Not Insuring These 6 Things Could Bankrupt You

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Getting ahead financially isn't easy. It requires hard work and persistence. So why risk years or even decades of hard work and sacrifice only to lose everything in one unfortunate, very costly event? (See also: Marketing, Life Insurance, and Behavioral Psychology)

"It won't happen to me," you say? I felt the same way years ago. But life happens. However unfair it may be, over time we all see some of our friends and family members face difficult challenges or even catastrophes. (I'll include a few examples of my own below.) As much as we hope to avoid them, we just can't predict or control all events. But we can at least hedge some of these risks by insuring against them.

What Should I Insure?

Insurance is for the big things. It's to protect you from major events that would cost you more than you can pay for from your short-term financial reserves. In other words, its purpose is to help shield you from serious and potentially devastating financial setbacks.

What Shouldn't I Insure?

As a rule, then, insurance is not for smaller financial risks or expenses you could absorb and pay for in the short term. This is where we often make a mistake — purchasing insurance or service contracts for goods and services that cost hundreds of dollars or less.

Is that to say that you should never consider taking insurance on a cell phone or a computer printer, for example? Maybe not, but be aware of the cumulative opportunity cost of those expenditures. That money could have been used to help you get ahead financially, by paying off an outstanding debt for example. Also, remember that companies that encourage you to buy their service contracts and warranties often make more profit on the warranties than on the actual product or service being insured.

So, what are the big things requiring insurance? And what types of insurance can protect you from being wiped out financially? Here are six that cover most if not all of the bases.

1. Health Insurance

By far, the number one cause of bankruptcy in the United States is unpaid medical bills. A study done at Harvard University identifies medical expenses as a leading cause of 62% of all personal bankruptcies.

Even the shortest of hospital visits now costs thousands of dollars. Just a few months ago one of our sons experienced sudden stomach pains, requiring a trip to the emergency room. After a number of tests (isolating the problem as an intestinal disorder) and some antibiotics he was released four or five hours later. The bill? Over $20,000. Thankfully our insurance covered most of the bill and his subsequent treatments. But it's easy to see how a single serious injury or disease, if not adequately covered by health insurance, could deplete your entire savings.

And even if you have health insurance, the ever-rising deductibles (sometimes $5,000 or more) can tip you over a financial cliff if they exhaust your short term funds and force you to delay credit card, vehicle, mortgage, and other payments in an attempt to recover.

2. Life Insurance

This one should be a no-brainer. If you have dependents or any unpaid debts or financial obligations that would need to be paid upon your death (not many people can answer "No" to all of those), then you need life insurance. The question is, how much?

There are many ways to estimate how much life insurance you need, but I like the following approach:

1. Determine your household's current TOTAL annual income needs and SUBTRACT income that's available to your spouse/survivor(s) from other existing sources. This will be their NET annual income need.
    
2. Multiply this net annual income need TIMES the estimated number of years your beneficiaries will require it.
    
3. ADD your total current outstanding debts.
    
4. ADD future unfunded expenses (your funeral expense, children's college, etc)

This total should give you a good initial estimate. For a more complete assessment I suggest Tony Steuer's Questions and Answers on Life Insurance toolbook .

My strong preference is term life insurance, not permanent life policies like whole life or universal that include an investment component. As a rough guide, I purchased a $300,000 supplemental term life policy at age 40 for $300 per year, or $25 per month. That premium amount will not change until my mid-60s.

3. Vehicle Insurance

Auto insurance is required by most states. It's actually a collection of policies that protects you from financial loss in three ways:

1. Property coverage pays for damage to your car, either from a collision or from vandalism, storm damage, or theft (if you have "comprehensive").
    
2. Liability coverage pays legal expenses to others for injury to them or damage to their property in an accident.
    
3. Medical coverage pays for the cost of treating accident injuries, and sometimes for lost wages and funeral expenses.

According to Money Girl podcaster Laura Adams, you ought to have "enough auto insurance to cover the total value of all your assets — such as your home, vehicles, savings accounts, and non-retirement investments — [in case you are] involved in a lawsuit."

4. Homeowners Insurance

Like vehicle insurance, homeowners insurance is required when you have a mortgage. It should cover the replacement value of your home and its contents, and it pays for claims associated with fire and certain natural disasters. A liability portion also covers you if someone gets hurt on your property. (See also: 8 Surprising Things Covered by Homeowners Insurance)

If you rent, and the loss of your personal belongings would cause a financial hardship, then you should consider renter's insurance.

5. Disability Insurance

As a young girl my grandmother excelled in school. She loved to read and looked forward to attending college. Her father was a successful stone mason and the family lived comfortably, so paying for college was within their means. Then a work-related accident left him disabled. He never recovered, and he didn't have disability insurance, so his daughter had to quit high school and get a minimum wage job to help the family make ends meet. Needless to say, my grandmother never attended college, and she never had an opportunity to achieve her dreams.

This is why having disability insurance is so important.

• Approximately one out of four workers entering the workforce today will become disabled for some period of time before they retire.
   
• More than 90% of disabling accidents and illnesses are not work related, which means they aren't covered by worker's compensation insurance.
   
• Social Security is only available after you've been out of work for a year and are completely disabled.
   
• Disability is the leading cause of about 50% of all mortgage foreclosures.

Most employers provide short-term disability insurance to non-contract workers, but they are less likely to offer long-term disability coverage, or if they do it's often less than you need. So look into supplemental disability insurance to make sure your family's needs are covered.

6. General Liability Insurance

Sometimes referred to as umbrella insurance, this is a "miscellaneous" policy. It covers amounts in excess of maximums in other policies, and it provides primary insurance for losses that aren't covered by other policies. Take personal injury lawsuits. However frivolous the claim, defending against a lawsuit can cost thousands. For example, my stepfather works for his local township and he spent over $40,000 clearing himself of an unfounded charge against him by a citizen of the town.

Also, have you noticed that insurance companies are narrowing the scope of what they cover in their traditional insurance policies? That same stepfather had storm insurance to cover his primary residence but didn't learn until after last year's Hurricane Sandy that the insurance company wouldn't cover $20,000 in damages to the garage on the same property.

Our household has a $1 million umbrella policy that costs about $50 per month. It gives us peace of mind.

Protect What You've Worked Hard For

Joni Mitchell wrote: "Don't it always seem to go that you don't know what you've got till it's gone." I think that sums it up nicely. It's hard for us to appreciate the consequences of a serious accident or unforeseen event until after it occurs.

But bad things do happen — we see it all around us. So do what doesn't come naturally: protect yourself against your big risks before they happen. Take stock now of your insurance needs and make sure you're covered.

Have you covered your big risks? How many of these insurance policies do you have? Can you think of any others?