Do I Really Need to Buy Insurance?

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Insurance is a great tool in the risk management toolbox, but it is not always the best way to manage your risk! This article will answer questions such as 'when should I buy insurance?', ‘when shouldn’t I buy insurance?’, 'when should risk be retained?', 'what's the difference between claim frequency and severity?', and 'when should loss control be used?'.

You may be shocked to find out that we don’t always recommend that you buy insurance. Indeed, sometimes we recommend that you don’t buy insurance at all, and sometimes we recommend that you just don’t need as much as you currently do!

There’s a common misconception that insurance should cover everything bad that could happen, and many people become disillusioned with insurance when they find out that their insurance claim was denied. This stems from a core misunderstanding of the use of insurance, in that insurance is only one of four primary methods of reducing risk. Each method’s use depends on the frequency and severity of the risk to be reduced.

To clarify, frequency is the probability of a loss occurring, and severity is the extent of the damages incurred by the loss. With these two facets of risk in mind, let’s look at the Risk Matrix:

Retain: These are losses that rarely happen and have minor financial consequences. It could be a uniform getting ripped or stained, office supplies being misplaced, or inexpensive equipment being damaged. Insurance or drastic precautions are unnecessary, because it would cost more in time and/or money than it’s worth. However, we would recommend creating a small reserve fund that will pay for these types of claims without disturbing cashflow.

Loss Control: These types of risks are very likely to occur, but are often of small significance, such as the prevalence of petty theft in a convenience store, or small acts of vandalism such as table-etchings by teenagers in a restaurant. While you could buy insurance for these losses, it is often not cost-effective to do so. The best way to handle these is by creating procedures and safeguards to mitigate these types of losses. Examples would be surveillance systems, employee procedure manuals, or requiring all minors to be accompanied by an adult.

Avoid: These are very risky situations, as it is very probable that a loss will happen and it is very probable that the loss will be large. What quantifies as too risky and too expensive depends on the size and type of your firm, but examples could include expanding operations overseas, work involving carcinogens (E.g. asbestos), or building a new headquarters in a flood zone. These situations need to be carefully analyzed, as it may not be economical to operate in them and/or to insure against these types of risk.

Insure: These are your regular risks that are statistically unlikely (but still calculable!), and would create a fianncial burden if they were to happen. These risks include fires, slips and falls, claims of negligence, etc. Because these risks are common among industry groups (E.g. contractors), losses can be accurately forecast and non-burdensome premiums can be paid to economically transfer these risks to an insurance carrier via an insurance policy. 

Insurance is a great risk management tool, but it is not always the best use of your risk management dollars. Make sure to explore your alternatives before you buy insurance—make sure you're getting the best value for your time and money!


Colten Zamrzla, CPCU

Colten first started in the insurance industry in 2010. He then pursued a Bachelor's degree in Finance & Insurance from the University of Nebraska at Lincoln. Once graduated, he immediately started studying for the CPCU and achieved it in just shy of a year. He is solely focused on commercial insurance, able to assist all types of businesses and nonprofits in risk management.

Colten has dedication and passion for his clients and the insurance industry as a whole. He dedicates time to furthering his knowledge on all things business and insurance, and he volunteers for the Independent Insurance Agents of Nebraska, a state-based trade association.