One thing I can’t wrap my mind around is the prevalence of full coverage auto insurance. To get at the heart of the issue, we need to think about what the definition of insurance is according to Warren Buffett:
The purpose of insurance is to protect you from a risk that you cannot easily aborb
Warren is explaining insurance in simple terms of paying a premium to an insurance company in exchange for transferring your risk to another party. The problem here is that an individual buying full coverage car insurance cannot easily absorb the loss of that car.
For example, if someone goes out and purchases a typically priced $35,000 brand new car with a $20,000 net worth. That individual cannot afford to replace that car if they were to get in a wreck. This means that the car has a high value relative to their net worth!
But why would having a car be a large portion of your net worth be an intelligent way to deploy scarce resources? Cars are depreciating assets. They lose value every day they sit outside and every mile they are driven.
A depreciating asset should not be significant relative to an individual’s net worth. Additionally, why would anyone want the extra burden of paying an insurance premium because of the risk? Most people owning new model cars are also paying interest to borrow money for these depreciating assets. These car payments create undue financial stress for individuals rather than increase their happiness.
If you need full coverage of insurance to protect your car, then your car is too expensive. You should have a cheap used car with collision insurance.
If your net worth is very high relative to the value of your car then you don’t need full coverage insurance since you can easily absorb the loss. You can cancel it and rake in the savings. If you have a large asset base, then you should also have an umbrella policy.
Ideally, if you wreck a car you should be able to easily replace it. I have collision only insurance and own two cars: one is a crossover with 120,000 miles that I paid $6,100 for and the other is a Coupe that has 210,000 miles on it worth maybe $2,000. I could afford an expensive car but it wouldn’t make me any happier: my cars already have luxuries that I enjoy like remote start, subwoofers, and Bluetooth.
If I were to wreck either of these cars, what would I do? I would go out and buy a new car for around $3,000 – $6,000 and pay cash. That makes a lot more sense to me than insuring something you cannot afford to lose to impress someone at a stoplight whom you don’t even know.