How to Teach about Insurance

To help you celebrate this Financial Literacy Month, we’re featuring two blog posts about personal finance education. The second post focuses on personal finance education trends.

You simply can never predict when things might go wrong, from fires and hurricanes to car accidents. Throughout history, humans have worked to protect themselves and their belongings from all kinds of threats. Luckily, along the way—starting at least as far back as 18th century B.C.—humans developed insurance to help protect their assets and plan for the unexpected. This Financial Literacy Month, I’d like to talk all things insurance and highlight resources that will help you brush up on the topic or teach it to kids.

What Is Insurance?

Insurance is defined as “protection from specified losses in return for a fee (premium).”

There are many different types of insurance. A few examples:

• Car insurance can help with expenses in the event of a car accident.
• Medical or health insurance can help cover expensive surgeries or medications.
• Property insurance provides coverage on homes in case of flood, fire or other disasters.

Some celebrities even have insurance to protect the income that specific body parts help generate, such as soccer superstar Cristiano Ronaldo, whose legs reportedly have been insured for over $100 million.

How Can You Teach Kids about Insurance?

Teachers and parents, if you need help explaining this topic to your kids, try using one of the Federal Reserve Bank of St. Louis’ educational resources.

1. Start with the article “Insurance: Managing Risk and Balancing Responsibility with Affordability,” which gives a great overview of insurance at a high school reading level.
2. Check out our series on car insurance, Understanding Car Insurance: Paving the Way, which explains nitty-gritty details like premiums and deductibles, which are the amounts you must pay for expenses before the insurance company pays.
3. Watch and share our video below on property insurance, “Insurance: Protecting Yourself from Damage,” which explains how insurance is used to transfer risk.


Transcript

Narrator Kris Bertelsen: What if your property were engulfed by flames or damaged by a natural disaster? Odds are your family wouldn’t have enough cash saved to replace everything you own. Few people would.

On today’s episode of No-Frills Money Skills, we’ll attempt to sidestep peril and learn the ins and outs of insurance.

To understand insurance, you need to understand risk. Think about the following activities. Would you take these risks? Would you go hang gliding, snowboarding, downhill skiing, or bungee jumping?

Everyone will make different choices because each activity has some level of risk for injury. If you wear a helmet, you can lower your risk of a head injury. But what if you get hurt? How do you lower the risk of having to pay a lot of money?

Well, insurance is a way to transfer the cost of loss or damage to someone else...for a fee. Here’s a simple example of how insurance started not too long ago and still works today.

Imagine we’re in the 1800s living in a community with 20 farm families. We all have similar barns, and for easy numbers, let’s say each barn costs $1,000 to build. In this case, if any family has a barn burn down, they have to come up with $1,000 to build a new one.

But then we get to talking and come up with a great idea to reduce the cost for any one family: We all agree that each family will put $50 into a special fund. If any family has a barn go up in flames, they’ll get the $1,000 from that fund to build a new one.

But what if two barns burn down in the same year? Well, in that case, every family would have to pay additional money into the insurance fund.

Simple, right? Well, today’s insurance is only slightly more complex. But there is one huge difference: Today, insurance companies are multibillion-dollar businesses. They offer coverage by pooling their customers’ money rather than groups of people pooling their own money.

People pay money—called premiums—to insurance companies to buy insurance, which protects their property in the event of damage. Insurance coverage defines how much the insurance company will pay for particular types of damages. If damage occurs, the insurance company will indemnify—or compensate—the insurance owner for the damage.

There are many types of insurance—for example, property, health, auto and life.

Here’s how property insurance works: Meet Jane. She borrowed $180,000 from the bank to build a home.

If anything happens to that property, she doesn’t want to lose her investment, and the bank doesn’t either. To make sure she and the bank are protected, Jane buys property insurance. When she does that, she transfers the risk of loss to an insurance company.

Jane will pay the insurance company a premium—a certain dollar amount—every year. Will Jane ever receive anything for that premium? She doesn’t know. However, in the event of a fire or any other covered loss, Jane could collect a lot more than she paid in premiums—especially if the insurance company has to pay to rebuild her house.

For example, let’s say Jane insured the house for $180,000, paid the $2,000 premium, and a fire caused $75,000 in damages. That would be a big payout for the insurance company. But that is the risk the insurance company takes.

On the other hand, Jane could pay the $2,000 premium every year for 37 years and never file a claim. A claim is when you ask to be paid for a loss. So, Jane would have paid $74,000 for peace of mind.

You may be wondering how insurance companies know how much risk to take. They hire people called actuaries and underwriters to calculate the risk of various activities and losses to property.

Actuaries use statistics, economics and probabilities to determine the premiums to charge for the types and amounts of insurance requested. Underwriters evaluate properties, conditions, and applicants to determine good and bad risks for the insurance company.

When evaluating risk for a building, underwriters look at things such as where the building is located, the type of construction, the condition of the building, and even how close it is to a fire hydrant.

When people choose not to buy insurance, they take all the risk of a loss. For example, if Jane said:

Jane: “I’m not buying property insurance!”

Bertelsen: She would be solely responsible for any damage to her home. In this case, though, it would be unlikely that any bank would lend her the money. Any bank would want proof that the money to replace the property would be available if disaster struck.

When you make a claim, most types of insurance will not pay 100% of the damages. Almost all types of insurance have a deductible. A deductible is a dollar amount that you must pay before the insurance company pays.

For example, if a fire caused $75,000 in damages to Jane’s house, if she had a $1,000 deductible, her insurance company would deduct $1,000 from her claim payment.

Protection for your home is not all you get with a homeowner’s policy. The typical policy includes coverage for your personal property, other structures (such as a storage shed), liability and medical.

Liability insurance protects you in the event of a lawsuit. For example, if someone is bitten by your dog or injured while on your property, your liability coverage would provide legal protection. Medical payments on your homeowner’s policy pays for medical expenses from injuries to people at your home, no matter whose fault it is, usually up to $1,000.

The coverage is usually not subject to a deductible.

You may be wondering, “What if I don’t own a home, can I still get insurance for my personal belongings?” Yes. You can buy renters insurance to protect your property, and like a homeowner’s policy, renters insurance includes personal liability and medical payments.

Insurance is a great way to ensure that your assets are covered in case of damage or loss.

Today we talked about property insurance. In the next episode of No-Frills Money Skills, we’ll navigate the world of car insurance, using specific examples to help drive home the point.

I'm Kris Bertelsen, and I'll see you next time.

How Do You Decide If Insurance Is Worth Buying?

Now that your kids and students know what insurance is, they’ll need to learn how to decide if they need it when the time comes.

Insurance is all about protecting yourself from risks that are mostly out of your control, so whether you take out insurance is up to how you feel about your odds. If you don’t own a car and never drive anywhere, you won’t need car insurance. But if you’re ever behind the wheel, it’s a must-have.

Teachers and parents, we have a great educational game you can play with children to help them understand how insurance works: Is Insurance Worth Buying? Students draw cards at random that represent life events, and in a controlled setting they get a taste for how luck can affect their finances in the real world. Bad luck and no insurance? You could be in for a world of financial hurt.

How Can You Brush Up on Insurance?

It’s always good to be prepared in the event of a disaster—no matter what type.

This Financial Literacy Month, dive deep into insurance. Teach the kids in your life and refresh your own knowledge of how to protect yourself and your assets from the unexpected. To learn more, check out all the Fed’s educational resources on insurance.