April 2009

What you need to know about...Insurance

Author: Lewis Wessel

I know Insurance is boring, but it’s something you have to deal with in your financial life. The good news is that you don’t have to bury yourself in the details to be smart about insurance. You just have to stick with a few basic rules:

Rule #1: Don’t risk more than you can afford to lose.
Rule #2: Don’t risk a lot for a little.
Rule #3: Consider the odds.
Follow these rules and you will make the correct insurance decision almost every time.

Insurance is, at its core, all about managing financial “risk,”—the possibility of something happening that will hurt you financially. These perils include premature death, disability, sickness, car accidents, fire, hurricanes, lawsuits, dementia, and many, many more.
Risk is, quite frankly, everywhere, and bad things ARE going to happen. The question is: What are you going to do about the resulting financial loss? Are you going to bear the entire loss by yourself, or are you going to transfer some, most, or all of it to an insurance company? This is your basic insurance decision and the three simple rules above should instruct you.
In insurance, size matters! If you can’t afford the loss, you need to make it a priority to get that loss covered. The flip side to that rule is that if you CAN afford the loss, it is probably not financially prudent to insure it. For example, increasing your deductible on your car, health or homeowner’s policy to an amount that you can readily afford, is, in general, a financially smart decision.
You need a plan! Every large, well-run company has a risk-management plan and a risk manager running it. You need your own personal risk-management plan and you need to update it whenever your life materially changes. Remember this: The purpose of your insurance plan is to mitigate the risks that threaten your overall financial plan. And those risks are ever changing. Consider the following:
As a single, working person, your primary risks are long- and short-term illnesses and, possibly, personal liability. These risks can be covered by health insurance, disability insurance and a personal “umbrella” policy. As you acquire assets, such as a home and auto, the associated risks should also be covered by insurance.
Once you are married, and certainly when you become a parent, life insurance must become a top priority and be added to your insurance mix.
As your children become independent and you enter your 50s and 60s and near retirement, the financial risk of extended long-term care from a stroke, dementia or other disease means that a long-term care policy should be considered. Once covered by Medicare, your health insurance mix also needs to be dramatically altered.
Upon retirement, you would also be wise to review your life insurance policies and revisit the reason you originally obtained the coverage- protection from loss of your employment income in the event of your untimely death. At this point, the decision to obtain or keep a life insurance policy may no longer be a risk-related decision, but, rather, an investment and estate-tax planning decision focused on amounts you plan to leave your spouse or heirs.

Here are some other thoughts to consider regarding specific insurance products:

Health Insurance: If you are covered through your employer, COBRA or Medicare, GREAT! If not, individual health insurance policies are available. As discussed in last month’s article, a high-deductible health plan (at least a $1,150 deductible for an individual and $2,300 for a family in 2009) qualifies you for a Health Savings Account—a terrific tax-advantaged vehicle. Do a lot of shopping here. The Internet offers a great starting point—and make sure the doctors and/or hospitals you want to use are included in the plan.

Property and Casualty (P&C) Insurance: This is the broad category of insurance products that relate to indemnifying you financially (i.e. making you financially whole) in the event of damage to your home, auto, or other asset. The most important advice I can offer is for you to gather up all your policies, make an appointment with a competent P&C professional and go over the policies line-by-line. Issues to discuss include deductibles, both overall and specific, and “riders” to the policy—additions and subtractions from the standard coverage. These can have a significant impact on coverage and cost, and you’ll need to accept or reject each one based on the three basic rules discussed above.
Usually included under the P&C category is the Personal Umbrella policy. This policy gives you excess liability coverage over those already included in your home and auto policies AND extends coverage to many other occurrences such as your dog biting the neighbor’s kid. You can generally get coverage of $2 to $3 million for around $1,000, and it’s well worth it if only for the good night’s sleep you’ll get.

Life Insurance: Life insurance comes in basically two forms: term insurance and whole or universal life. Term is PURE protection against your untimely death and has no savings component. Term is surprisingly inexpensive and an absolute must for parents of young children. Make sure to buy enough to truly protect your family against the total loss of your income! 20 to 25 times your annual salary is not unreasonable for someone in their 30’s “Level-term” policies keep the premiums level for a designated period such as 10, 20 or 30 years and are a good option for many. A “conversion privilege” allowing you to convert the term policy to whole or “permanent” insurance at a later date is also a welcome add-on to your policy but will result in slightly higher premiums.

Disability Insurance: This policy pays you a monthly amount (usually around 60% of your salary) in the event you can’t work due to extended sickness or an accident. The odds of a 25-year-old being disabled for 30 days or more prior to age 65 are about 1 in 3, significantly higher than the odds of dying during the same time frame. Don’t rely on Medicare for this coverage; to qualify for Medicare, you essentially have to be so disabled that you can’t do ANY work. Ideally, you want a policy that pays you if you can’t perform your own or similar occupation.

Long-Term Care (LTC) Insurance: Long-term care whether received in your own home, an assisted-living facility or a skilled nursing home, represents a financial risk to you that runs potentially into the hundreds of thousands of dollars. Contrary to widely-held belief, Medicare does NOT provide long-term care and Medicaid is an option to be avoided, not embraced. I strongly advise sitting down with a specialist as early as your 40s and 50s to discuss the particulars.

Full disclosure: Lewis Wessel is licensed to sell insurance in the state of South Carolina. These rules and many other concepts discussed here are taken from Fundamentals of Risk and Insurance, Ninth Edition, Emmett J. and Therese Vaughn, John Wiley and Sons, Inc.

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