Come on! What else did you think day 13 in the makeover was going to be about? 😀

On day 12, several people mentioned the importance of an emergency fund, so with that idea so firmly ingrained, it should be easy to get the insurance issue out of the way.

An emergency fund is essentially a form of unemployment insurance where you self-insure. This idea can easily be taken further. Consider for a moment what else could be self-insured? Your house? Your bicycle? Your stuff?

Think of insurance as a money transfer from people who get into accidents less often to people who get into accidents more often with insurance companies taking a cut (this is called the combined ratio) of typically 10% to arrange this transfer.

Would you voluntarily take this offer? Only if you are more risk prone than average (say you eat 5 double cheese burgers a day, smoke, and have an annual car accident) or you can not afford to cover the loss if the event happens to you or both.

If you can self-insure and work on reducing your risk below those of the average insured person (insuree?), you will be better off statistically than those who carry insurance.

In other words, if you self-insure, YOU get to invest the float and receive the interest. If not, Warren Buffet gets to do it (if you’re using Geico that is) and he’ll keep the interest for his shareholders.

This is of course not a binary decision. For instance, due to the prevalence of frivolous lawsuits we carry liability insurance. You never know if someone is going to stumble on your door step and then decide that their clumsiness was your fault. We do however not insure our stuff as this can easily be replaced many many times in case it gets destroyed(*). For my health insurance, I carry a HDHP, which has very low fees, because I carry all risk from $0 to $3500/year after which the insurance pays the rest. Thus I’m protected from catastrophic loss but I have a fairly large economical stake in my health. The money to cover this comes from a HSA which can be increased tax-free by $3050 per year. Thus in the worst case scenario, I will be paying $3500/year every year. Even $100,000 in savings will sustain that for 29 years, so there’s little to worry about(*).

(*) Relative to say having your health insurance through your job and worrying about getting so sick that you eventually get laid off unable to work after 1.5 years thus losing your nice corporate health care, and then what?