What’s the one purchase people make and hope never to use? It sounds like a riddle, but the answer is pretty obvious once you give it some thought: Insurance.
Insurance protects your financial interests in a worst-case scenario: A home fire, a car accident, an injury or illness that leaves you unable to work, or even the death of a loved one. People don’t expect to crash their car, get sick, or face a devastating natural disaster. When it happens, they’re grateful they were insured.
Yet, people tend to have cognitive bias when it comes to paying for insurance. If nothing bad has happened in the past, they might feel they don’t need extensive coverage and might end up underinsuring. If they’ve had frequent claims in the past or a history of illness, they might purchase more insurance than they logically need.
Insurance companies count on customers who pay their premiums, perhaps buying even more coverage than they need, and don’t make claims. It’s one of the ways insurance companies make money.
Insurance companies play on your emotions to entice you to buy their policies. By understanding the psychology behind how people make insurance buying decisions, and the tactics insurance agents use, you’ll be equipped to make better choices. By purchasing the right coverage levels for your situation, you can save money.
Understand the Key Drivers Behind Insurance Purchases
People buy insurance for two reasons. It’s either required by law or they want the peace-of-mind that comes with insurance protection, whether that’s for their home, their vehicles, their health or their income.
There’s no immediate benefit to most policies apart from that feeling of security you’ll have knowing that you’re protected. With this in mind, it’s important to work with a financially stable company you trust, so you have faith they’ll pay your claim if the time comes.
It’s also important to understand the emotions behind your purchase so you can make the right choice.
Loss Aversion
In general, people are more motivated by fear of pain or punishment than by hope of reward. Psychologists call this loss aversion.
Insurance agents tap into this psychology, since purchasing coverage is directly related to mitigating the consequences of a loss. Some people may even feel anxiety over the possibility of losing their home or car or becoming sick and unable to pay their medical bills.
If someone is extremely motivated by fear of loss, they might purchase coverage they don’t need, keep their deductibles very low which can lead to higher premium costs, or over-insure their property.
Peace-of-mind
Of course, there are people who are more motivated by rewards than by fear of loss, as well as people who are driven by both factors simultaneously. Consumers who are more motivated by reward might focus on the peace-of-mind that insurance provides. More coverage might make them feel more secure.
The Endowment Effect
People are likely to put a higher value on something they own than something they don’t own. They’re also less willing to lose something they already have than miss an opportunity to gain something new.
This plays into insurance sales in many ways and it can be different for each person.
For some people, the high value they place on their car, home or their health, for instance, will lead them to sacrifice their money for better insurance.
For other people, insurance seems intangible since it protects against future events. They might under-insure their properties because they don’t want to part with what they already have – their money – to gain protection they might not ever need to use.
Optimism Bias
Optimism bias also comes into play when people underinsure. If they’ve never had to make a claim in the past, they feel they won’t need to. They might increase their deductible, skip certain types of coverage if it’s not required, or go without insurance altogether.
Desire for Instant Gratification
Finally, people may under-insure because it’s simply more gratifying to pay for something you’ll enjoy today than something you may or may not need in the future. Or, maybe their budget is stretched thin and they need to cover today’s expenses, like food or utility bills, so they want to keep their insurance costs as low as possible by reducing coverage.
If you’re inclined to think in the short-term when it comes to finances, tapping into those feelings of loss aversion and the pain of an insurance claim can help you assess your insurance needs more realistically.
Obviously, some expenses, like housing, have to come first. But you may be able to find ways to save money on your insurance and still get the coverage you need.
The Risks of Underinsurance
Depending on the type of insurance, it’s a risky decision to go without insurance or to underinsure your property.
Auto Insurance
For instance, there’s a 50/50 chance you will file at least one auto insurance claim in your lifetime, according to data from YouGov.com. By age 29, 23% of people have made an auto insurance claim.
Going without auto insurance can be a costly mistake. The average car accident claim was $6,551 for property damage and $26,501 for bodily injury in 2022 (the most recent year for which data is available from the Insurance Information Institute).
Home Insurance
The odds are lower you’ll make a home insurance claim. Each year, one out of 18 homes files a claim, with more than 96% of those claims related to property damage.
If you have a home mortgage, the bank requires you to protect their asset with home insurance. But if your home is fully paid off, you have a choice. But the stakes of going without homeowners insurance are high.
The average home insurance claim costs $17,059, with fire claims averaging more than $88,000, according to data from HealthSureHub.com. In a catastrophic loss, your home insurance can pay to rebuild your home, replace your belongings, and give you a temporary place to stay. Unless you have millions sitting in the bank, a catastrophic loss without home insurance can ruin your financial future.
For high-net-worth individuals, home insurance is even more important. They don’t want to tap into investment accounts to pay for a loss, especially since their property costs more to replace than the
Life Insurance
Going without life insurance is the ultimate short-term decision, since it can leave your loved ones short on cash if they count on your income. The younger you are when you buy life insurance, the less it costs, in general.
The amount of coverage you need depends on your current income, lifestyle, and even your expectations for how you’d like to be celebrated and remembered after death.
How to Find the Right Balance of Coverage and Premium Costs
Taking emotions out of the mixture can help you make the right decisions when it comes to buying insurance. Find an insurance agent you can trust to walk you through your options.
You may be able to reduce your rates by increasing your deductible. Just make sure you have cash to cover the deductible if you have to file a claim.
When it comes to auto insurance, look up the minimum required coverage for your state and then decide if you need more than that.
Don’t let anyone rush you or make you feel pressured to purchase additional coverage. When you take fear out of the equation and focus on your finances, you’re more likely to make smart choices when it comes to insurance.
The information provided on this website is for general informational and educational purposes only and should not be considered legal, financial, or insurance advice. While we strive to keep content accurate and up to date, insurance laws, policies, and regulations can vary by state and may change over time.
Nothing on this site constitutes professional advice or a recommendation of any specific insurance product, provider, or strategy. You should consult with a licensed insurance agent, financial advisor, or legal professional regarding your individual situation before making any decisions.
Sources:
https://yougov.com/en-us/articles/50576-who-are-the-most-accident-prone-drivers-in-america
https://corporatefinanceinstitute.com/resources/wealth-management/endowment-effect
https://www.iii.org/fact-statistic/facts-statistics-auto-insurance
