Insurance is a tough subject for a lot of people. With major carriers like Allstate (NYSE: ALL ) , Nationwide (NYSE: NFS ) , and State Farm facing allegations of wrongfully denying claims related to Hurricane Katrina, many carriers have stopped selling insurance entirely, making it nearly impossible for prospective homeowners to get mortgage insurance. And even if you can still get insurance, prices always seem to be on the rise. Whether it's insurance for your car, your home, or your health-care costs, you may never have seen your rates actually go down from year to year. To make ends meet, it's important to keep costs down where you can.
One way to keep your homeowner's insurance costs down is to reduce the amount of coverage your policy provides. In general, there are two ways of reducing your coverage. You can either reduce the maximum amount your policy will pay, or you can increase the minimum amount you're responsible for before your coverage kicks in. Reducing your policy limits can be a recipe for disaster if you suffer a major claim, potentially leaving you responsible for hundreds of thousands of dollars of damage. However, increasing your insurance deductibles can create big savings without increasing your overall risk beyond your comfort level.
Betting against losses
By raising your insurance deductible, essentially what you're doing is betting that you won't have to file a claim. For instance, say your homeowners insurance has a $500 deductible. What that means is that if something happens that damages your home, then you'll have to pay the first $500 before your insurance starts paying. So if a hailstorm forces you to get a new roof that costs $10,000, you'll pay $500, and your insurance company should pay the other $9,500.
If you decide to raise your deductible to $1,000, you're doubling the amount you'll have to pay if something happens. But by increasing your deductible, you'll cut your premium payments; because the insurance company has less exposure to claims, you don't have to pay as much for your higher-deductible coverage. You might be surprised at how big an impact this can have on your insurance bills. Although the amount of savings varies quite a bit, it's not unusual to see savings of 15% to 25% simply from moving your deductibles up a notch.
Your odds of winning
Before deciding whether or not to adjust your deductible, a simple calculation can help you make the right choice. Raising your deductible to $1,000 from $500 may cost you an extra $500 if you suffer a loss. By contacting your insurance company, you can find out how much you'll save in premiums each year. Once you know your premium savings, divide the extra deductible cost by the savings. This will tell you how long you need to go without a claim in order to break even.
For instance, if you'll save $250 each year on your premiums by raising your deductible by $500, then you'll break even in two years. If you don't expect to have losses that often, then it makes sense to make the increase. On the other hand, if you'll only save $50 each year, then it'll take you 10 years to break even, and you may be less comfortable taking on the extra risk.
Making it work
To make this strategy work, you need a solid emergency fund that can absorb the extra shock of a higher deductible payment. Relying on high-interest credit-card debt in the event of a loss will offset much of the savings you get from lower premiums, so it's smarter to set aside more cash in a high-interest savings account.
Because of the stakes involved, making smart insurance decisions is tough. But if you have the means to work through your financial problems if disaster strikes, then you can turn your financial stability into increased savings on your insurance bill.
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You'll find more helpful hints for managing your risk in our Insurance Center. If you're looking for broader advice on how to get all your finances in order, check out Motley Fool Green Light. With Green Light's easy-to-follow plans to solve common problems, you'll be a pro at managing your money before you know it. A free 30-day trial will get you started on the right foot.
Fool contributor Dan Caplinger has to handle all the insurance for his family. He doesn't own shares of the companies discussed in this article. The Fool's disclosure policy ensures that you won't face any nasty surprises.