After all, you usually buy something on price when there is little difference in quality, like pencils or baking soda. Yet, while people will pay up for a different brand of bottled water, they won’t pay up for better insurance.
Save Me Time!
- Insurance is hard to understand. When things are hard to understand, people look for shortcuts like the lowest price.
- If one insurance policy is cheaper than another, it’s probably because you’re getting less coverage.
- You don’t save money in the long run if you have to pay more out of pocket when something goes wrong. You might even pay a lot more in the end.
The Rest of the Story
People know that not all insurance policies provide the same levels of coverage and that some companies are more (or less) likely to pay when you have a claim.
Why then do they select on price?
Processing…
Because it is too hard to evaluate the value of what they get if they spend more. When you make things hard on consumers, they get overwhelmed and shut down, so they default to the easiest thing they can observe – the price.
This can obviously have unfortunate consequences down the road if that cheap insurance doesn’t adequately cover your claim.
Don’t worry, there’s good news! This doesn’t have to be a problem anymore.
Informed is here to make it easier to understand how insurance policies differ, so you can make more confident decisions about what is truly in your best interest.
In the rest of this article, we will create a framework for how to think about why insurance policies may be priced differently from each other and when these differences may be positive or negative for you.
Cheap Insurance Is Cheap For A Reason
Let’s start with a truism: there are three main reasons you can get a lower price from one insurer vs. another.
Both companies are offering you the same coverage but one thinks you’re a better risk so lowers their price
= this is GOOD for you
One company is offering you less coverage than the other and, thus, offers you a lower price
= this can be very BAD for you
One company is offering you the same coverage as the other, but is more likely to deny your claim when you have one
= this can be very BAD for you
Most people likely believe the reason they got a lower price for the first reason when, more often, it is probably one of the latter two. While it’s nice to think the insurance company with the lowest prices realizes how good a risk you are compared to your neighbor, this is unlikely to be the true reason!
Rather, insurance companies know what we discussed earlier…you are unlikely to be confident enough to assess the coverage differences, so you decide on price. Thus, insurers cut coverage to bring the price down and hope you don’t notice.
They don’t want you to be informed. They are hoping you remain ignorant, because it makes the sales process easier for them.
If you remember one thing from this article, it should be that you are probably taking more risk by taking the lower price. Don’t assume the lower price is in your best interest!
Some Quick Math
Perhaps it would help to use an analogy. When you buy a washing machine, you can either buy the cheap one that you know will die in five years or pay up for the one likely to last ten.
When you buy the cheap one, you might hope it makes it to seven years and you “won”, but you know there’s a good chance it will be done in five and you didn’t really save any money in the long run.
It’s the same thing for insurance. If you save $100/year on premium for ten years, you need to avoid $1000 of future out of pocket expenses (either from uncovered losses or paying a higher deductible when you have a claim) to come out ahead.
Let’s do a really simple rule of thumb to keep the math easy. Just over 5% of homeowners have a claim each year. So over ten years, it’s a little above 50/50 whether you’ll have a claim or not.
If, when you have a claim, your cheaper insurance causes you to pay at least $2,000 of the claim out of pocket, you are worse off, as near 50% of the time you had no claims and save $1,000 while just over 50% you lost $1,000 (you saved $1,000 in premium but had to pay $2,000 for repairs).
Understanding the Downside
So, how likely is it you’ll have $2,000 or more of uncovered damage with cheaper insurance? With the average homeowners claim being over $10,000, if you have an uncovered claim, it could easily exceed $2,000.
There are a number of ways insurers can leave you on the hook for part of a loss. Or they could flat out deny your claim!
What if, instead of being responsible for $2,000 if something goes wrong, it’s $5,000 or $10,000 or $25,000? Are you still willing to bet on the cheaper policy?
Are you starting to realize paying extra for better insurance makes more sense than paying extra for that branded bottled water???
If you think you might have a policy with less coverage, then you probably want to treat it like that cheaper washing machine. Don’t assume you really “saved” money, but start setting money aside for when you have to pay the difference when things break down.
Want to know a better way to save money on your insurance without taking undue risk? Read our story about deductibles.
