophic loss such as a wildfire, tornado, or hurricane damages multiple homes in that area, then the company cannot rely on just the premiums they took in for the current year to cover the losses for all of the damaged homes. Therefore, state laws and rating agencies look to carriers to hold enough funds in reserve to cover such catastrophes. As such, part of insured's premiums each year are set aside in reserve for future losses. The higher the potential for catastrophe, the more premiums the carrier has to set aside in reserve. Otherwise, if there are not enough funds held in reserve when the catastrophe hits, then the insured could be one who doesn't get a payout if the reserve funds are exhausted and the carrier may become insolvent and liquidated by the court, thus triggering the guaranty fund to provide coverage.