What is insurance, really?

You probably have an intuitive understanding of what insurance is and how it works. You may even have had extensive experience in buying insurance and in dealing with insurance companies. But few people-expert or novice-stop to ask themselves what insurance actually is. So what does it mean to buy insurance, really? Buying insurance is paying someone to assume risk for you. Risk is...well, risky. Everyone is willing to assume some risk in their lives. After all, it's difficult to imagine life without a little risk. But some risk is too great to bear. Insurance is a way to manage these types of risk by shifting the burden to somebody else in exchange for money. This may sound a bit abstract, but understanding how insurance works at this level give us a solid foundation for addressing the issues and answering the questions that we've laid out for ourselves in this article.


Why buy insurance?

The first reason is that a minimum amount of insurance is required by state laws. The second, I hope, should be fairly obvious: buying insurance is smart. More than anything else you own, your vehicle is by far the most likely cause of significant injury to yourself or others, and the most likely reason why you'd be sued for significant sums of money-in most cases far more than you'd be able to afford. For the vast majority of people, the type of losses that are commonly the results of accidents represent risks that are too great to assume themselves. The third reason is a matter of our duty as responsible citizens. It's about protecting others from us. We all make mistakes, but, unfortunately, driving means that seemingly minor errors-momentary lapses in judgment and attention-can irreversibly alter another's life, and even end it. Buying insurance is the best means of ensuring that we are able to take full responsibility for any mistakes we make on the road.


What types of insurance am I obligated by law to buy?

Each state has different requirements. California law, for example, requires that every driver "maintain financial responsibility" for any accident he or she causes. By far the most common way of satisfying this legal requirement is to purchase liability insurance. At minimum, the law requires liability insurance with a limit of $15,000 for a single death or injury, $30,000 for death or injury to more than one person, and $5,000 for property damage.


How should I shop for insurance?

There is a right way and a wrong way to buy insurance. The wrong way, unfortunately, is the approach we are most accustomed to taking when comparison-shopping: we figure out what we're looking for, and then we look for it at the lowest price. Based on the assumption that the product is essentially the same regardless of where one buys it, this focus on price makes a great deal of sense. But insurance is different than most of the things we buy. Insurance, first of all, is not a thing-it's a contract that we purchase. Simply looking for a certain policy limit of the lowest price means we're ignoring what's actually in the contract. Our assumption tends to be that if we buy an insurance policy, it will cover us in the event of an accident. But if matters were that simple, insurance contracts would be far shorter than they actually are. Most policies include lists of limitations and exclusions, which create holes in the coverage. More often than not, you get what you pay for.