141 comments

Insurance: A Tax on People who are Bad at Math?

I recently read a Facebook conversation about health insurance where one person said, “I’m better off saving the $1000/month premiums and paying for my own medical bills if they ever come up”. And the other person said, “Bah! Recipe for bankruptcy! You need full insurance!”. Which person was right?

Years earlier, I was talking to a friend who had just bought her husband a Rolex watch as an anniversary present. As part of buying the watch, she also bought an insurance policy which would buy them a new Rolex if it was stolen. Was this policy a good idea too?

What about collision insurance on your car? And life insurance?

Insurance of all types – car, house, jewelry, health, life – is a crazy field swayed by lots of marketing, fear, and doubt. In fact, I’d bet most insurance is bought partly on fear and without doing any actual math on whether it’s a good deal. If you’re an average consumer, you spend several thousand dollars per year on insurance. Maybe there’s a way we can cut that down and let you keep some money for yourself!

The first thing to understand about insurance companies is that they are making money off of you – lots of it. They do this by employing a team of brilliant mathematicians called Actuaries who analyze detailed mountains of statistics about the average behavior of people like you, and thus how much money they expect to pay out to you in claims. They then strategically set your premiums to a level where on average, they can pay your claims, pay their employees, and still make a large profit for their shareholders. So they have, of course, rigged the odds against you. So when buying insurance, you will most likely pay in more than you get out of it.

This seems obvious, but some people still need a little reminder, because I keep hearing things like, “I need dental insurance, so I don’t have to pay the $300 every time I take my kid to the dentist!”. That’s a mindset that is imagining that insurance actually SAVES you money on average, which it does not – otherwise the insurance companies would all lose money – which they do not!

Once you understand this, you realize there are only three possible reasons to get insurance in any particular area.

  •  You’re forced to do it (car insurance laws, house insurance required by your mortgage bank)
  • You can’t afford the consequences (A burned-down house or a year in the intensive care unit at $20,000 per day)
  • You are riskier than the insurance company thinks you are (you engage in drunken car racing or competitive eating events on the weekends).Or on a more serious note – if you are planning or expecting a baby, or have any known upcoming or chronic health conditions.. these are good times to plan in advance and set yourself up with a much lower-deductible plan. The US is an unusually expensive place to have a baby in a hospital, and even I wouldn’t advise risking paying for this out of your own pocket. The cost will range from $3,000 to $1 million+, depending on complications you cannot predict in advance.

That covers the main categories of insurance. But what about things that you can’t afford but are really unlikely? Do you get kidnapping insurance on yourself to cover up to a $3 million ransom? Identity theft insurance? Insurance on your kids? Extended warranties from Best Buy on your new laptop?

Stop! It’s all a trick.

Luckily there is a solution: Get almost none of it. Especially if you already have a healthy ‘Stash of savings built up and could thus afford any unexpected expenses.

Since you’ll be driving only affordable used cars with no bank loans, get only liability insurance.  Since you will be keeping yourself healthy for life, get only a “catastrophic” type of health plan where you pay ALL your own bills unless the cost exceeds $5-10k in a given year. Since you will be building up savings and cutting your living expenses, and you are very unlikely to die in the next few years, you may not need any form of life insurance.

My wife and I have never carried life insurance on ourselves, and we consider it a compliment to each other: “I believe you would do Just Fine if I wasn’t around, because you’re a capable and independent person”. Get the highest deductible on your house insurance that the mortgage company will allow. Or if you have no mortgage, the highest you are comfortable forking over after an incredibly unlikely event (I usually set mine at about $10k).

Then for the insurance lines that you are keeping, do a nice afternoon of shopping around – I did this last January and sliced about $300 per year off of my remaining home and car insurance. The winners for me ended up being subsidiaries of Geico, although different people will find their results vary with different insurance companies, strangely enough.

Then put all the savings from these premiums into growing your nest egg, realizing that you are now getting paid to be your own insurance company.

It sounds risky if you let the fear creep in. But it should actually feel deeply satisfying and safe. By not buying into a product where the odds are stacked against you, you are STATISTICALLY likely to win. We can’t predict the future, but we do have one tool that lets us turn the unknown to our advantage, and that is statistics. They are my best friend when it comes to becoming wealthy, and they should be yours too.

The savings of thousands per year will add up alongside all your other newfound riches from frugality, and you’ll soon find that none of these potential expenses will scare you. Over the past 10 years, I’ve saved about $40,000 in insurance premiums compared to the average level of spending, and now that $40k is sitting alongside my other employees, producing $2800 of passive income each year, and already more than big enough to cover replacing a crashed car or paying any possible deductibles on medical bills.

And after 10 years of relatively exciting living, I haven’t even had to dip into it once. Now I see why insurance companies make so much money!

 

  • Gary M. December 28, 2014, 1:24 pm

    Read this post with interest, but it seems that the “Affordable” Care Act has turned this advice somewhat on it’s head.

    A little background if I may: My wife and I are both 55, healthy, no children. I am an electrical and mechanical engineer, but part-time employed by choice. I have substantial assets and a paid-off house. My parents were raised in the Depression, and I learned a great deal from them, and was living debt-free long before it became ‘fashionable’.

    I can easily afford to cover our day-to-day medical expenses out of pocket, and would prefer to do this while purchasing a catastrophic medical policy to cover us in the event of cancer, heart attack or accident, but the ACA won’t allow this. I am essentially forced to purchase “minimum essential coverage”, which costs ~$13,000 annually for premiums and carries $6,000 annual deductibles for each of us. This makes my worst case annual expenditure right at $25K for premiums and deductibles should both my wife and I need this much medical intervention.

    The ACA calls this my “shared responsibility”, and should I choose not to purchase “minimum essential coverage”, I am fined a percentage of my annual income at tax time. I’m fine with not purchasing a “minimum essential coverage” policy, paying out of pocket for my normal medical expenses, and even paying the penalty tax, but I still can’t purchase a catastrophic medical policy. Best I can tell, these have become unobtanium in the current insurance market.

    So I wonder MMM, what changes would you make to your January 2011 posting to bring it in line with current ACA requirements?

    As an aside, I’ve felt for some time that owning stock in my health insurer was better for me financially than buying insurance from them, and several of the health care related ETF’s I own have made me substantial monies over the past two years. I fully expect this to continue, because I believe that even a Republican majority house and congress will not turn off this corporate money train.

    Best regards,

    Gary M.
    Colorado Springs

    Reply
    • Rich December 29, 2014, 7:46 am

      Gary,

      I was frustrated by the ACA as well and found a way to opt out. It will not fit everyone’s needs but if you are Christian you might look into a Christian healthcare bill sharing plan. I chose Samaritan Ministries. It cost my wife and I $360 a month. Not as cheap as my catastrophic plan but I get more than most $6k deductible plans. I will not try to sell you on it but only advise that anyone paying too much for a high deductible plan do the research on it, as it is the only way around an expensive ACA plan that I have found. It is not a fit for everyone though.

      The only thing I miss about my insurance plan is being able to contribute tax deductible money to my HSA. Good luck.

      Reply
  • Bob January 2, 2015, 9:28 pm

    To be more precise, many insurance companies like Gieco do not make money off of your premiums. They make money by investing premium payments between the time they are paid and when they have to pay out claims. It’s called their float.

    You get a brief explanation of it here.
    http://www.fool.com/personal-finance/insurance/2006/12/05/insurance-industry-basics-float.aspx

    Reply
  • dave February 2, 2015, 9:49 pm

    i don’t care how much nicer the weather is in the USA I’m staying in Canada where health care is covered by the government. I can always take long trips to florida to avoid winter while keeping my universal health care

    Reply
  • Javier Cervantes March 4, 2015, 11:26 am

    Mr. Mustache,
    I’ve been reading your blog beginning a couple days ago and I have already put a few of these practices in place! I couldn’t wait until you got to the insurance portion because I actually work in insurance! After reading this article, and already knowing how much of a rip-off insurance is, I shopped and lowered my deductibles down enough to save me $24.35 a month! This is about as rock bottom as I could get it but every cent counts! Everyone should know that there are so many coverage’s on an insurance policy that are usually optional and tend to be a bit overboard. Everyone should talk to their agent and have them thoroughly explain what they re covered for and what each coverage means. I bet anyone who does this can save at least $30 a month or $3,600 over ten years…I’ll keep reading on and continue to watch my money mustache grow!

    Reply
  • Charlie April 23, 2015, 10:07 am

    I need a 2 sentence version of this to explain to my mother-in-law every time this comes up:

    “You didn’t insure my daughter’s ring?!?!?!” “What do you mean your insurance won’t cover your car’s hail damage?!?!?!!?” “You’re paying to fix the fence out of pocket? Your deductible is over the cost to fix it?!?!?!.. what’s the point in having it that high?!?!?!”

    So far “I did the math and it’s cheaper in the long run” or “we have the cash to cover it” then change the subject works.. but there’s got to be something more concise which explains it better.

    Reply
    • Spork April 23, 2015, 10:57 am

      How about: “How much does your insurance cost per month? Really? Mine is $X.”

      Reply
  • Cathryn July 22, 2015, 9:21 am

    Hello good sir!

    You may have already answered this in another comment, however I like human interaction and would like to hear from you and not assume anything about my situation. I personally take medication for, in a simplified version, mood because of a mental disability. I’m currently a teenager and I live in a good and stable home that is not lacking money to pay for my current needs, but when I’m on my own would it be more beneficial to pay for insurance for meds or to just pay for the meds out of pocket? I would also be paying for going to a doctor to prescribe these meds and, possibly, a therapist. The therapist possibility is not a guarantee, however I want to add it in as a factor based on how I rely on many of the staff at my boarding school for counseling on overwhelming situations as of this moment. What do you think?

    Reply
  • Marty May 12, 2016, 7:52 am

    Quick question – I live in a shady part of a really dangerous city (somewhere in the top ten worldwide). I don’t think I know anyone who hasn’t experienced some kind of attempted or realized assault while living here. It’s out of my home country, so if anything happened to me, it would be a lot of expense for my parents to pay to get me home. I checked with my life insurance to see if they’d cover if anything happened while I was living here and they said yes. I pay $3/month and the payout would be $25,000. Would you guess that I fall in the high enough risk category to make it worthwhile or am I buying into sensationalist fear mongering? Thanks for your help!

    PS There’s tons of good things about it here, it’s really great! This is not a complaint about the place, I only just want to make sure I’m not a) being duped and paying out the big bucks for no good reason or b) possibly leaving people I care about holding the bag if something happens to me.

    Reply
  • Winslow July 21, 2016, 4:57 am

    I like the idea of being our own insurance company, and this is a goal we’re striving for. Just turned on the jackhammer, and obliterating more of Consumertown.

    Reply
  • Eric August 3, 2016, 4:45 pm

    I started at the beginning of the blog and have had a hard time giving up certain things (cable TV & real haircuts) or cancelling commitments (my ADT monthly security system – but will when the term expires). This insurance stuff I can change. And so it begins…

    Today I:
    Cancelled life insurance on my spouse. I’ll be fine if she goes. Savings $21.60/month.
    Removed collision on my 11 year old car worth $3,500. Savings $11.27/month
    Removed rental car insurance on both autos since relatives moved here and would lend us a car (they did just this week!). Savings $3.56 a month.
    Increased my home deductible from 1/2% to 3%. Savings $16.83 month.
    Total Savings $53.26 month. 10 year savings of $9,213.98.

    The insurance guy was like “oh, but if you have a total home loss you could be out of pocket $13,000.” So by my rough math, if my home burns down completely only every 15 years I still end up ahead.

    What are the savings of $53.26/month over a 30 year period? Surely the effect (affect?) compounds. Can anyone help me with that? Knowing that number really helps me make better decisions.

    You’ll have to pry certain things from my cold, dead hands but these things were a great place to start. I’m hopeful that these little changes are the catalyst for more.

    Reply
    • Eric August 5, 2016, 4:04 am

      Answering my own question here and checking MMM math (which of course checks out!):

      to calculate a weekly expense compounded over ten years multiply the price by 752 (yes).
      to calculate a monthly expense compounded over ten years multiply the price by 173 (it checks out!)
      to calculate a monthly expense compounded over thirty years multiply the price by an incredible 1,220!

      $10 a month in savings = $12,199.71 in savings over 30 years, wow.
      Save or cut your expenses by $100 per month? You just grew your mustache by $121,997

      Reply
  • Dividend Family Guy August 11, 2016, 2:41 pm

    I had my last child in 2015. At the time I was stuck with an expensive HSA. Ended up paying for everything out of pocket ~ 8k. First time I had an HSA. I am not a fan of them at all.

    Reply
  • Candace September 5, 2016, 11:55 pm

    Hello again!

    Still working on making my way through your entire blog! VERY interesting post. Unfortunately, where I live it is illegal to drive without insurance. Rats! However, I pay for life insurance (my parents set me up with it when I was young) that covers me for $40,000. I guess I don’t know much at all about this, because is this even necessary? Maybe for now until I have more savings in line…? But if I back out will I still get what I have put in so far? Any idea on how that works?

    Secondly, a funny (but terrible) story that furthers your point. I bought a fancy drone almost two years ago when I clearly hadn’t heard of your blog yet or thought hard enough about my decision. But the point is, I remember purchasing the drone and at the counter the salesperson asked me if I wanted insurance. At the insanely high price of the drone, I was *afraid* that if I crashed it, my money would go completely to waste. I told her I would think on it (the insurance was $300 to cover 2 years—- I know you are cringing right now, I apologize). However when I told her I would think on it, she informed me that once the drone is out of their hands, insurance is no longer an option (basically it was now or never). I was roped in by a horrible policy put in place by a greedy insurance company/drone store looking to make a buck off of my *fear*. I now realize this two years later.

    P.S. I have yet to crash the drone and my two year insurance policy is up. $300 in the toilet.

    Reply
    • Mr. Money Mustache September 8, 2016, 11:21 am

      Hi Candace,

      Yes – car liability insurance is mandatory in every developed place I’ve read about so far. This ensures that you will cover other people in case you hurt their body or property.

      But I’m arguing that you should skip the optional parts, where the insurance company pays for your car to be fixed if you crash it or somebody vandalizes it. On average, you come out ahead covering those risks yourself. And of course, if you can’t afford to cover them, you’re not rich enough for car ownership yet!

      Life insurance: cancel that and run away! Nobody needs money in the event of your death. Instead, work while you’re alive to generate a surplus and not leave a burden for others.

      Drone insurance – you’re right, I am cringing! Glad you know more now though – this is something to celebrate.

      Reply
      • Joe September 8, 2016, 12:55 pm

        I think the advice about life insurance needs an asterisk. If someone (spouse, kids) is depending on your income and you don’t have a sizeable stash, then you should have some term life insurance.

        Reply
        • Mr. Money Mustache September 11, 2016, 10:53 am

          I sort of agree with you of course, Joe – if someone truly depends on your income, it’s worth insuring them.

          But my bigger point is that financial dependence is not a good state to be in. So work towards eliminating that rather than insuring it and then just saying everything is fine if you have insurance. For example, Ideally either member of a couple should have the ability to support the family if necessary. So develop skills and keep costs (including family size) at a level that would allow that.

          And get the “independence” side taken care of before expanding too far into the luxuries (boats, pets, second houses, new cars, etc).

          There are plenty of real-world exceptions where this idea won’t work – health issues, odd work and family situations, etc. But keeping it in mind as a general rule can still help most of us plan our lives to be more resilient.

          Reply
      • Paul September 9, 2016, 8:41 am

        Liability auto insurance is not mandatory in New Hampshire! Live free, or die!

        Of course, if you cause damage to someone else with your car, and you fail to pay for it, you lose your license….

        Reply
  • MorningLightMountain January 2, 2017, 7:41 pm

    Wow, I know this is an old blog but thanks for the facepunch! I consider myself a very thorough guy (I make a spreadsheet for most life decisions), but I had never given my auto insurance coverages a second look since starting my stache.

    Bumped up my collision deductible but didn’t remove (car is only 3 years old, was a pre-mustachian purchase) and got rid of the stupid rental car coverage. I use the car maybe once per 3 days or less so why the fuck would I need a rental?

    Savings of $200/year.

    Reply
    • Anny January 17, 2017, 2:18 pm

      Same here. I bumped collision deductible from $500 to $1000 but still keep it for a year. Now I evaluate my car, only worth maximum under $7K or so. It doesn’t seem right that I crashed it so hard to pay out of pocket $1K before I can take any money from insurance company.

      Reply
  • David January 8, 2017, 4:47 pm

    Do you think Bill Gates pays for any un-required insurance? I’d be curious to see what his decision process is.

    Reply
  • Anny January 17, 2017, 2:11 pm

    Enlightening me every time MMM. I bought a used 2012 VW Jetta in 2014. If I didn’t run into an accident and my old Honda got total, I wouldn’t buy a *new* car either. Anyhow, I didn’t have enough saving so I had to get finance from the bank, and I was forced to do full coverage with $500 collision deductible. From an old Honda with $30/mo half coverage, I had to pay $90/mo full coverage, not including monthly payment to the bank (Ouch!). I refused to give the bank anymore interest, so I paid off the car as soon as possible within half a year or less. I was debt free shortly but I let to $90 monthly auto insurance hanging around for couple years. I don’t know why I did that….!!!! Just now, I switched to Geico and dropped the Collision coverage and paid full 6 month. So I’m saving almost half of what I was paying.

    It’s a scary feeling, to come from fully protected to half protected. But I said you enlightened me because I overlooked the fact that I have been diligently saving enough that I can afford to cover my own collision. With the money I don’t pay for insurance company, I will add more to the stash. The world is still an unpredictable place, but at least something we can feel pretty certain is our control over our spending and plans for our life. Services are good, but depending too much on those services can make us feel small, too dependable and forget that we do have the ability to be in charge of our life.

    Reply
  • James April 25, 2017, 4:33 pm

    This article is very old and I have not read through all the comments so forgive me if you have already addressed this, but in case you haven’t: it’s not actually true that most insurance companies set premiums at a rate where, in a vacuum, they make a profit on their average expected claim. That’s called operating with an “underwriting profit” and it’s an unusual state of affairs. Most of the time, insurers lose money on the underwriting part, but (hope to) make it up due to the fact that they are allowed to invest the money you’ve paid them in premiums, tax free, while they wait to see whether you actually get in an accident. Warren Buffett famously dubbed this tax free pool of money “float,” and basically built Berkshire Hathaway on it, so it’s not negligible in value. However a side effect of this is that insurance is often actually a pretty good deal for consumers. Of course, they could invest their own premium money, too, so it’s not black and white – but that’s exactly my point. Despite actuaries being very smart etc. etc., the nature of the insurance industry is such that insurance is actually often a good deal for both the consumer and the insurer.

    Reply
    • Mr. Money Mustache April 25, 2017, 6:00 pm

      Good points James, and I just looked up the latest results and found that State Farm endured a large underwriting loss just last year. In general they still try to make an underwriting profit (as competitor Geico did in 2016), but it’s a competitive industry.

      There are still benefits to skipping the stuff – if you’re safer than the insurance company is willing to admit (for example, I drive 2000 miles per year but my insurance company’s lowest category is 8000). And the psychological advantage of forcing yourself to admit the risk before buying something in the first place.

      Reply
      • James April 26, 2017, 7:51 am

        Got it. The Rolex insurance example is certainly a good example that supports your point. I have heard that Sears actually loses money on the sale of Kenmore appliances, after you take out the great profits they make selling the warranties on them (which are rarely used).

        Reply
  • Michael April 26, 2017, 12:58 pm

    “You can’t afford the consequences”
    This!
    I recently came to this conclusion. That statistically, the odds is almost always in the favor of the insurance company (except for a preexisting condition of a terminal disease, thanks to the laws that force insurance companies to insure the person).
    Thus, insuring something to “win” doesn’t work. Instead of looking at the odds of winning, I now look at the consequences. Example, my wife can not financially afford me to die, thus i have life insurance, I can not afford being disabled and not going to work anymore, thus disability insurance is about to be signed and so on. The criteria is: can I afford the financial consequences regardless of the odds? Yes, don’t insure it, No, insure it.
    Insurance is a tax of being poor, and I am trying my best to get out of this and dump the insurance policies that I have.

    Reply
  • Tara May 8, 2017, 6:43 am

    YES! When I looked at the numbers for Pet Insurance (as my cat was starting to age), I realized I’d be MUCH better off saving $30/month in case of vet bills.

    I hear people talking about Life insurance a lot, and again, I’d feel much more comfortable managing my money rather than giving it to a corporation to “invest”. (Fortunately I don’t have any dependents, nor do I plan to, so I don’t need it, period).

    Health Insurance- I’ve been in Healthcare in the US for almost 10 years. And personally, I DON’T BELIEVE IN HEALTH INSURANCE. It is a huge resource drain and it doesn’t make anybody healthier.

    Full disclosure- I’m only staying in my job long enough to have health insurance to cover testing to determine if I have cancer.

    I do have to be thankful for car insurance though, as I had a car that was rear-ended 3 times (totaled the 3rd) and I was pleased with the payouts. Of course, as it stands today, if I had simply saved my premiums ($800-$1000/year for 15 years and counting-New Jersey is expensive), I’d about break even.

    Reply
  • Leo July 18, 2017, 11:50 am

    Personally I have been a fan of permanent life insurance so long as it is designed right for the individual and receives dividends. With an expected rate of return of around 5-6% it lets you keep the regular taxable stuff in your Vanguard/Betterment stuff more aggressive in retirement. Sure 5-6% isn’t the same as the stock market but with tax-free-ish roth-y treatment it gets pretty close. Most are self-paying if you get sick or injured so the stash growth goes on auto-pilot. The life insurance is just icing on the cake.

    Reply
  • Luke November 28, 2017, 9:47 am

    What are your feelings on a Variable Universal Life policy, where some of the funds are put on the stock market to start making money?

    Reply
    • Mr. Money Mustache November 28, 2017, 4:21 pm

      Hi Luke,

      In general, I feel you’re better off skipping that and just putting the money into low-fee index funds instead.

      Reply
      • mista'kotta November 29, 2017, 7:13 pm

        I agree. I started investing for retirement in a Variable Universal Life policy when I was first married at 22 years old. The fees were very high and really hurt the returns. Also, the surrender charges were very steep but declined to zero after 15 years. I held onto the policy for 16-17 years to avoid surrender charges and then cashed out a few years ago, reinvesting in Vanguard funds and also putting more into my 401K. I now have a term life policy instead. If I could go back in time, I would have started with a term life policy and kept my investments separate from my life insurance.

        Reply
  • Mary January 1, 2018, 10:55 pm

    Another late reader to your site. I think compared to a lot of people I am pretty frugal but this site is making me realize how *much* better I could do. I doubt I will ever have a life partner and only got a career pretty late in life so I definitely need to buckle down.

    One thing I am doing for insurance is a HSA through my job. I pay 50 a month for high deductible insurance (it is the same if you do the HSA or the cheaper “regular” insurance.) My job puts in 1300 and I put in the other 2100 a year to the HSA itself. I invest everything that I am allowed (I just need 2k in the non-investment account) and I picked a medley of Vanguard funds. This year had a nice average 16% return – I know not typical but it was fun to see! Anyways, after 3 years I have about 9500 in the investment portion.

    I plan to do this for as long as I think I won’t need to have regular doctor visits or medications. Even if I can only do a couple more years I think that will be a large enough starting amount that by the time I hit 65 my tax free investment earnings – plus my initial pre-tax deposits – should hopefully cover most of my retirement health expenses.

    Reply
  • Anonymous April 3, 2018, 5:02 pm

    I’m looking for an MMM or Mustachian opinion on Roots Car insurance. I’d also like to use a referral code from a Mustachian.
    This seems to be the most relevant blog post but it pre dates Roots and their business model.

    Reply

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