Players in a college or high school basketball game are limited to 4 fouls and disqualified from competition upon receiving 5 fouls. This limitation is intended to discourage players from consistently fouling to maintain the pace of play.
In basketball, there are good fouls and bad fouls. A good foul could be the result of commendable hustle or might prevent the opposing team from scoring an otherwise easy basket. Conversely, observers of a broadcast game often hear announcers use the terms ‘cheap foul’, ‘silly foul’, or even ‘dumb foul’ to describe a foul that serves little purpose. These fouls often do not prevent an opposing team from scoring but merely bring the violating player one foul closer to disqualification and provide the opposing team with an unexpected gift. Coaches preach discipline to players because they understand that cheap fouls change the outcome of many close games.
What if we had such statutory foul limits in life? Warren Buffett uses this analogy when he talks about investing:
“You’d get very rich if you thought of yourself as having a card with only twenty punches in a lifetime, and every financial decision used up one punch. You’d resist the temptation to dabble. You’d make more good decisions and you’d make more big decisions.”
To extend this analogy, what if there were limits on how much you could spend on insurance products each year? You might first criticize higher powers for running your affairs but then you’d be more thoughtful and diligent about the insurance you purchased. You would be less apt to buy the extended warranty and you would spend more time reviewing line items on your auto policy. You’d increase deductibles and buy insurance only for the catastrophic risks. In short, you’d be less likely to commit cheap fouls.
Consumers commit a lot of cheap fouls when it comes to purchasing unnecessary insurance. The rationales for doing so generally break two of my four cardinal rules of insurance:
- Inexpensive insurance does not equal useful insurance. Like I tell my kids in the dollar bin at Target, just because it’s cheap does not mean you need it.
- Pay to insure financial catastrophes and self-insure the rest. We know that money doesn’t grow on trees but when it comes to insurance, we pretend it does. We think of insurance as an investment that will provide a return, neglecting the fact that insurance companies make billions of dollars off consumers each year. For every $100 that we spend on auto insurance, roughly $70 pays claims, $25 pays salaries or expenses of the insurance company, and $5 is profit to the insurer. In the case of extended warranties, the profit to the seller runs between 40-80%. You should buy insurance with the realization that you’re losing 25-80% of the cost to prevent big unpredictable losses.
There are two fundamental types of insurance fouls that you should seek to avoid. The first type is mistakes made when purchasing necessary insurance. This includes possible mistakes such as maintaining low deductible collision coverage, purchasing the wrong form of life insurance, adding expensive annuity riders, or ignoring high deductible health insurance as an option. These will be covered in a future article. The second type of mistake is merely purchasing completely unnecessary insurance.
In assisting clients with their annual employer insurance enrollment decisions or property and casualty insurance reviews, we often see both sets of mistakes. The list below is common insurance types that can generally be described as cheap fouls or unnecessary insurance for most people.
1) Accidental Death and Dismemberment Insurance
The purpose of life insurance is to replace future income that is necessary for the support of your family. If your family depends on life insurance proceeds due to your premature death, they need these proceeds whether you die accidentally in a shark attack or from cancer. Moreover, you don’t need dismemberment insurance that pays if you lose a finger or limb. You need insurance if you are disabled and unable to work which should be covered with a long-term disability policy. Accidental death and dismemberment insurance is generally inexpensive coverage but if you need life or disability insurance, buy term life or disability insurance and not some nuanced alternative.
2) Auto Medical Payments Coverage
This auto policy option covers limited medical expenses resulting from an accident in the insured vehicle (not someone else’s vehicle) for the driver and passengers. I refer to it as poor man’s health insurance. The purpose of health insurance is to cover significant medical expenses, which it will if you are injured in a car accident. In Georgia, like most states, medical payments coverage is primary to your medical insurance. What that means is that unless you cannot afford health insurance, paying for this coverage is basically buying insurance to protect your medical insurer, not you.
Some states require minimum amounts of medical coverage but Georgia and South Carolina, among others, do not. Insurers might argue that it is inexpensive or that it adds protection to your health insurance. The inexpensive argument is never good reason to buy insurance. Moreover, if your health insurance is insufficient, you should not just purchase additional medical insurance that covers you in an accident in your car. Consider the possibility of being hurt in a rental car, in someone else’s car or as a pedestrian? If needed, adjust your health insurance to adequately protect you in all forms of accident.
3) Identity Theft Insurance
This has become a popular insurance add-on in the wake of more frequent identity theft at large corporations. It is inexpensive coverage but that has a lot to do with the limitations of the coverage and the low likelihood that it will ever apply to you. This coverage is misunderstood and unnecessary for several reasons:
- Identity theft insurance does not protect you from monetary losses. The new loan that a thief opens in your name is still your financial responsibility, with or without this insurance. Identity theft insurance simply reimburses you for costs to repair your identity like phone bills, notary fees, certified mailing expenses, and attorney fees. None of these costs are likely to be substantial.
- A credit freeze is a far more effective and cheaper way to protect your credit than identity theft insurance. You are much better off avoiding identity theft in the first place than buying insurance which reimburses you $78 for the 9 hours of wasted time you spent on the telephone to correct the identity theft.
- Finally, if a thief steals your credit card and uses it to purchase items online or by phone, you are completely covered. If the card is used fraudulently for in-person transactions, your maximum liability is $50. These are not life-changing risks.
4) Rental Car Insurance (Collision Damage Waiver)
Nearly all credit cards cover rental car collision repair these days meaning that if you pay for the rental with such a credit card, you get this coverage for free. Moreover, your auto insurance will normally cover 14 days of temporary rental car use so you are likely getting this coverage in more than one place. In the event of an accident, you will still owe any loss of use fees for time that the rental car is being repaired and cannot be rented but these costs are modest, at worst. Rental car companies make nice profits off this coverage which is why the desk clerk will continue to make you feel as though you need it. The reality is that you do not.
5) Credit Card Fraud Insurance
Credit card providers commonly market this insurance by mail hoping that you will feel compelled to insure the risk. This is basically insurance you purchase to protect the credit card issuer. As mentioned above, the federal government limits your liability for all purchases made on a stolen card or for erroneous charges. There is no need to buy insurance which protects your credit card provider from their own inability to carefully monitor for fraudulently activity.
6) Cancer or Specified Disease Insurance
Agents cite the high risk of getting cancer during a lifetime or the extreme costs of treatment and make this coverage appear critical. Importantly, you need health insurance and life insurance to cover these risks, not some insurance that only covers you in specific circumstances. You do not need more insurance coverage for expensive cancer treatment than you need for expensive heart disease treatment. Aside from being unnecessary insurance, cancer insurance is notorious for coverage loopholes or for conveniently excluding more common diseases like skin cancer.
7) Group Life Insurance
Group life insurance benefits one class of people – those who are otherwise uninsurable for health reasons. If you purchase group life insurance, recognize that you’re being priced as if you are an unhealthy, out-of-shape, lifelong smoker. If you are uninsurable, group life insurance is a great avenue to get coverage. Otherwise, you are better off buying term life insurance which will be less expensive and which is portable if you leave the company.
8) Extended Warranties
Retailers make a fortune selling this unnecessary coverage to nervous buyers who are willing to pay a few dollars to protect that large purchase. For most big ticket items, the manufacturer’s warranty already protects you from the small probability of a defect and you automatically have an extended warranty provided at no additional cost from nearly all credit cards.
9) Juvenile Life Insurance
Juvenile life insurance became popular in the 1800s when infant mortality rates were high and parents could not afford funeral or burial costs for an infant. It is still sold today with agents citing the financial planning benefits of creditor protection, tax deferred growth, guaranteed coverage, estate tax avoidance, or college funding. The reality is that all of these benefits either have major flaws or are better accomplished using vehicles like 529 Plans than with the high costs of permanent life insurance. While losing a child would be emotionally catastrophic, it would not be financially catastrophic and the money would be better spent on your kids rather than to insure your kids.
10) Mortgage Life or Disability Insurance
Mortgage companies love to offer this coverage as a way to siphon more money from customers. The concept is that if you die or become disabled, the insurance will pay off your mortgage balance. There’s really only one good reason to buy this insurance and that is if you cannot get life or disability insurance elsewhere because of pre-existing conditions. Otherwise, consider the drawbacks:
- It is more expensive per dollar than traditional term life or disability coverage.
- It is less flexible than traditional term life or disability coverage. You don’t want your family to be forced to pay off the mortgage if the life or disability insurance proceeds can be better spent somewhere else (like sending the kids to college or putting food on the table).
- It penalizes you for pre-paying your mortgage, even if that is the sensible financial move. Given that prepaying a mortgage reduces the financial obligation of the insurance company (the death benefit), you’d expect them to send a gift.
It is easy to fall into the trap of being sold unnecessary insurance. By nature, we are more risk-averse than risk-seeking. So perhaps it helps to think about Buffett’s punch cards or a foul limitation when it comes to insurance and to recognize that there is no free lunch. If this helps to avoid unnecessary insurance that you either do not need or already have covered somewhere else, the savings can be significant (consider just the amount you may be paying for medical payments coverage on your auto policy which is likely hundreds of dollars each year). Whereas one or two undisciplined cheap fouls can change the outcome of an important basketball game, consistently buying unnecessary insurance can more than offset the $699 you saved on Black Friday.