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Wednesday, February 07, 2007

Insurance: wealth vs. cashflow preservation

There are two general types of insurance:

o Wealth preservation insurance. This is a hedge against big, unknown expenses like getting sued or enormous medical bills.

o Cashflow preservation insurance. This is a hedge against "bump in the road" issues like car repairs or replacement of electronics or appliances.

Life insurance is the ultimate form of wealth preservation insurance: the point of it is to "capture" at least some part of the aggregate earning power of the insured if they die untimely.

Other examples of wealth preservation insurance are auto liability insurance, homeowner's insurance, or high-deductible "health savings account" health insurance. An example of cash flow preservation insurance is pretty much all auto insurance other than liability; the amount it will pay is bounded by the replacement cost (or sometimes the new price) of the car. "Combination" insurance would be most employer-based health insurance.

We're big savers, so we run with "wealth preservation" insurance and figure that cashflow preservation will be managed by emergency fund savings. Following this logic, we never buy extended warrantees on electronics or appliances, and have high deductibles on everything that permits deductibles.

Typically, wealth preservation insurance is cheap compared with cashflow insurance, so this is a reasonable strategy for us, and shows how having an emergency fund can save money in other ways than needing to use debt to cover cashflow hiccoughs.

Nice analysis there. I'd never heard it put quite that way, although I've been following these principals (minimizing my cash-flow insurance) for some time now.
Insurance rate is a factor used to determine the amount, called the premium, to be charged for a certain amount of insurance coverage. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.
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