Insurance is a way of pooling risk. You ask an insurance provider to take on your risk, and they calculate a premium based on the number of people sharing the risk, and your chances of needing to claim. On the face of it, this is a fairly simple proposition. However, it is not always easy to choose the right insurance—or even to know when it makes sense to take out insurance in the first place.

This page describes how you might go about choosing insurance, including when to insure. It also provides advice about how to choose the right insurance: that is, insurance that will protect you against the risks that you cannot manage yourself.

Understanding Insurance

Our page on Financial Contingency Planning explains that insurance is a ‘risk game’.

By paying a premium, you are paying the insurer to take on your risk. They calculate the chance of having to pay out, and the cost of doing so, against that premium. If they think that the risk is likely to happen, or the cost of paying out will be high, then the premium will also be high. A smaller risk, or a much larger pool of people wishing to insure, will change the premium.

When you know what the premium is likely to be, you can make a judgement about whether it is worth paying.

• If you judge that the premium is considerably less than the cost of having to pay out yourself, especially if the likelihood of needing to claim is quite high, then the insurance is likely to be worthwhile.

• However, if the premium is extremely high, close to the cost of paying yourself, then you may feel that it is not worthwhile, and you would be better saving the cost of the premium and paying out yourself if necessary.

For both you and the insurer, insurance is a balance of risk and reward.

If the insurer judges that the risk is too great, they may refuse to insure you at all.

This balance of risk and reward gives you a reasonable way to assess whether you need that particular type of insurance.

However, once you have decided that you do need insurance, how do you decide on the right policy?

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Choosing the Right Policy

To decide on the best insurance policy for you, the Association of British Insurers advises that you need to consider:

• Why you need cover, because this tells you what you should aim to include.

• What you want to include in your cover, that is, the events for which you want your insurance company to pay out, and also what you want by way of payment or benefits. This is important because you want to ensure that you have covered everything that is important to you, but you do not have benefits that you do not want or need.

• What other terms are important to you. For example, some policies will have a cheaper premium, but charge an administrative fee if you need to change them mid-term. This could be a problem if you think you might move within the term, or if you might need to upgrade the policy. You may also want to have your insurance with a provider that offers a phone line in the event of needing a claim—or prefer an online-only option.

• What you can afford to pay in terms of both the monthly or yearly premium and also any co-payment or excess, the payment that you make in the event of a successful claim. Sometimes you can get a much cheaper premium in return for accepting a larger excess. You also have to remember that the cheapest policy may not be the best if it does not meet your needs.

• The length of the cover, which can vary considerably from 25 years for a life insurance policy designed to cover your mortgage in the event of your death, to just a couple of weeks for travel insurance. You may find that it is (relatively) cheaper to take out a policy that lasts for longer, or to pay yearly instead of monthly.

• Who you want to include on the policy, for example, just you, or family members as well.

It is also worth checking the terms and conditions of the policy in full. If you find—even after you have paid—that it does not meet your needs, it may be possible to change it. In the UK, insurers have to offer a ‘cooling off’ period of at least two weeks, during which you can cancel if you change your mind.

Policy Renewals: What to Consider

Choosing the right policy is not just important at the point where you first take out the policy. You also need to consider whether it is still the right policy when the time comes to renew.

You need to check all the items above again—even if your policy was right last time, it doesn’t mean it will still be right now. In particular:

• Consider whether any of your circumstances have changed. For example, have you any additional health conditions that might affect your insurance, or have you had any additional equipment installed in your car?

• Check whether any of the terms and conditions have changed—and if you still think that they are acceptable.

• Check your options for premiums, excesses and co-payments, and make sure that they still suit your needs.

• Shop around, and make sure that you are getting the cover you need at the best price. It is worth calling your existing insurer to see if they can lower the price, because it is widely recognised that many insurers will charge existing customers more and have some room to lower the price.

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A Final Thought

Some types of insurance are mandatory, such as motor insurance. However, for many others, you have to make a decision about whether they are right or necessary for you. Some, like household insurance or life insurance, make sense because the consequences of not having them and needing them are too devastating. However, in each case, you need to balance the risk against the reward. Sometimes, you may decide that you do not need insurance—and this can be entirely appropriate.