A brief introduction to insurance
A quick note: I am not giving out tax or legal advice, and you shouldn’t think I am. The advice I have to offer through this site is generic only because the audience is so diverse. If you have specific questions, you should consult a financial planner or insurance specialist.
What Is Insurance and How Does It Fit Into My Plan?
Insurance is the cheapest and most immediate way for a person to displace risks that are too great to assume individually. I can afford the doctor for an annual check-up, but what if I need an MRI and surgery? By paying a smaller amount up front, I am moving the responsibility from my shoulders to a large organization.
When you displace that risk with a large group of others, you are pooling your risk with your neighbor. The insurance company is a large organization charged with administering that group of risks in the unforeseen event that something happens to any individual in that pool.
There are all types of risks that we face on a day to day basis. Any of these risks can throw a monkey wrench in our months and years of frugality, and ruin the spirit of getting rich slowly. Some of the more concrete risks that we face are getting into a car accident or our house burning down — known as property and casualty. Some risks are less tangible such as getting sick, staying sick, and dying — known as life and health.
When I originally wrote J.D., I told him that I saw two potential problems that his readers faced:
- Throwing away good money on insurance when your cash flow is better spent in other areas. This basically means that if you are struggling to make ends meet on a $19k salary and drowning in credit card debt at the rate of 21%, your first priority should not be picking out permanent life insurance.
- Being unprepared for a catastrophic event which could have been easily displaced. Someone in my neighborhood died last month. When my wife and I took the casserole over to his family, I offered to help his wife with the insurance claims forms if she couldn’t contact her agent. Come to find out her late husband had two kids, a business with 12 employees to run and no life insurance.
What Steps Should I Take?
Many people have inadequate insurance protection because they don’t know where to begin. Don’t be frightened. Here are some easy ways to get started:
- Figure out what your risks are. Do you have adequate life insurance? Have construction costs doubled since you last reviewed your homeowner’s policy?
- Prioritize the list. Once you have figured out where your exposures to risk are, put them in order by doing some research. You are more likely to get sick during your working years than you are to die during the same period, so take care of that first.
- Always get more than one expert opinion. Everyone who has an opinion projects the biases of their background in their words. I don’t care if it’s your father, your insurance agent of 15 years, or me. Make sure that the advice really rings true to you and makes sense in your situation. Talking with at least two experts in the field will get an informed opinion from at least two perspectives.
- Use some common sense. If it costs too much to insure your Mustang, maybe it’s time to sell your baby. If you have a cash surplus of $10k, maybe you should increase the deductible on your health insurance to reduce premiums.
Finally folks, you need to review your plan from time to time to make sure that things are still on track and your coverage hasn’t changed.
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There are 24 comments to "A brief introduction to insurance".
Insurance is one of those strange things in life. I always feel like I’m betting the insurance company that something bad will happen to me.
ME: “I bet you $1200 each year that I’ll wreck my car in an accident.”
IC: “Sure, I’ll take that bet.”
ME: “You’re on!”
Insurance is all about risk management. Insurance companies have the tallest buildings in the city for a reason. Their good at risk management…
Insurance is best used for low probability, high consequence risks. You may manage risk by accepting more of it with high deductibles and your own “insurance” in the form of an emergency fund. If your home is blown away in a storm, what is the difference in a $1,000 deductible and a $5,000 deductible? Will that extra $4,000 “break you” financially?
With the low probability of the storm blowing away your home and your higher deductible, you’ll likely save hundreds of dollars per year in premium payments…
Now that’s risk management!
I agree with the article. Your insurance needs should be reviewed regularly. The construction costs have increased dramatically in NJ over the past few years. If there is a total loss from a covered peril (fire, wind, etc), it may cost $350,000 to rebuild your home from the ground up, but you may only receive the $185,000 limit from the insurance company that was declared on your policy 10 years ago.
There are tools on the web or you can ask an independent agent to run a replacement cost valuation on your home for you so you will have a good idea as to the limit you should have on your policy.
Plan your escape:
Actually, it should be viewed as:
I bet you $1200 that if I get in an accident this year, you’re going to pay for it!
Lol. That’s how I like to see it.
It is scary the number of people that I talk to that have small children, limited assets and NO life insurance. It is tragic when one parent dies, but if the remaining parent has to work two jobs to provide for small children, it is the children that will suffer in the long-term.
Best Wishes,
D4L
You shouldn’t think of it as a bet, but as security.
I will give you $60 per month (or whatever premium) and if something happens to my house, car, health, I will be secure in knowing that the insurance company will make me whole financially after the event. Also, if you get sued for $1,000,000 because someone slips and falls on your property, you will be secure in knowing that the insurance company will provide for the defense instead of you having to pay the attorney costs and any judgement yourself.
Kevin: Yep, you’re right! 🙂 That’s how I like to see it too!
Good point Kevin. Insurance is less expensive than the risk you displace with it because both parties agree it isn’t likely to happen. The more likely it is to happen and the more catastrophic the financial loss, generally, the more it will cost.
I’m looking forward to the discussion to see where people’s interests and questions are.
Each of the different types of insurance would deserve a post unto itself, but here’s the basics that every person who isn’t self insured (ie, very wealthy) needs to have.
Health (+dental/vision)
Auto
Homeowner/renter
Long term disability (you’re more likely to become disabled than die before age 65)
Life insurance (ONLY buy TERM insurance, usually 15-20 year)
A new type of insurance that may be a good idea is ID Theft Protection. For example Zander Insurance has this available and its about $12/mo for a family. This kind of policy is a good idea because identity theft is the fastest growing white collar crime in North America.
Insurance is one of the least understood financial products available. People buy all kinds of things they don’t understand. Dave Ramsey’s Financial Peace University has a lesson on life insurance. The information in that lesson alone can save you enough money to pay for the full course ($300 retail, often offered for $90-120). That was true for my wife and I, and it is true for at least 20 couples that took FPU at our church this year.
I’m a big believer in insurance, I’ve been without it enough to know how important it is. Of course, when I have it, I’m okay, usually, I only need it when I don’t have it – so I ALWAYS have every type of insurance possible.
If you have them, don’t forget to insure your kids too. My godson died in a car accident on the way home from my wedding. They live in San Diego, the wedding was in Hawaii. His mom got VERY lucky when her employer decided to foot the entire funeral bill – including transportation of remains. It’s unpleasant to think about, but the last thing she wanted to deal with was worrying about how she would manage paying for getting him home.
Good Point on the ID Theft Protection, jtimberman. You may want to check your homeowners policy to find out if it is covered there or available at a small additional charge. A lot of homeowners companies in NJ are adding a sublimit for Identity Theft at low annual additional premiums of around $25.
I believe I read in David Bach’s book that if you’re single with no dependents, you shouldn’t spend your money on life insurance. Do you have any advice about that Aaron? If something happens to me, my parents know to pull the plug, and donate my organs, but what will happen to my house? Should I make a living will for the stuff I care about (dog, motorcycle, house)? I don’t know what would happen to my three biggest posessions. If I’m dead, I don’t REALLY care, but it would be nice to pass them on to someone who can/will use them.
@Peachy
If you’re completely debt free, then go for it. If not, take a look at your loan agreements, they may not be forgiven in case of your death. For example, all of my student debt is forgiven but I’m 99% certain that whatever credit card balance is not.
Peachy,
You don’t need life insurance if you’re single with no dependents. The purpose of life insurance is to replace lost income for remaining spouse, or to take care of children financially, due to death of spouse/parent.
You should have a will, however. This will insure that your assets (and pets :)) are handled the way you want them handled if you die. You probably don’t need a sophisticated plan drawn up by a estate planning lawyer, and I believe there are free will forms available online, and there’s will writing software. I’m not a lawyer so I don’t know the legal requirements.
Melissa/Peachy,
When you die, your estate has to stand against any outstanding debts. Houses and material possessions will be sold at an estate auction and any money raised will be applied to the balance(s) remaining.
Some credit card companies and other creditors will go after these debts from family and friends of the deceased. If those people didn’t sign up for the loans, then they have no obligation to pay them.
Disclaimer: I’m not a lawyer.
“If those people didn’t sign up for the loans, then they have no obligation to pay them.’
Thanks. That’s what I thought, but I wasn’t really sure. I think my 2008 goal will be to set up some type of will.
The auctioneers can sell my dining room table and chairs, random photo albums and tv for the balance on my house. I’m ok with that. 🙂 I call myself a minimalist, so whatever they can get from my little bit of stuff is fine.
Something’s been bugging me for some time and this looks like a good place to ask.
My credit tanked several years ago as a result of an uninsured extended illness and hospitalization with loss of income.
While I returned to work a few years ago, I have been unable on my minimum wage income to restore my credit. (I have two sticky derogs I cannot resolve on my income, and zero positives.)
I’m having difficulty with the (apparent) idea that I’ll be stuck paying exorbitant insurance premiums the rest of my life if I can’t fix my credit. What can you tell me?
There are still some companies that do not participate in insurance scoring(although I have to admit the number is becoming fewer.)
Do a little research in your state or call an independent agent, who has access to multiple auto companies, to find out which companies do not use insurance (credit) scoring.
@ Minimum Wage, I would recommend checking with a couple or three different sources who do not use credit scoring for your home and auto. Not all independent agents have access to the same markets, and a little friendly competition usually results in a better deal for you.
@ Peachy, you need to define the risks involved before you consider insurance. In your case, it sounds like your estate would be settled as insolvent. This may bug you and it might not. The call is up to you. I don’t think there is a correct answer.
You may also want to consider life insurance now to offset any future insurability concerns, but only if you foresee having dependents and so on. Depends on the path life takes you, and I wouldn’t think it should be a top priority if you have other things to work on. This again is a personal choice, and I wouldn’t pretend to be able to give you an answer without knowing more about who you are.
Good luck to all.
funny how according to an online financial health tool, I’m between 80-90%. I’m not at 100% because I’m evidently short on life and disability insurance. I’m still determining whether my $600k life insurance policy is adequate. a $1million policy would get me to 90%, then to get 100% I need to get disability insurance covering 60% of my annual salary.
The other insurance people should have, especially in the US suing society, is an umbrella policy for liability.
Tim,
Your term life insurance policy should be for 10 times your annual income. This should be enough for your spouse to pay off the house (you’ve already taken care of the consumer debt, RIGHT? :-D), and have enough to invest in good growth stock mutual funds that earn ~12%, so she can live off the interest, replacing your lost income.
Long term disability insurance is going to vary by company policies and YOUR job. You might not be able to get 60%. I could only get 50% and I’m a white collar IT worker. My previous employer provided 50% with an upgrade option to 66% for those that qualify (I didn’t, per their medical questionnaire).
I wouldn’t worry too much about your score on some arbitrary financial “health” tool. The key is to spend less than you make, and make sure you’re comfortable with your financial plan. If you have peace of mind about your finances, and your family has peace of mind, then that matters more than some web tool.
Tim,
Great Point about the Umbrella policy. A $1,000,000 limit on top of your Personal Liability and Auto Liability coverage (and any watercraft/recreational vehicles)may only cost about few hundred per year.
This would prove to be an invaluable purchase if you unintentionally cause harm to a third pary and have more assets to protect than covered by underlying polices ($300,000 or $500,000 usually personal max limit.)
jtimberman, i wasn’t actually worried about my financial health score, because I’m satisfied with my insurance positions. 10x my annual income for life insurance is insane in my book. if my wife didn’t have a higher education and a job, maybe I would consider adding more life insurance. life insurance isn’t to make your family wealthy, but to enable them to establish financial basis–that is, get an education or skills for a job and cover expenses while do so. At least this is how I see life insurance; otherwise, you are simply paying too much.
as far as disability insurance, it is much like life insurance. It should cover expenses associated with rehabilitation and getting a new job, if you cannot stay on at your current one, that can accommodate your disabilities.
I don’t think there really is a hard a fast rule about how much life insurance you should have. A simplistic view like Dave Ramsey’s may work for some, but for others like Tim it might not. This is part of the reason why I suggest talking to more than one professional in the field. By hearing multiple, informed viewpoints, it will be easier to figure out what is right for you.
If you are a working couple and your spouse is only comfortable getting 7% return in the market, you may need more insurance than if s/he is comfortable getting 12%. How much do you insure a non-income earning spouse? Will you still need the same amount if you are getting close to your retirement goal?
You may also want to get multiple underwriting opinions if one company thinks of you in a higher risk category (like jtimberman mentioned). There are always discrepancies in underwriting philosophy among insurance companies, and sometimes you may be able to play these differences in your favor.
Ultimately, you are much better off having too much or too little coverage than none at all. If you are uncertain, try going through my steps 1-4 again. Life changes, and sometimes your coverage changes too, so doing this periodically makes sense.