# Insurance: good, bad and ugly

Types of insurance you probably need, and types you probably don't need.

## When to pay for insurance

You can buy insurance for pretty much anything these days. But adverts promising peace of mind are designed to make you overlook the fact that you don't always need insurance, and some types of insurance aren't actually worth paying for.

Insurance is often a very good idea, though. The question you need to ask is: if I didn't have the insurance, could I pay for the loss out of my own pocket? Obviously, you're not going to want to pay for the loss, but that's not the question. The question is whether you could if you had to.

For instance, imagine a person in Lambeth in London buys themself a shiny new mobile phone. Let's say they pay £149.95 for it, and a further £47.99 for a headset. One company currently [June 2006] charges £72 to insure both items for a year against attended theft, loss and accidental damage, and this policy has an excess of £19.501. Let's assume this person is too careful to need to claim for accidental damage, and assume that the chance of this person not losing the insured items in one year is 78%2, and assume that the chance of this person not being robbed in one year is 97%3. Then there is a 76% chance of the year ending with no use of the insurance policy. So there's a 24% chance of the insurance policy saving the person £106.44 (cost of the phone and headset, minus the insurance policy excess, minus the cost of insurance), and a 76% chance of the insurance costing the person £72 (a saving of negative seventy-two pounds because the insurance has been paid for but not needed). This means that the expectation is that the person makes a saving of: 0.24 × 106.44 + 0.76 × -72 = -29.17

Which means that a person buying this policy could expect it to save them negative £29.17. In short: insurance would cost the person almost thirty pounds more than they could expect it to pay them over the year.

These figures are only approximations based on a quick bit of research4. But the idea is to give an illustration of how insurance companies make their profits. They have actuaries researching the probabilities and costs very carefully so that they know how much to charge for each insurance policy. And as their ultimate aim is to make a profit, the policy will always cost the average person more than they can expect to get back from it.

So back to the question: could you replace items like these with your own money? Most people could do so immediately, and I don't believe insurance is a worthwhile expense in their case. A much better idea is for them to put the money they'd have spent on insurance into an emergency savings account. Then if something gets lost or stolen, they can use their own emergency fund to buy a replacement. This way, they'll have spent no money paying fees to an insurance company. On the contrary, they'll earn interest on the money in their emergency savings account.

However, many types of insuarance offer cover for amounts of money that most people cannot get hold of immediately. The suggestions below are types of insurance that most people are probably well advised to pay for, and below that are types of insurance that most people are probably better off avoiding.

## Insurance you probably need

### Buildings insurance

Buildings insurance for your home is usually a requirement of mortgage lending — the lender wants a guarantee that they'll get their money back whatever happens to the property. But buildings insurance is a very good idea even when the mortgage is paid off.

On a BBC news report a few weeks ago, a couple whose home was damaged by a neighbour's gas explosion explained to the reporter that their mortgage had been paid off a couple of years ago and they'd allowed the buildings insurance policy to lapse. Most people cannot simply dip into their bank account and produce enough money to replace their home if disaster strikes, so a blow like this will force them to start from scratch.

### Home contents insurance

Whether you need home contents insurance depends on whether you could replace all the items you'd miss after a burglary. Most people wouldn't be able to find the cash to re-equip their home with a big-screen television, computing equipment, consumer electronics, jewellery and artwork. If your home is full of items that you can't live without and couldn't afford to replace all at once, then you ought to think about home contents insurance. Make sure that you read the small print to find out what cover for valuable items is provided, and what level of security a policy requires. For instance, the locks on doors and windows often need to be up to a certain standard.

### Life insurance

If you die tomorrow, would anyone suffer financially? If your spouse and / or children are quite capable of looking after themselves, then life insurance is probably just going to cost you more money than it's worth (and possibly increase the chance of your family bumping you off to get the cash). But if your death would leave a spouse or children who would find themselves unable to pay the mortgage, or would be unable to meet the ongoing costs of their everyday life, then life insurance might be a cost you have to take on to avoid disaster in the unlikely event that you die before your family are secure.

### Health insurance

In the UK we are lucky enough (for now) to have a National Health Service that covers the costs of emergency and necessary health care of all UK citizens. But in countries where no such welfare system exists, a serious injury or illness can easily cost tens of thousands of pounds' worth of hospital fees. In such countries, anyone without the equivalent of a few hundred thousand pounds sloshing about in their bank account should definitely find out what health insurance policies will suit them.

### Travel insurance

Anyone travelling abroad should have travel insurance that will give them ample coverage to insure them against the cost of medical treatment in all of the countries they are visiting. The costs of medical treatment and emergency repatriation (being flown home in a medically-equipped plane) are astronomical in countries like the United States. Do some research to make sure you're buying insurance appropriate for the countries you'll be visiting. Also bear in mind that the length of your trip may change while you're away. If you buy a policy that lasts 28 days and you find yourself staying abroad for longer, you could be in trouble if the policy cannot be extended. (Note that even annual travel insurance usually only allows trips to last thirty days at a time.)

Travel insurance also covers another potentially astronomical cost: personal liability. If someone sues you in the United States (for causing injury or damage to them or their property) the chances are you'll need very, very large pockets if a court finds in their favour. Make sure any insurance policy you buy has a suitable amount of coverage for such an outcome.

### Car insurance

In the UK, it's a legal requirement that drivers have insurance that covers the cost of damage to other drivers' cars. Do not try to save money by driving around with no third-party car insurance.

Whether or not you need comprehensive car insurance (which covers damage to your own vehicle) depends on whether you can afford to repair or replace your car in the case of an accident. If you can afford to cover the cost yourself, then in the long term you will probably be better off buying third-party coverage and putting the money you save into an emergency savings account. If you can't afford to repair or replace the car, and the car is essential to your livelihood, then you may have to add comprehensive coverage to your policy to avoid being left with no transport. (Note that it's not actually necessary to own a car in London. Give public transport a try. You get used to the odour of stale vomit and urine. Honestly.)

## Insurance you need to be careful with

### Critical illness insurance

In theory it might be useful, offering income or a lump sum to people who fall ill so that they can pay their bills. In practice, however, up to a quarter of claims are rejected5. The insurance companies will use every piece of small print, and every omission (failure to declare previous health conditions and medical procedures) to avoid paying out. So a person who thought their income was secure in case of emergency has to face the fact that not only are they seriously ill, but the insurance policy they've been paying money for is worthless and they'll soon see their budget run out.

If you do decide you need critical illness insurance, do plenty of research and make sure to declare every cough, every doctor appointment, and anything even vaguely medical when you apply for the policy.

## Insurance you probably don't need

### Mobile phone insurance

As described in the introduction of this page, most people should be able to replace a phone using their own money, so this type of insurance will probably just cost them more money than it pays out in the long run. However, make sure to read your contract to find out who pays for any calls made if your phone is stolen, and find out how to have your account blocked to stop thieves making any further calls.

### Extended warranties

When you buy an electrical item, such as a washing machine or television, the electrical store often work hard to encourage you to pay an additional fee to cover the cost of fault or breakdown for three or five years. Some electrical retailers are believed to have made more money on sales of extended warranties than on sales of the electrical goods themselves6. Almost anyone can afford to pay the cost of repair or replacement for most electrical items, especially if they're putting a bit of money away each month into an emergency savings account. So you're almost certainly better off avoiding extended warranties.

### Identity theft insurance

In the UK, your bank or card issuer is responsible for money stolen through identity theft. (Note that this may not apply if you are seriously negligent, but most insurance policies will not pay a claim if the claimant acted negligently.) And the extra services thrown in with identity theft insurance are not considered worth the cost of the policy7.

### Blackjack insurance

If you're trying to save money, you're better off giving gambling a miss. But if you do regularly find yourself at the blackjack tables, you're better off without taking insurance, apparently8. Not exactly the sort of insurance this article is really about, but casinos and insurance companies do have a lot in common — they both expect to come out on top in the long run.

## Footnotes

1. These figures are for a Sony Ericsson K750i on Pay As You Go with T-Mobile from Carphone Warehouse. According to their telephone sales team, this model is in band 3 of their Lifeline insurance, which costs £6 per month for the "Total" policy.

2. According to a BBC news report about mobile phone loss, "A survey conducted by Retrofone found that almost 52% of those questioned have lost their phone in the last three years". I have taken this figure to refer to loss only, and not theft or damage. A 48% chance of not losing the phone in three years gives a 78% chance of not losing the phone in one year.

3. Approximation based on number of robberies in Lambeth BCU for the period April 2001 to March 2002: 6,465 according to Home Office Research Study 254: "The nature of personal robbery" [no longer online]. The Census 2001 figure for population in Lambeth stated the number of residents over age ten years as being 232,444.

4. I wasn't able to find a figure for the chance of accidental damage to a mobile phone. If you can point me in the direction of a reliable source, let me know.

5. From an article on FT.com about critical illness insurance: "The Financial Services Authority said recently that more than a quarter of critical illness claims were being rejected . . ."

6. A press release by the Consumers' Association in 2003: "Recent sources suggest that as much as 47 per cent of Dixons pre-tax profits come from warranties and that Comet makes up to 80 per cent of its profit from sales of warranties."

7. Identity theft insurance is a "bad product" according to the Which? magazine report "Financial services sins and wins" [no longer online].

8. According to the online article "To Buy or Not to Buy — Blackjack Insurance That Is" [no longer online].