Insurance basics: what each common policy covers

The right way to think about insurance: it exists to protect you from outcomes you can't financially absorb. A $500 phone repair is the kind of cost people often handle by self-insuring: covering the cost yourself. A $400,000 medical bill or a lawsuit after a car accident is the kind of cost a policy exists for.

What each common policy covers

• Health insurance pays for medical care after your share (the deductible, copays, and coinsurance), up to the plan's yearly out-of-pocket maximum.
• Auto insurance pays for damage and injuries from a crash, up to the policy's limits. Most states set a minimum amount of liability coverage for drivers.
• Renters or homeowners insurance pays to replace your belongings and covers liability if someone is hurt on your property.
• Term life insurance pays a set amount to the people you name if you die during the term, commonly 10 to 30 years. The premium is set by your age and health when you buy.
• Long-term disability insurance replaces part of your income if an illness or injury keeps you from working for an extended period. Many employers offer it as a benefit.

Coverage that often duplicates what you already have

• Whole life (cash value) insurance bundles a death benefit with a savings account inside the policy. For the same death benefit, its premium is higher than a term policy's, and it is usually sold on commission.
• Extended warranties often overlap the manufacturer's warranty, and some credit cards extend that warranty at no added cost. They are priced so the seller expects to pay out less than it collects.
• Identity theft insurance overlaps with the free monitoring many credit cards and banks include, and placing or lifting a credit freeze at each of the three bureaus costs nothing.
• Mortgage life insurance pays off the mortgage if you die. A term life policy can cover the same balance, and a mortgage policy's payout usually shrinks as the balance falls while its premium stays the same.

The deductible decision

Higher deductible = lower premium. The tradeoff is the deductible itself: it is the amount you pay before coverage starts, so a higher one means a larger bill when you file a claim, paid from your own savings.

What this lesson is NOT

Insurance exists for catastrophic losses that could not be absorbed out of pocket, not for small or predictable costs. This lesson is the framework for telling those apart; it does not recommend specific policies, companies, or coverage amounts.