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Personal Finance Unit 5: Insurance and risk management

Insurance transfers the risk of large financial losses to an insurer in exchange for regular premiums.

Covers: Risk management strategies, insurance basics, health insurance, auto insurance, homeowners and renters insurance, life and disability insurance

Study guide

Risk management means handling the chance of financial loss. Strategies include avoiding risk (not doing a risky activity), reducing it (installing smoke detectors), retaining it (paying small losses yourself, perhaps with an emergency fund) and transferring it (buying insurance). Insurance works by pooling: many people pay premiums so the insurer can pay the few who have losses. Key terms include the premium (the regular payment), the deductible (what you pay before insurance pays), coinsurance (the percentage you pay after the deductible), the copay (a fixed fee for a service) and the out-of-pocket maximum (the most you'll pay in a year). A higher deductible usually means a lower premium.

Health insurance may come from an employer, a government program (Medicare for people 65 and older, Medicaid for people with low incomes) or the Health Insurance Marketplace created by the Affordable Care Act. Young adults can usually stay on a parent's plan until age 26. Plans differ in their networks; HMOs require using in-network providers and referrals, while PPOs offer more choice at higher cost. A health savings account (HSA) paired with a high-deductible plan lets people save pre-tax money for medical costs.

Auto insurance is required in nearly every state. Liability coverage pays for damage and injuries you cause to others; collision covers your car in an accident; comprehensive covers theft, weather and other non-collision damage; and uninsured motorist coverage protects you if the other driver has no insurance. Rates depend on age, driving record, location and the car. Renters insurance covers a tenant's belongings and liability, since the landlord's policy covers only the building; homeowners insurance covers the house and belongings. Life insurance pays beneficiaries when the insured person dies; term life covers a set period and is cheaper, while whole life lasts a lifetime and builds cash value. Disability insurance replaces income if illness or injury prevents work.

Which insurance you need depends on your situation. Every worker who relies on a paycheck benefits from disability insurance, but life insurance mainly matters when someone, like a child or spouse, depends on your income. A single young adult with no dependents usually needs health, auto (if driving), renters and disability coverage before life insurance. Insurance is most valuable for losses that are unlikely but too costly to pay yourself, such as a hospital stay or a lawsuit. Small, predictable costs are often cheaper to cover from savings. Premiums also carry an opportunity cost, because that money can't be saved or spent elsewhere.

You can lower premiums by choosing a higher deductible, keeping a clean driving record, earning good-student discounts, bundling policies with one insurer and comparing quotes. Filing many claims can raise future premiums.

Key ideas

• Risk can be avoided, reduced, retained or transferred.
• Insurance pools premiums to pay for members' losses.
• Higher deductibles usually mean lower premiums.
• Auto liability insurance pays for damage you cause to others.
• Renters insurance covers a tenant's belongings and liability.

Formulas and rules

Common mistakes

• Thinking a landlord's insurance covers a tenant's belongings; it doesn't.
• Confusing the premium (regular cost) with the deductible (paid when you file a claim).

Words to know

Risk management

Strategies for handling the chance of financial loss.

Risk transfer

Shifting financial risk to an insurer.

Premium

The regular payment for an insurance policy.

Deductible

The amount you pay before insurance pays.

Coinsurance

The percentage of costs you pay after the deductible.

Copay

A fixed fee for a covered service.

Out-of-pocket maximum

The most you'll pay for covered care in a year.

Medicare

Federal health insurance for people 65 and older.

Medicaid

Health insurance for people with low incomes.

HMO

Health plan requiring in-network providers and referrals.

PPO

Health plan with more provider choice at higher cost.

Health savings account (HSA)

A tax-advantaged account for medical costs.

Liability coverage

Insurance that pays for damage you cause to others.

Collision coverage

Insurance for damage to your car in an accident.

Comprehensive coverage

Insurance for non-collision damage like theft or hail.

Renters insurance

Insurance covering a tenant's belongings and liability.

Term life insurance

Life insurance for a set period.

Beneficiary

The person who receives an insurance payout.

Disability insurance

Insurance that replaces income if you can't work.

Sample practice questions

5 more questions like these, from level 1 to 5, are in the practice set.