The Insurance Buyer's Guide

One of the most popular questions that I see posted around the internet is some form of the "what is the best way to buy auto insurance" question? It could be in the form of "is Geico better than State Farm", or "I heard that Progressive doesn't pay claims well, is that true?"

Here is my two (long-winded) cents on the matter:

First of all, you need to get in the right frame of mind about what insurance does for you. Insurance provides protection against a large but remote loss. Most people do not profit by purchasing insurance. The premiums are expensive, and, on average, the amount paid in claims is well below the total amount paid in premiums over the life of the policy (Of course, there is insurance fraud, but that is a different story!) Insurance allows you to take risks in areas of your life which are somewhat under your control (i.e. your job or personal business) by limiting the loss of events that are somewhat out of your control (i.e. a car wreck, fire, etc.)

Will the Insurance Company Pay your Claim?

Therefore, the first and most important rule about purchasing insurance - any insurance - is to find a company that will pay your claim. The most objective way to assess a company's claims-paying ability is to look at their A.M. Best financial strength rating, which ranges from A++ (extremely strong) all the way down to D (in Default). A.M. Best did a study which looked at historical failure rates of different ratings, and came up with the following statistics:

Rating Chance of Failure
A++ or A+ 1 in 1,658
A or A- 1 in 515
B++ or B+ 1 in 133
B or B- 1 in 48

The good news is that there is a wide selection of brand-name insurance companies competing fiercely for your business. The bad news is that there is a wide selection of brand-name insurance companies competing fiercely for your business.

So how do you choose?

First of all you need to look at the buying method that best suits your situation and personality. There are three major ways to buy insurance:

• Direct (ex. Geico, Progressive, Esurance, Unitrin Direct)
• Captive Agent (ex. State Farm, Allstate, Nationwide, Farmers)
• Independent Agent (ex. Travelers, Progressive, Hartford, Liberty Mutual)

Direct Insurance Companies

The way you buy insurance depends heavily on your personal situation. Do you know exactly what you want and know the different terms and conditions? Try three of the direct insurers. Most of the time, a direct insurer has very competitive prices, since they don't have to pay the agent's commission and have large economies of scale. However, the buyer can get lost in the weeds of terminology, and can find it an intimidating experience.

Captive Agents

Do you want someone to walk you through the different options, and/or be available for follow-up questions? Do you have a lot of insurable property that may take time to sort out? Call up your local State Farm/Allstate/Farmers agent. Call several of them! Captive agents usually represent large, strong insurance companies that can insure a wide range of property, and have agents that will bend over backwards to get your business. However, the prices can be somewhat higher, unless you have a ton of multi-product discounts (i.e. two cars and the house and the boat).

Independent Agents

Do you want the personal relationship/handholding of an agent, but are less choosy about the insurance company? Visit an independent agent. These agents often have contracts with 10-20 insurance companies, and can literally rank them in order of price. The "catch" is that they (a) might be getting paid to steer customers a certain way or (b) not all of their companies may pass the "A- or better" test. Independent agents can be valuable to someone who has trouble getting insurance, because their wide selection of companies gives the customer the best chance of finding a decent company that will overlook the five speeding tickets. Small business owners may also want to take a look at an independent agent, because he/she will often represent commercial insurance companies as well.

Check your coverage

Last but not least, you need to buy enough insurance. Different states mandate minimum limits of coverage for auto insurance, but those minimum limits are inadequate for most people with financial assets to protect. If you total some guy's BMW and put his wife in intensive care, your $50,000 liability limit will disappear very quickly. Guess who pays once the insurance runs out? That's right - you do.

Deductibles are a hot topic as well. Many financial planners recommend increasing the collision/comprehensive deductible from $250 to $500 or even $1000, because the premium will drop - sometimes significantly. This may be a good strategy for some people who have sufficient assets to cover a claim, but can be rough on a cash-strapped family staring at a $1000 deductible following an accident. Remember, insurance companies spend thousands of person-hours figuring out what a policy should cost. The premium goes down, because the insurance company puts the risk back on you, the buyer. Keep that in mind when you look at your deductible.

So, to sum it up, here are the four things to keep in mind when buying insurance:

1. Find a company that will actually pay your claim
2. Choose the method (direct, captive agent, independent agent) that fits your situation the best
3. Get at least three quotes
4. Make sure you buy enough!

Despite what some people say, no one channel will give you the cheapest policy all the time. The "deal" you get is directly proportional to the time that you invest into the process. Don't make one call. Make at least three. It will be worth your while.