Monday, July 25, 2016

Self-Insure For Routine Expenses Whenever Possible

People really don’t like paying their bills out-of-pocket. This observation was brought home to me recently through several examples. I had suggested that somebody drop their physical damage coverages on a 5+ year old car. Someone who overheard objected that a cracked windshield (covered under the Comprehensive coverage) could cost perhaps a few hundred dollars to replace. I thought, “Yeah, a couple years’ premium for something that you’ll do maybe once or twice in your lifetime.” In another case, I was being shuttled back-and-forth between the garage and work while my car was being worked on. My co-passenger was complaining that the extended warranty he’d purchased on his car didn’t cover any of his repair costs that day. (In this case I was thinking, “Who buys the extended warranties? Doesn’t everybody know these are overpriced ‘insurance’ policies?”) In another case, someone was trying to ensure that a series of medical costs all fell in the same year, so that they would count toward her deductible. If they were billed the following year, her deductible would “refresh” and she’d have to pay those costs out of pocket. In another case, a parent with several children was arguing with a dentist who didn’t deal with insurance; the parent insisted that the dentist bill the insurer, rather than the parent having to deal with the hassle of claims-handling himself. This parent was a doctor, and I was thinking at the time, “Wow, even at the highest levels of education, people don’t get it.” Finally, policy fights frequently flare up in the news cycle over which trivial expenses should or should not be covered by health insurance.

So far this is a pretty banal observation. “Duh. People like to get free stuff more than they like to pay for stuff.” The problem is that getting something paid for by insurance isn’t at all like getting “free stuff.” When your insurer suddenly has to cover a cost that used to be paid by the customer, it has to increase the premium charged to its customers to cover that cost. In a sense the customer still pays, it’s just that they pay ahead of time and the insurance company later gives them their money back. It’s actually a little worse than this. The insurance customer *also* has to pay for the costs of having someone handle his money for him: bank transaction costs, actuaries setting cash reserves and pricing policy provisions, claims handlers who negotiate with the hospitals, etc. As a one-off, it might feel like a quick win to get your insurance to pay a bill that you were going to have to eat, but in the long run it’s a losing game to make your insurer pay your bills for you. It’s cheaper in the long run to self-insure for the small stuff.

You should never buy the extended warranty. These are always priced to make a big profit, and suppliers generally make big margins on these contracts. They may “pay off big” on rare occasions, but those are so uncommon that you’re better off saving up for those rare mechanical failures. If you own your car, you should either get a high ($1,000 or more) deductible on your Collision and Comprehensive coverages or do away with them entirely. Yes, you are exposing yourself to a larger share of repair costs if you get into an accident, but the savings are substantial. If you have the discipline to save aside those saved premium dollars rather than spend every penny you come across, you can easily self-insure for that once- or twice-in-a-lifetime collision requiring a lot of body work. I am *not* talking about liability coverages, which cover expenses to third parties when you are liable for the accident. You should always have a policy with high limits on liability coverages.  I’m also not talking about uninsured motorist coverage, which covers your medical bills if an uninsured (or inadequately insured) driver hits you. Don’t skimp on that, either. Buy lots of coverage, 250k/500k if you can afford it. If you have a lot of assets, buy an umbrella policy on top of your auto policy. When I say “self-insure”, I am only talking about the stuff that won’t wipe you out, as a massive at-fault auto accident might.

The general principle here is that you should self-insure as much as is feasible. Insurance is about protecting assets. It’s not about paying your expected, routine bills. That’s what a budget is for. There really are those big hits that can wipe out your savings: a house fire, an auto accident in which you seriously injure someone, a gigantic medical bill for tens of thousands of dollars. Those are events that you should be insured against. Insurance is for these low-frequency high-severity events, which are so rare they might never happen to you in your lifetime and so expensive they wipe out most or all of your net worth. But you shouldn’t be dipping into an insurance policy for every piece of routine auto maintenance, and you shouldn’t require a lifetime warranty to cover an appliance failure, which you should expect to happen every few years or so. If you have the self-discipline to actually save back the money you waste on these insurance policies, you will save money in the long run by self-insuring.

Even for those expenses that are large but *expected*, you should consider the possibility of self-insuring if it’s not too painful. Say, “I know I’ll have to pay this expense three times in my life, so I’m going to save up for it.” Think replacing a roof after hail damage (you should be replacing your roof every decade or two anyway) or replacing a car after a minor accident (once again, you should expect to replace a car a few times in your life). If you’re in a position where your cash savings can cover these kinds of expenses, you should consider getting a really high deductible on your home and auto policy (or do away with comprehensive and collision coverages on auto altogether if your car is old enough).

There are caveats to this. Of course if you are incapable of saving money, you should pick the low deductibles because a sudden unplanned for expense really will wipe out your savings. But this is a self-control issue that I think people can voluntarily avoid if they wished to. Most people, if they *really* thought about it and really showed some self-discipline, could curtail their household spending and save more, perhaps even earn more. Once a cushion of a few thousand dollars is built up, you can start doing away with those expensive insurance policies that cover trivial expenses. In terms of health insurance, you are extremely limited in what you can purchase. You can’t choose to buy a no-frills catastrophic-expense-only policy. You choice of deductible options is limited, and your choice of coverage options is probably completely inflexible. You can’t buy a policy that excludes routine stuff like birth control or office visits. So with health insurance there is probably no way to actually follow my “self-insure” advice until there are significant reforms in health insurance regulation. Finally, perhaps you think that you are especially skilled at extracting money from your insurance policies. *Other* people buy the protection plan and just forget about it, but*I’m* going to use it. Or: This insurance product is overpriced for the *average* customer, but it’s an especially good deal for me. More power to you, but I suspect that in the long run you will fail. Insurance companies are pretty good at setting the price to the risk. So unless you have some very specific knowledge that your insurer doesn’t have, you’re going to lose this fight.

Quite generally I wish people would get more comfortable with the concept paying their bills out-of-pocket. A little price-consciousness would almost surely bring down the very high cost of medicine in the western world; that price-consciousness is totally absent when someone else is footing the bill. People want unlimited medical care, paid for by someone else, and they want the total cost to be affordable to society as a whole. At most maybe two of these conditions can be met (as Arnold Kling points out in his book on the economics of medicine, Crisis of Abundance.) If people get more comfortable with paying their own routine (even some of their unexpected-but-not-too-severe) medical expenses, we can move into a space where people manage these trade-offs for themselves. “Self-insure whenever possible” is good private advice; you don’t have to swallow anything I say about public policy to follow it, nor do you have to wait for a major policy change to benefit from it. But I do believe it would lead to some public benefits if we all got better at managing our own expenses.

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