MAT 245 Module 6 Insurance and Legal Protection Example

Insure the Disaster, Keep the Small Stuff: An Open-Enrollment Review of Every Policy a Young Hygienist Holds

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Business Administration Program, Aspen University

MAT 245: Personal Finance

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Month Day, Year

Insure the Disaster, Keep the Small Stuff: An Open-Enrollment Review of Every Policy a Young Hygienist Holds

Open enrollment at Taylor Monroe's dental practice arrives each November, and for three years Taylor has clicked through it in two minutes, keeping whatever was chosen the year before. The auto and renter's policies renew automatically. Taylor has no will and has never named a beneficiary on the 401(k) from the previous job. This paper reviews every policy Taylor holds against the risks Taylor actually faces and adds the legal documents a single adult needs. Taylor is invented, and nothing here is insurance or legal advice.

The Rule Behind the Review

Insurance makes sense for losses that would be ruinous and are unlikely, and makes little sense for losses that are small and could be paid from savings. An insurer has to charge more than the expected cost of claims to cover its expenses, so insuring a small loss usually means paying more than the loss is worth over time. With the emergency fund from Module 2 now holding more than $3,000, Taylor can afford to carry small losses and should spend premium dollars on large ones.

Taylor's Risks, Ranked

Paying Too Much to Avoid Small Losses

Sydnor (2010) examined the deductible choices of tens of thousands of home insurance customers at one large insurer. Most chose a $500 or lower deductible rather than $1,000, paying close to $100 more a year in premium for $500 less exposure, even though claims were filed in fewer than 5% of policy years. Paying that much to avoid a small, unlikely loss implied a level of risk aversion that no reasonable model could explain. Sydnor suggested that people overweight small probabilities and dislike the feeling of paying a deductible, rather than reasoning about expected cost.

Taylor's policies show the same pattern. Raising the collision deductible from $250 to $1,000 cuts the auto premium by about $190 a year, and raising the renter's deductible from $500 to $1,000 saves about $30. Taylor files a collision claim perhaps once a decade, so the lower deductible costs far more in premium than it ever returns. The two device warranties, costing $120 a year together, fall under the same logic and will not be renewed.

Choosing the Health Plan With Arithmetic

Bhargava et al. (2017) studied employees at a large American firm who chose among dozens of health plans that differed only in deductible, copays and coinsurance. A majority of employees chose plans that were dominated, meaning another option on the same menu would have cost them less at every possible level of medical use. Low-deductible plans were the most common dominated choice. In surveys, many employees could not correctly apply basic terms such as deductible and coinsurance, which helps explain the error.

Taylor's practice offers three plans. Each charges 20% coinsurance after the deductible until a yearly out-of-pocket maximum is reached. The table shows yearly cost, premium plus out-of-pocket spending, under three levels of use.

Taylor has been in the low-deductible plan, the most expensive choice in every case. Switching to the plan with a health savings account saves at least $1,180 a year, and more than $2,000 in a light year, and the account's balance carries over and can be invested.

Why the Review Must Repeat

Handel (2013) studied employees who chose health plans and then faced the same menu in later years after prices changed. Many kept their original plan even when the change made it a clearly worse deal, and the amount they were willing to lose by not switching was large. Inertia also changed which employees ended up in which plan, which affected the prices the plans could charge. For Taylor, the lesson is that a correct choice this year can become a wrong one next year, so the review goes on the calendar every November instead of being clicked through.

Filling the Two Large Gaps

The biggest gap is disability. Taylor's short-term policy pays for twelve weeks; after that, a back injury, which is a known risk for hygienists, would leave Taylor with no income. The practice offers group long-term disability paying 60% of salary after a ninety-day wait, at about $22 a month through payroll. Taylor will enroll. Because the premium is paid with after-tax dollars under this option, benefits would be received tax-free.

The second gap is liability. Ohio's minimum auto liability limits of $25,000 per person would not cover a serious injury to another driver, and a judgment above the limit could reach Taylor's savings and future wages. Raising limits to $100,000 per person and $300,000 per accident costs about $140 more a year, which the deductible changes more than pay for.

Legal Protection

Insurance protects money; legal documents decide who acts and who receives when Taylor cannot. Taylor will name a primary and a contingent beneficiary on both 401(k) accounts and the employer's group life policy, because beneficiary forms control those accounts regardless of what a will says. A simple will will name who receives everything else. A health care power of attorney names someone to make medical decisions, and a durable financial power of attorney names someone to pay bills and manage accounts during an incapacity. An attorney in Columbus offers the will and both powers of attorney as a package for about $600, which Taylor will pay from the irregular expenses fund.

The Net Effect

The decisions add long-term disability and higher liability limits, cut the cost of the deductibles and warranties and move Taylor to a cheaper health plan. Taken together, Taylor pays roughly $1,600 less a year in premiums and warranty fees while being protected against the two losses that could actually wreck the plan.

Conclusion

Taylor's old coverage protected against small, frequent costs and left the large risks open. Sydnor, Bhargava, Loewenstein and Sydnor and Handel explain how people end up that way, and the review reverses it: higher deductibles, a plan chosen by arithmetic, disability and liability coverage and the legal documents that let someone act for Taylor if needed.

References

Bhargava, S., Loewenstein, G., & Sydnor, J. (2017). Choose to lose: Health plan choices from a menu with dominated option. The Quarterly Journal of Economics, 132(3), 1319-1372. https://doi.org/10.1093/qje/qjx011

Handel, B. R. (2013). Adverse selection and inertia in health insurance markets: When nudging hurts. American Economic Review, 103(7), 2643-2682. https://doi.org/10.1257/aer.103.7.2643

Sydnor, J. (2010). (Over)insuring modest risks. American Economic Journal: Applied Economics, 2(4), 177-199. https://doi.org/10.1257/app.2.4.177