Managing Personal Risk

Risks you can insure

You face risks that could cost serious money: a car accident that causes expensive damage, or an illness that keeps you from working for months. Insurance exists to protect you from losses like these.

Not every risk can be insured, though. An insurable risk involves a potential loss due to chance, such as an accident or a weather event. It also has to be quantifiable and statistically predictable, which means an insurer can estimate the cost and the likelihood of the loss. No insurer knows which house on your street will catch fire this year. Across thousands of houses, though, it can estimate how many fires there will be and what they will cost, and it sets premiums to cover them. A loss that is certain, like a new car losing value as it ages, is not a loss due to chance.

Personal, property and liability risk

Insurable risks come in three kinds, depending on whose health or property is at stake.

• Personal risk involves the health and well-being of the insured person, such as an injury from an accident or suffering due to illness.
• Property risk involves property loss, such as damage to the insured person's home or car.
• Liability risk involves someone else's property or health, such as damage to a parked car or a pedestrian hurt by reckless driving. The loss belongs to another person or business, but you can be held responsible for it.

One accident can involve all three. Run a red light and hit another car, and your own injuries are a personal risk, the damage to your car is a property risk, and the other driver's car and medical bills are a liability risk.

How insurance works

You protect yourself from the financial loss these risks can bring by buying insurance. The main types are health insurance, auto insurance, homeowner's insurance, renter's insurance and life insurance.

You pay a premium, annually, semi-annually or monthly, for a policy with the amount of coverage you want. If you suffer a covered loss, you file a claim for reimbursement. Many policies also have a deductible, the part of a covered loss you pay out of pocket before the insurer pays. With a $1,000 deductible and a covered loss of $6,500, you pay the first $1,000 and the insurer reimburses the other $5,500.

Health insurance is often an employee benefit, with the employer paying some or all of the premiums. Life insurance is usually meant to replace lost income, pay end-of-life expenses or fund dependents' future financial needs. Extended warranties and service contracts on expensive purchases, such as cars or appliances, may serve as a type of insurance: you pay in advance, and certain repairs are covered later.

How much insurance is enough?

The amount and type of coverage you need depends on several factors, including legal requirements, your risk tolerance and the number of people who depend on you.

Some insurance is required. Legal requirements vary between states, and between nations. Most U.S. states require auto liability insurance, and in those states you cannot legally drive without coverage for damage you cause to others. A lender that gives you a home mortgage requires you to buy property insurance on the home, because the house is collateral for the loan.

Beyond that, you decide how much risk to bear yourself. If your risk tolerance is low, you may buy more comprehensive insurance with higher premiums, to avoid unanticipated costs later. If your risk tolerance is higher, you may buy less comprehensive insurance, or insurance with higher deductibles, knowing you could face higher out-of-pocket costs in an emergency. A high deductible only works if you could actually pay it.

Dependents raise the stakes. People with dependents may need more insurance: family health insurance, insurance on more than one vehicle, and more life insurance to provide for their dependents' future financial needs.

Behavior changes the price. You can lower your premiums by reducing risky behavior. A good driving record lowers auto insurance premiums, and not smoking lowers life insurance premiums.

Insurance fraud

Insurance works only if claims are honest. When policyholders misrepresent facts or file falsified claims, that is insurance fraud, and it is a crime. Lying about who drives your car to get a lower premium is fraud. So is claiming a laptop was stolen when it was not. Sellers can commit insurance fraud too, by misrepresenting what a policy covers or what benefits it pays.

Fraud and predatory lending

Some financial risks come from people who are trying to take your money. Predatory lending pushes borrowers into harmful loans through deception and aggressive sales tactics. Phishing is a fake email, text or call, made to look like it comes from a bank or company you trust, that tries to get your passwords or account numbers. Identity theft is someone using your personal information, such as your Social Security number, to open accounts or borrow money in your name. Online scams run from fake stores to investment offers that are too good to be true.

To protect yourself from predatory lending, compare loan terms from a variety of sources, resist pressure to agree to terms quickly, and get advice from a nonprofit credit counselor before you sign a loan agreement.

To protect yourself from fraud, judge whether a financial offer is credible before you act on it, and resist pressure to share personal or financial information online or by phone. You can also freeze your credit, which blocks new lenders from seeing your credit report (3.2 Borrowing, Credit, and Debt) and makes it much harder for a thief to open an account in your name. If you are scammed anyway, seek legal aid.