The key to insurance is balancing the cost of reducing risk with the potential severity of a loss. Should you insure against all losses? While this may be possible for some people, it is not possible for most people. The costs would be too high.

The key is to realize that some losses are not as critical as others. You should insure yourself against high-severity losses that rarely occur—those that would have a major impact on the financial condition of you and your family—such as death, bad health, auto or home accidents, and accompanying liability issues. And you should avoid, reduce, or self-insure yourself against other risks.

You can analyze and classify risk by looking at two important areas. The first area is the frequency of the potential loss: how often could the loss happen? Could it happen every month, every year, or just once in a lifetime? The second area is the severity of the loss: how severe would the implications be for you and your family if the loss occurred? These factors can be charted in Table 1.

Table 1