Insurance starts with a pretty noble idea. It takes a low probability but catastrophic outcome and smears the risk across a broad swath of people. In some ways, it's like a giant GoFundMe with lots of complicated math.
In reality, insurance is often associated with headaches and confusion. Most people interact with insurance by wading through paperwork and paying hefty monthly premiums. They're given dozens of options and simply shop by brand name or comparing the price of different plans. After all, it's hard to sort through the different deductibles, liabilities, premiums, and types of coverage. There are better (and probably easier) things to do, like building a startup.
So, I spent some time looking through different pieces of insurance recently, and here's what I learned.
Why Normal Insurance Doesn't Make Sense
Insurance enables people to pay a premium, with a negative expected value, to smooth out the cost of rare but expensive risks.
Most insurance companies assume that their customer's wealth is tied up in the corresponding asset. Someone who buys auto insurance is looking for financial security in case they total their car. Someone who buys home insurance is protecting their investment in their house.
But that logic falls short when being applied to founders. Most founders don't have a lot of present-day cash but, potentially, a lot of future-day income. In those cases, the default of buying insurance to cover current assets doesn't make sense.
Instead, founders should purchase insurance against truly catastrophic-level outcomes. Most of these outcomes come in the form of liability costs – damages or injuries caused to a third party. These personal injury lawsuits can cost millions to even hundreds of millions.
Most people underbuy on their liability insurance.
When I asked GEICO for a quote on their auto-insurance, the option they showed me had Bodily Injury Liability at $100,000/$300,000 (the first number is maximum coverage per person, the second number is max per accident).
It seems reasonable enough. But for $80 more per year, I could increase my coverage to $300,000/$500,000. On the other hand, increasing my deductibles (the amount I pay to before an insurer steps in) from $500 to $2500, decreased my quote by $750 per year.
The difference between paying $500 and $2500 out of pocket is fairly minor to me, but the change from $100,000 to $300,000 in liability coverage is significant.
Categories of Insurance
Below, we'll talk about home, renters, auto, and umbrella insurance.
Home Insurance
As a whole, home insurance is pretty easy to understand. For most Americans, their home is the largest asset. Insurance is a hedge against disasters such as fires, earthquakes, hurricanes, or other freak events.
That's also mostly true for founders. While startup stock is nice, a house (especially in the Bay Area) is still a major portion of the founder's net worth. However, traditional home insurance plans will emphasize on the cost of rebuilding the home rather than liability protection. For founders, a fire that burns down your house is bad but financially recoverable. A fire that starts on your property that spreads to the neighbor's is very bad and sometimes unrecoverable.
Another pitfall in home insurance is overbuying on the deductible amount. For example, some insurance plans offer protection for belongings worth more than $250 as opposed to $1,000 or more. Like the quote that GEICO gave me above, decreasing the deductible significantly increases the policy's premium. In a case where the plan triggers, low deductibles means more claims, which then results in rates going up in the long run.
Renters Insurance
Renter's insurance is much less complicated. Because it's one to two magnitudes cheaper than home insurance, there's not a lot of room to price-shop or optimize. Like home insurance, the main part that people under buy is liability coverage, which covers damages to others or the landlord in an event such as leaving the faucet on and flooding the apartment or house.
Auto Insurance
Unlike home or renters insurance, auto insurance is a bit more complicated. There are 6 main categories of coverage, ranging from liability to uninsured motorist to collision coverage.
Buying coverage on these different categories depends on the state of residence and ownership of the vehicle. In a financed car, such as leasing or having an auto loan, drivers need to obtain comprehensive and collision coverage. Owning a car outright gives more flexibility, although state requirements may require uninsured, medical payments, and personal injury protection. Liability coverage is required by all states, minus New Hampshire and Virginia.
In my case, buying maximum medical and liability coverage only increased my premium by low-hundreds per year. On the other hand, decreasing my comprehensive and collision coverage saved me almost a thousand per year. It's relatively cheap to buy a new car; it's much pricier to pay for medical or liability costs. One is a recoverable event, the other is catastrophic.
Another mistake with auto-insurance is treating it like a car warranty. With comprehensive coverage, it's technically possible to file a claim for every ding and scratch. Given a low enough deductible, the insurer might even pay out on these claims. But the long-term effect is an increase in future auto-insurance premiums.
A handy tool for understanding when to file claims is Coverage Cat's claim calculator. For example, filing a claim for a 2017 Lexus RX 350 would increase my premium by $102 per month or $8,568 over the next 7 years. So if it's just a small dent, I'd probably be better off ignoring it.
Umbrella Insurance
So far, we've talked a lot about catastrophic events. Car crashes and houses burning down. In these cases, there's a real possibility that the specific home or auto insurance runs out of coverage. For example, the fire that spreads to the whole block might cause damages beyond the liability insurance's limit. In that case, the policyholder is still responsible for excess damages. Umbrella insurance solves this by kicking in when other policies are exhausted.
Within umbrella insurance are two categories:
- Excess Liability – provides additional monetary coverage to an existing policy. This would cover and pay for excess damages from the fire that burned down the block.
- Primary coverage for excluded losses – provides additional types of coverage. For example, the policy can cover libel or slander lawsuits (so you can tweet to your heart's content). It also covers edge cases, like a guest tripping in your home or a tenant's dog biting someone and suing you, that aren't normally covered by home insurance.
For founders, umbrella insurance is one of the best insurance policies to purchase. In a catastrophic situation, liability protection from home and auto insurance is often miles away from providing enough coverage. It's also generally quite affordable to purchase policies with coverages of $1 million or higher, and policyholders can even purchase the policy from a different provider than the current primary home and auto insurance providers.
Buying Insurance
So say I've already bought insurance and there are still a couple of months left on the policy. And the policy has a low liability coverage limit. That's not great.
Thankfully, buying a bad policy doesn't mean being stuck with that policy. While most policies have a policy period (often 1 year), these periods are mostly in place to protect consumers. Anyone can cancel any policy at any time and the insurer will refund the pro rata remainder. On the other hand, the insurer can't unilaterally cancel the policy from their end.
That comes in pretty handy for policyholders. Right now (7/12/2023), Farmers Insurance is pulling out of the state of Florida. What that means is that they're no longer issuing new policies, but for homeowners that currently have a Farmer's policy (roughly 100k people), they will still receive compensation from Farmer's Insurance if their house burns down (until the end of their policy).
Beyond cancelling my policy, I still need to find a new policy. And, well, that's often a time-consuming search. I can either try my hand at Google or purchase the policy through an insurance agent.
When trying to buy insurance solo, there's a tendency to shop based on the brand name. Seeing dozens to hundreds of options, I started with GEICO, a name that I was familiar with. But the different between large insurance company like State Farm and a smaller one like Wawanesa Insurance is marketing. They're both selling essentially the same product, with different tweaks around deductible and premiums.
So trying to find the best deal, I might go through an insurance agent. That's also a path fraught with danger. Most agents will spam their prospects, leaving dozens of voice mails and texts to close a deal, and often present options that bring them the largest commission.
Unfortunately, working with an agent is often times the only choice for those living in Florida and California. Most larger insurers are refusing home insurance coverage for those states and even though smaller insurers have to prove to state regulators that they're financially solvent, it's hard for me to know they even exist.
There is, however, a third option. In writing this post, I talked with Max Cho from Coverage Cat (YC S22). They're a tech-enabled insurance agent, starting from the thesis of helping consumers buy insurance with the right-sized coverage. Instead of spamming and highlighting commissioned policies like traditional agents, Coverage Cat finds tailored policies based on risk preferences and coverage needs.
These days, between insurance companies pulling out of states and agents becoming more aggressive in their sales tactics, insurance has become more of a headache than a feature. Coverage Cat hopefully can reverse that trend.