Insurance and risk management

Insurance is one tool in a bigger kit called risk management, which is just the grown up name for deciding what could go wrong and what to do about it in advance. Businesses employ whole teams for this. You can do the personal version on one page.

Two questions for every risk

Take any risk in your life and ask two questions. How likely is it? And how bad would it be? Those two answers place every risk into a rough grid. A dropped phone is likely but cheap. A house fire is unlikely but devastating. Causing a serious car accident sits in the worst corner for a new driver: more likely than they think, and potentially ruinous. The grid tells you where to spend your protection money, and it is almost never on the likely but cheap corner.

The four moves

• Avoid the risk: do not do the risky thing. Not driving in a dangerous storm avoids the crash entirely.
• Reduce the risk: make it less likely or less severe. Park off the street, lock the house, service the car.
• Carry the risk: accept it and cover any loss from your emergency fund. The right move for small stuff, also called self insuring.
• Transfer the risk: pay an insurer to carry it for you. The right move for the ruinous corner of the grid.

Good risk management mixes all four. A sensible young driver avoids some risks, reduces others by parking well and maintaining the car, carries small losses with an emergency fund, and transfers the ruinous ones with insurance. Notice that the excess from lesson three is really a slider between the last two moves: every dollar of excess is risk you carry, every dollar above it is risk you transfer.

Take one illustrative student and watch all four moves land at once. She has a $6,000 car, a $1,200 laptop she needs for school, and a casual job. The ruinous risk is the damage she could do to another car, so she transfers it by holding at least third party property cover. The laptop is painful to lose but not ruinous, so she reduces the risk by backing up her work to the cloud and carries the rest herself rather than paying to insure a single item. On a night of heavy storms she simply does not drive, which avoids the crash entirely. And she keeps a few hundred dollars aside as an emergency fund so the small stuff, a cracked mirror or a stolen bike light, never becomes a crisis. Same student, one afternoon, four different moves, each matched to where its risk sat on the grid.

Rethink it every year

The right answer changes as your life does. A $2,000 first car might not justify comprehensive cover for a young driver paying young driver premiums. Five years later, a $25,000 car and a cheaper premium flip the answer. The skill this topic has been building is not knowing what to insure. It is knowing how to redecide, every time the numbers change.

That skill is what pulls the whole topic together. The early lessons showed why insurance exists and how the pool and the premium work, the middle lessons mapped the types and taught you to read a policy, and this grid is the tool that decides which of them you actually need this year. The case study that closes the topic is this grid in action, following one driver through a real shaped decision with real numbers, so it is worth working through slowly with everything here in mind.