Selection of a Proper Amount of Insurance

Choosing the proper amount of insurance, like choosing the proper policy, begins with knowledge of the need for insurance. The need for insurance is related to the severity and the frequency of a potential loss. In property insurance, the need for protection usually is based on either the acquisition cost or the replacement value of a physical asset. This need can be calculated. In cases of business income insurance or liability claims, estimates of potential losses are needed. It has been suggested that people tend to buy too much insurance for low severity, high frequency losses but tend to purchase inadequate coverage for high severity, low frequency exposures. An example of such a mistake would be to purchase a service contract on a new car extending the warranty several years, while simultaneously driving with the minimum amount of liability ' coverage. The most one could lose in terms of a car repair bill is far less than the most one could lose in a liability suit.

In choosing the proper amount of life or disability insurance, the starting point is the consumer's financial goals. How much money is needed to solve financial problems if death or disability were to occur immediately? The second step involves determining the amount of available assets to meet these needs. Available assets include existing life insurance policies, individual savings, social security benefits, and group life insurance provided by employers. If a gap exists between financial needs and available assets, this gap is the appropriate amount of life insurance to purchase. For the purposes of this chapter, suffice it to note that making an informed purchase of the proper amount of life insurance often is a complicated procedure. Despite the difficulty in choosing the proper amount of insurance, some commonsense rules apply:

• Insure first those exposures to loss most likely to cause the greatest amount of damage. • Never expose more to loss than you can afford to lose. • Never risk a great loss (a high percentage of your assets) in exchange for a small gain (saving the insurance premium).