Through your regular insurance company (homeowners/renters - like State Farm) you can get a Floater policy on just about anything (they won't do iPods though - too much theft) that covers everything from theft to dropping it, to fire and flood (but not manufacturing defects). It's not much money at all.
I'd also recommend AppleCare - between the two, you've got all bases covered.
As for security, when I travel, I use a cable lock. Easy, quick, cheap, and it keeps honest people honest, but won't deter a determined thief (which is why I use encryption - see below). The only time it's out of my hands, or not locked up is in the x-ray machine at the airport - and I keep my eyes on it the whole time.
If I were back in school in the dorms or an apartment, knowing how many master keys are floating around, I'd sure lock it up when I wasn't with it. My Compaq Portable II was too heavy to steal, but I put a padlock on it anyway

.
As for encryption, FileVault flakes out with a bunch of things (including time machine). I create an encrypted disk volume, and store all my personal data there (disk utility is free, PGP works OK but costs > $100, and TrueCrypt is also an option that's free, but does some strange things with drivers). That includes moving some things out of ~/Library to it, and replacing them with symbolic links - Mail, iCal and address book are the biggies (and quicken if you use that).
For backup, you can manually add the encrypted volume to time machine and have it back up the contents (which is what I do at home, with the drive secured) unencrypted, or for mobile backup, just copy over the entire encrypted volume.
Since there's free options, and losing your identity can be catastrophic, my vote is absolutely yes, encrypt everything. PGP is about to release whole disk encryption, but they've had spotty quality on the Mac, so YMMV, but if it works, it's a damn simple solution to the problem.
FWIW - part of my job is security architecture for large companies. I'm well aware of the frequency and impact of laptop theft.