Do You Need Insurance?
By Carl Lachman, MBA, CFP®
Of Course!
It seems like a rhetorical question, especially if you ask someone that sells insurance. Do I need the insurance you are selling? Insurance agent answers, “There is never a bad time to secure your future.” How much should I buy? Agent says, “Tell me your income, assets, investments, and net worth, we will use our software to optimally help you spend all of your extra money on insurance. You are in good hands!”
As financial planners at Eclectic Associates, we approach insurance differently because we don’t sell it and we don’t get paid on a commission. The best answer? It depends.
It’s About Risk Management
Life has risks and we live with those risks every day. The vast majority of those risks are exceedingly small, and we might live our entire lives without encountering them. But the most common of those rarely occurring risks can be managed with the purchase of readily available insurance. The reason insurance is a good idea for many of those risks is because, if some of those risks happen, they can ruin a person’s financial security for years or maybe the rest of their life.
Take for instance a family’s house burning down. The cost for rebuilding and being displaced can cost $500,000 or more. It might never happen to you, but a policy that costs less than $100 a month to avoid that catastrophe makes a lot of sense.
Life insurance is similar. The death of a person who earns the primary income a family depends on can be catastrophic. Again, a policy that can replace that income in the unlikely event that the person dies can help to avoid a ruinous financial result.
So, at Eclectic, we see the wisdom for certain insurance as a risk management tool, but almost always, that’s it. Will the insurance help prevent some sort of rarely occurring financial ruin?
It’s Not About Eliminating All Risks
Insurance does not eliminate the risks and hazards. Those will still exist. But insurance can often lessen or eliminate the consequences of many risks and hazards. If you want to lessen or eliminate risks and hazards, you need to live your life in such a safe way that you will encounter fewer of those hazards. For instance, an electricity-free and fireplace-free all-concrete house will probably not have a bad fire, but it won’t be a fun place to live.
So, insurance helps to lessen the financial impacts of these rare events, but it is up to you to make wise choices to try to lessen the chances of the risks.
Perhaps You Can Self-Insure?
The idea with self-insurance is that you have the financial resources to absorb some bad outcomes without the need for insurance. For instance, if you buy an excellent electronic product and you take care of it, you probably don’t need an extended warranty, which is a form of insurance. New tire “certificates” are another form of insurance you can probably skip. The certificates usually cost about 1/4th the cost of each new tire, so if buy four tires at a time and you generally have to replace a tire only every other time you buy a complete set, you will come out ahead if you self-insure.
Homeowners & Auto Insurance
You usually can’t self-insure your home, since the mortgage company requires homeowner’s insurance. And, you can’t self-insure certain parts of auto insurance, since the State of California requires a certain minimum amount of auto insurance coverage. But, in both of these areas the bad outcomes are so bad, insurance is an easy and low-cost (in comparison to the bad outcomes) way to manage the risks and save your finances from a multi-year hit.
Life Insurance
Life insurance has a different answer. If you have people depending on your income that can’t work (children, disabled spouse, elderly parent), then life insurance might be a critically good idea. But, when others don’t depend on your income, and won’t be hurt financially if you die, then maybe you no longer need life insurance. Also, when one retires, that person is usually saying that he or she has all the assets and resources they need to afford the rest of their life without working, so usually no one that retires needs insurance.
Long-Term Care Insurance
This is a tricky one and the best answer depends on a lot of things. First, it is a costly insurance and can go up dramatically. Second, it is a dollar-limited and time-limited insurance, so it never covers everything forever. Third, you may have the resources to self-insure. Most care that LTC insurance will pay for is needed for less than 36 months. So, while that care is costly, it is not out of the realm of possibility that a person has resources could pay for that care. Fourth, usually the care that LTC insurance covers ends in death. So, sorry to point it out, but it probably doesn’t matter if your finances are used up with your care, because you won’t need them end the end of the sort of situations that LTC insurance covers. Fifth, you may have family that can take care of you and you’ll probably prefer that care if they can do it. You can have LTC that covers in-home care, but having strangers in your home all day can be rather hard, too. So, it is not easy to say if you need this insurance or not.
Insurance Only Covers The Actual Cost of The Loss
Many people don’t understand this point. Once you understand it, you won’t buy more insurance than is needed.
An example of this is homeowners’ insurance that will cover up to $600,000 of the cost to rebuild your home, but your home would actually only cost $500,000 to rebuild. If this is the case, you have paid for an extra $100,000 of insurance that will never benefit you. If you have too much fire insurance, you don’t get to build a bigger house funded by your insurance company.
Another example is auto insurance. Most policies don’t replace your car with the same car in the same condition. You can get a guaranteed replacement policy, but it costs significantly more. This is why if your car is totaled and not worth fixing to the insurance company, they give you cash for what the car was worth before the accident, but that usually is not enough to replace the car just as it was.
So, whatever insurance you are buying, make sure you get the right amount. A huge amount of coverage doesn’t give you a huge payoff in most cases, even if the worst happens.
How About A High Deductible?
If you follow Eclectic’s advice on an emergency fund worth 3-6 months of living expense, you can probably save some money with generally higher deductibles on insurance policies. Such an emergency fund will probably be in the $10,000-20,000 range, which is ready to be used to cover a $1,000-2,000 auto insurance deductible pretty easily. After a couple years of good driving and no accidents, you will save more than your deductibles with lower policy costs and come out ahead pretty quickly.
Travel Insurance
If you read the fine print and follow the rules, you can often have this coverage with a premium credit card in your wallet, but it is not always clear what the rules are. I had a covered loss on a premium credit card, but when I applied for compensation, I discovered I was not covered because I did not also charge the “triggering event” charge on the same credit card. That charge was on a different card. The triggering event was the purchase of an airplane ticket. So, if I had known that, I would have placed all charges for that trip on the same card and had coverage. If you want to avoid purchasing travel insurance and use the coverage that you think you have with your credit card, just make sure you thoroughly understand all the steps you must take to have that insurance for your next trip.
Investments and Other Financial Reasons for Insurance
Insurance agents work every day earning sales commissions by convincing their clients to buy intangible products. They are often excellent at their job. They make excellent points with carefully crafted presentations. They are usually people you like. But, that doesn’t mean you need what they are selling or that there isn’t a better, less costly solution. Especially when it comes to the other financial products, more exotic life insurance, and no-lose investments that insurance companies sell these days, we almost always find that there are better solutions, with better returns, for less money from other sources or approaches. So, be careful when you go to buy insurance and quickly get pitched other products. Usually, we can show you that you don’t need those other products. Ask us the next time we meet.
Conclusion
We don’t sell insurance at Eclectic, but we do see it as a valuable tool to manage the potentially catastrophic financial results for many of life’s risks and hazards. We include insurance analysis as part of our regular services for all of our clients. If this article causes you to think you need us to take a look coverage or help with an insurance decision, please schedule a meeting with your Eclectic advisor. If you aren’t one of our clients, give us call us for a complimentary meeting. We will be happy to answer your insurance questions and explain how we help our clients achieve peace of mind with their money and their futures.