I drive an 11-year-old Toyota Yaris. It looks as though someone rolled it down the hill – sideways.
There are dents and unsightly scratches pretty much everywhere. I pay for full comprehensive insurance, but am reluctant to make claims on the cosmetic stuff for fear of what that might do to my premiums.
I’m also in a bit of a financial pickle because I know full well that I haven’t remotely saved up enough money to survive the lean years when frail-care costs could wipe me out in the blink of an eye.
Finally, at the ripe old age of (no, I’m not going to put that in print), I’m in a quandary about what I should be doing about my health coverage. On the one hand, there are simply a lot more things going wrong with my body than have gone wrong before.
But it’s also getting harder to know what’s likely to start going amiss next.
These three sets of financial concerns leave me in a position of vulnerability that I estimate many South Africans are in too: when money is tight, what insurance coverage can I afford to let go of, in terms of coverage and costs?
What should I consider as non-negotiable in terms of too much risk exposure?
And, finally, if I have to make trade-off decisions, where am I likely to get the biggest bang for buck given my limited wallet size?
The problem is, it’s hard enough for an individual to make a decision about what is and isn’t a necessary expenditure for one form of insurance, much less navigate the complex decision-making process required to determine where to make trade-offs between the different types of coverage.
The industry tends to just complicate matters even further every time it adds new bells and whistles to the package.
Insurance products, in general, are tough to wrap your head around.
In most cases you get nothing out unless the worst happens.
If insurance was viewed like an investment, policyholders would rationally feel like this was one investment with little prospect of a great return.
The result is that people often see insurance as a grudge purchase.
Why should anyone buy an insurance product that costs a fortune, and provides only the promise of a benefit on the off-chance that the insured event happens at some point in the future?
That said, there is something hugely important in terms of managing financial stress in knowing that should an unfortunate event ever unfold, you are protected from financial loss – at least to some extent.
And therein lies the problem. Most purchasers of insurance products have only a vague sense of how expensive those protections are.
Bottom line: consumers tend to do a lousy job of really thinking through their options in a rational, effective manner.
And that often ends up with people paying far too much for something they don’t really need – or, conversely, paying too little for something that could have been a lifesaver.
The behavioural economist George Loewenstein and his colleagues uncovered an important insight about how we humans typically respond when faced with complex questions around insurance.
Instead of being able to rationally weigh up deliberations around cost, need, and risk, the bulk of decision-making focuses on one parameter: which option appears to require the lowest premium contribution.
And not: “Where can I get the best value for what my family needs?” Clearly, we need a better way to help consumers navigate their way through the maze.
A decision-making framework that would allow us to determine what we really need, how much we need, and what our options could be, would be really helpful to identify the lowest cost solution that still provides us with the requisite protection.
This framework asks two questions: “What is the probability of that event happening?” and: “Should the event occur, would my family be able to cope with the financial/emotional/inconvenience impact?”
The probability insight is unquestionably the hardest to get right, because individuals do not have sufficient information to assess it accurately.
People also tend to be very poor at quantifying the financial impact of an event.
As a result, they may underestimate how much money they may need to absorb losses. People in general have an optimistic bias, i.e. bad things only happen to other people, or, if and when it happens, it will not be as severe.
The more manageable discussion is the one around whether you and your family could effectively cope, should the event occur.
The good news here is that we can construct a particularly useful decision tree to help us navigate the different options at our disposal.
At the start, let’s accept that individuals and their families have four different options at their disposal for mitigating risks in their lives:
- They can look to government to provide them with protections. (No retirement savings? Don’t worry, if you pass the means test, government will provide you with R1?650 a month to live on. Will that do it for you?)
- They can self-insure. (This just means that you have enough savings to cover the loss yourself.)
- They can use informal support systems for risk mitigation.
(These include burial societies for funerals, stokvels for emergency savings to cover the cost of an accident, theft, or death – with the hope that these investments will be secure.)
- They can buy formal insurance products. (Paying a premium to an insurance company in return for a protection from a predefined event that can cause a financial loss.)
The critical questions
Now let’s look at our decision tree and work our way through four fundamental questions that can guide my decision-making with each of these areas of risk in my life.
Is the liability associated with the insured event limited?
If my 11-year-old, paid-off Yaris gets into another scrape, how important would it really be for me to make sure that I could get every little ding out of my car?
Obviously this is not a high priority in my life. As such, one clear-cut area for saving is not to purchase comprehensive insurance on my car.
I could redeploy those savings to address some other risk concern.
But… should the car roll down the hill and smash into a Ferrari with a baby strapped in the back seat, I could become liable for millions of rand in compensation, which could instantly wipe me out.
In this instance, the non-negotiable would be that I need third-party insurance.
The upper limit of this type of liability is not known and you can therefore never know with certainty whether you have enough savings at your disposal.
Here is another consideration: what if I still owe money to the bank for the car?
If I crash the car, I'll still owe that money and I won't have a car. So if that's something I can't manage, I should insure.
Do you have enough emergency funds to absorb the loss associated with the insured event?
Here, we’re talking about self-insurance. Given that I owe nothing on my car or personal effects, I will be opting to “self-insure” any damages to my car or belongings.
I simply haven’t got enough emotionally invested here to make this purchase make economic sense for me.
But could I possibly “self-insure” myself against potential third- party damages or frail-care costs?
Not with the amount of savings I have.
Let’s apply the same line of thinking to something like life cover.
Here we’re able to determine how much you need to leave behind so that your family members can cover their daily living costs.
You should include expenses like the outstanding bond on the house so that your family has somewhere to live, the cost of education, estimated medical costs, and the cost of food, to name a few.
Know these amounts and then look at your existing asset holdings to see if you have enough to act as a substitute for insurance.
Here you might count the value of your retirement fund savings, emergency savings, existing cover from your employer, and so on.
The decision as to the appropriate amount of life insurance to buy depends on the assets that will be available to family members to use upon your death.
Note, however, that it isn’t always easy to assess all the costs that you could face if you experienced the loss event.
When it comes to disability insurance, for example, there are many costs you may have to pay for, like physiotherapy, that you don’t think of when assessing whether you have enough money to offset the risk.
Or, what if I have a critical illness or a disability where the condition is permanent and affects one’s ability to generate income?
These types of events may demand a rethink if I don't have enough available funds to support me over the time.
Do you have social structures to support you should you incur the loss?
My daughter is a doctor. She already knows that if I get into trouble in old age, whether I need frail care or a place to live, she will be my default option.
It’s not ideal, but I’ll be looking to her for the support I need here simply because no economic miracle in the investment markets is going to make up for the power of compounding that I’ve missed out on with my retirement savings.
Elsewhere throughout South Africa, communities have strong social ties and the sharing of medical costs and income support are common.
If you’re comfortable relying on this support system to protect your family when you’re gone, you may be less inclined to buy large amounts of life insurance.
However, two factors are making this option more problematic.
- Urban migration in search of employment is making it increasingly difficult for families to stay together and support one another.
- The costs you may incur are difficult to estimate with accuracy and can sometimes be unlimited.
While social support may help, this option may have unintended ramifications.
Those providing the social support may find that their own financial position may become compromised and vulnerable to adverse events.
Maybe the question should be: “Do you feel comfortable around this and can the social structure withstand the impact of the losses that will be transferred to them?”
Will you be able to live your life as you wish if the insurable event occurs, or could you adapt your lifestyle?
Humans are much more adaptable to losses than we think we are.
If your cellphone is stolen, you could probably adapt and buy a cheaper one if your finances did not allow for replacing it with like for like.
However, if you don’t insure your car and it is stolen, would you be able to adapt to taking the bus?
Another way of looking at this could be to say, to what extent would your life be affected if the event occurs and no cover is in place?
If an uninsured cellphone gets stolen, it may be a big blow for someone who does business on their telephone.
Other questions to ask when you are considering whether to insure a possession: Would its loss…
- affect my ability to generate income?
- affect my normal day-to-day functioning?
- have an impact on my dependants’ well-being?
- affect my ability to retire?
These are not just questions about the financial consequences, they also relate to questions of convenience.
If I had to queue at a state hospital to get care for a family member who had become disabled, would this impact my ability to keep my job?
Bottom line: you have to think about whether you could adjust your lifestyle without compromising you or your family’s well-being.
Note the diagrammatic representation of the decision tree above, and try the exercise for yourself the next time you ask yourself a question about insurance coverage need.
It’s a great way to keep yourself from simply succumbing to fear (or marketing spin) when considering whether you need a specific form of insurance coverage.
One thing that’s clear from the above analysis is that a more deliberative approach is needed when making an insurance decision.
While in our everyday lives we have grown accustomed to making automatic decisions based on our subjective assessment of probabilities, insurance decisions are far more complex and consumers need assistance to help them make these decisions so that they can follow the right principles to ensure that they make measured, deliberative decisions.
But what the decision tree doesn’t solve is how to navigate the complexity of pricing models (think especially health insurance here).
We also don’t have a sense of what we should prioritise if we had only one or two insurance options that we could afford. Here we categorically need to appeal to the industry and ask insurers to apply their minds to both of these questions if we are going to move beyond simply selling people insurance to helping them buy it where it is most needed.
Anne Cabot-Alletzhauser heads up the Alexander Forbes Research Institute.