Have you noticed the pressure to buy insurance? It seems to be everywhere: from headphones to nail clippers, you now have the comfort of knowing that if something goes wrong, your purchase is covered. Or is it? More importantly, did you even need the coverage to begin with?

Just to clarify, risk management and the purchase of insurance are personal and based on the facts and circumstances of your situation. Bill Gates, Oprah Winfrey, and Elon Musk likely have no need for the types of insurance I am speaking of here. However, for most of our clients, insurance may be broken down into three categories: 

1. Essential coverage— This is essential because the financial consequences of the covered risk would be devasting to you or your family without it. It generally includes home, auto, disability and life insurance.
2. Important coverage—This is where you intentionally and proactively seek protection. An example here may be an art collection or jewelry. In some cases, an extended or maintenance warranty would fall into this category, such as for a car or air conditioning unit. If it is important to you, it falls in this category.
3. Optional coverage—This is the irritating “addon” coverage that you learn about when you are finalizing a purchase. Examples include furniture, airline tickets, and electronic items. In most cases, you could easily cover the replacement of these items with funds in your checking or savings account.

Of the three categories above, the optional coverage is perhaps the trickiest. Most people do not seek to buy optional insurance coverage; they are sold it in the last 5 minutes of the sale, when you have your credit card in your hand, or you are ready to check out your online shopping cart. The car salesman may even hold off finalizing your auto purchase until he convinces you of the need to buy fabric protection for your new leather seats.

There are two theories at play here: Regret theory and insurance theory.

Insurance theory says that where there is a quantifiable risk of a peril, a large pool of people can come together and each chip in a bit of money to cover the few people where the very thing that was dreaded happens. 

Regret theory is where you are concerned about a peril (such as spending money on something that may break), and this influences your decision to minimize possible losses. This fear of regret is what may motivate you to buy the insurance, even though you don’t need it. You may have heard your Arkansas Financial Group (AFG) advisor discuss regret theory in relation to how aggressive or conservative your investment portfolio should be. However, it has implications beyond your investment portfolio. In this discussion, it also applies to the costs and benefits of risk management. 

The reason optional insurance is a major pain is that from time-to-time, you may not want to buy the coverage, but peace of mind may dictate that you do so.

A real life example

An example here is a lady who broke her ankle on the first day of an Alaskan cruise. She had to be airlifted off the ship, so she not only had the cost of the airlift and the medical attention, but the cost of the cruise was a loss. She regretfully told me the story of how that Alaskan cruise was the one time her and her husband decided NOT to buy trip insurance, because they realized they could cover the costs themselves. However, a few years later she took the same cruise that she lost out on before, but this time, she bought the coverage. She said that her experience was so painful with the money that was lost on the previous trip that she will never go without trip insurance coverage again, even though they had ample financial resources. Not only that, but she now thoroughly researched the different companies and the coverage details to determine what their best option would be. This is a perfect example of how regret theory moved her thoughts about this. For her, it was no longer optional insurance coverage but important.

The more expensive the purchase and related insurance, the more time you may want to spend evaluating the coverage and what is included or excluded. The key is to evaluate the potential feeling of regret if a loss is experienced. Would you lose sleep over it? Could you quickly recover financially?

In summary, risk management is important in your financial life, and the emotional element of regret is a key consideration. So, be aware of this the next time you are offered insurance for a small ticket item, or a peril that you could easily cover. Either give yourself permission to just replace it if something goes wrong and not worry about the need to insure it, or consider in advance whether it is a peril worth covering with optional insurance.

Kristina Bolhouse, CPA/PFS, CFP®

Vice President/Shareholder

© 2023 Kristina Bolhouse and The Arkansas Financial Group, Inc., All rights reserved.

The Arkansas Financial Group, Inc. is a Fee-Only Financial Planning Firm located in Little Rock, AR serving clients in Arkansas and throughout the country.

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