Written by: Corey Janoff
This post was originally published on our previous blog website on August 8, 2018 and has since not been revised and/or updated.
As the saying goes, offense wins games, but defense wins championships. Well, sometimes in life you need to play a little defense. Insurance is the defense of your financial plan. It will protect you and your family during the rough patches in life.
When people think of financial planning, insurance is usually one of the last things that comes to mind. The first thoughts are about investing, how much to save, what types of accounts to use, diversifying, budgeting, saving for college, retirement, and how to reach certain goals in life. Where the heck does insurance fit in to that?
If the result of a particular event could ruin you or your family financially, then you should purchase insurance to protect against that event, if the insurance is available.
Risk management is one of the more overlooked pieces of financial planning. You can have the greatest savings plan and investment strategy in the world. You are on track to retire at 55 and pay for your kids to go to college and then you get diagnosed with terminal cancer and all of those plans get thrown out the window. How do we plan for those risks? If we leave ourselves financially exposed to catastrophic events, it is just a matter of time before our financial lives get blown to smithereens.
When it comes to risk management, there are three ways one can approach it.
- You can avoid the risk altogether. You can avoid the risk of drowning by not going near a swimming pool or large body of water.
- You can assume the risk yourself and self-insure. This is appropriate for things you can afford to replace. There is no need to purchase an extended warranty for your washing machine. If the machine breaks, you can pay to fix it or buy a new one. Something like that won’t drive you into bankruptcy.
- You can transfer the risk to someone else by purchasing insurance. When you purchase insurance, you pay a company a small amount and said company assumes the financial risk of the event you are insuring against. This is most appropriate for low probability, high cost events, such as your house burning down.
There are many insurances out there that you can buy. Most are a waste of money. Anytime you are faced with an insurance purchasing decision, ask yourself, “If this event happens, could it potentially ruin me or my family?” If the answer to that question is, “Yes,” then you should buy the insurance.
The biggest risks that could ruin people financially are medical expenses, disability, death, and lawsuits. Let’s protect against those things. Therefore, the common insurance policies that most people should have include health insurance, disability insurance, life insurance, home/auto insurance, and personal/professional liability insurance.
Health Insurance
Most people are probably aware of the high cost of healthcare in the United States. If you need to have a major surgery and spend the night in the hospital, you could easily be looking at a cost of over $30,000. Tack on an ambulance ride, post-op follow-ups, medications and the tab keeps rising. If you are diagnosed with a serious illness, the medication alone could cost six figures per year. Good luck paying for all of that without the help of medical insurance.
I won’t go into all of the details of different types of policies, but everyone should have health insurance. Everyone should also have a base-level understanding of what their policy covers. Know your deductible (how much you pay before the insurance company steps in), your out-of-pocket maximum (the most you will be obligated to pay for covered medical expenses in a year), and what hospitals/doctors you can go see. Most employers offer multiple options so try to select a plan that suits your healthcare situation. Obviously the more robust the coverage, the more expensive it will be.
Disability Insurance
I have written about disability insurance before in this blog. There are several posts in the insurance section of the blog you can read. Disability insurance is probably the most underappreciated and overlooked insurance out there. It protects your most valuable asset by far, which is your ability to work and earn an income. We are talking millions of dollars of income earning potential over a career for most people. Upwards of $10,000,000 for some of you. Even if you earn a rough median income in America of $50,000/year, adjusted for inflation at 3% per year, you will earn about $4,000,000 over your career if you work for 40 years (mid-20’s to mid-60’s).
As long as you depend on your income, you are insane to not protect your income as best as possible. That means getting an individual policy that you purchase on your own, separate from your employer-sponsored benefits. The coverage offered by employers usually isn’t very good, doesn’t cover all of your income, and doesn’t follow you when you leave your job. And not all employers offer coverage. For the same cost as your cell phone bill, or maybe your car payment for the higher earning professionals, you can get a quality policy that protects your income if you cannot do your specific job.
Now, the ability to qualify for disability insurance is contingent on health. So is life insurance. If you have health issues, it may be difficult to get the ideal policy. If that is the case, there are other options out there. Some companies specialize in high risk cases. Most employers who offer disability insurance to employees don’t require health underwriting to secure the policy. While that probably isn’t the best coverage in the world, it is better than nothing.
Bottom line, if you rely on your income, buy the best possible disability policy you can get your hands on and don’t let go of it until you are financially independent and no longer need to work anymore.
Life Insurance
If you have a spouse, children, or anyone who depends on you financially, you should probably buy life insurance to protect them in case you die and are no longer around to support them. This assumes, of course, that you love your family and care for their wellbeing. If you don’t care about them, then up to you if you want to get life insurance. But assuming you care about your spouse and/or children, buy life insurance so you can provide for them financially even if you are gone.
There are many different types of life insurance. They all fall into one of two categories: temporary or permanent.
Temporary insurance is called term insurance. It only lasts for a specified amount of time (i.e. 20 years). After the time period is up, the coverage expires. It is therefore the least expensive form of life insurance, because most people outlive the term length. It is also usually the most appropriate form of life insurance for most people. Most people only need their life insurance to last until the kids are out of the house, or until they reach financial independence or retirement.
Permanent insurance is the category all the other types of policies fall into. Different policies are designed for different purposes, but all permanent policies last indefinitely. Therefore, you can hang onto the policy as long as you want and it will pay your family a large sum of money if you hold onto the policy until you pass away. I won’t get into the scenarios for when it is appropriate to have permanent life insurance, but just know there is a time and place for everything. Most of the readers here will never need a permanent life insurance policy, but depending on the circumstances it could make sense to explore one.
Home/Auto Insurance
Thanks to state mandates, everyone is required to have auto insurance in order to drive a car. Also, a bank won’t give you a mortgage for a house unless you have homeowners insurance. Because it is all state-regulated, the insurance companies all offer policies that are pretty similar. You can get similar benefit amounts at every company. The only real difference is pricing and customer service.
The real reason you have car insurance is the liability portion. If you are at fault for an accident and the person you hit has medical complications and decides to sue you on top of that, you could be on the hook for a lot of money. So max out the liability portion of your coverage. It is also wise to get extra coverage for uninsured/underinsured motorists. That way, if someone who doesn’t have insurance hits you, you are protected.
Do what you want on the collision damage portion of the policy. If your car gets totaled and you don’t have collision damage, you can probably overcome that. If you can’t afford to pay cash for the car you drive, you are probably overspending on your vehicle.
On the homeowner’s side of things, get enough coverage so you are protected if your house burns to the ground. It can also be wise to purchase a separate earthquake policy if you live in an earthquake zone (the entire West Coast). If you live in a flood zone, get flood insurance too.
With all of these insurance, an easy way to keep costs manageable is to raise your deductible. If you go with a $1,000, $2,500, or even $5,000 deductible, your policies should be pretty inexpensive. If the insurance company knows you will pay for the first $5,000 before they are on the hook for anything, they aren’t going to charge very much for the policy. It is rare that the event damage exceeds that cost, so it is a low risk to them.
Umbrella Liability Insurance
This is a nice extension of home/auto insurance that protects you for personal liability. You get it through the same company you have your home/auto insurance with. Typically it is sold in blocks of $1 million for only a few hundred dollars per year.
If you are at fault for a car accident and get sued. Maybe the neighborhood kids are playing in your backyard and one of them falls down the steps and gets injured and his parents decide to sue you. If the lawsuit exceeds the amount of liability coverage you have on your home/auto policies, then the umbrella policy steps in as a backup. It is really inexpensive to get a large amount of umbrella coverage and well worth it for the cost. Hopefully you will never need it, but if you own a home or drive a car, consider it mandatory with how litigious people in our society are.
Conclusion
Make sure you play some defense. Just look at Super Bowl LII as an example. Not much defense was played by either team during that game, but the team that made one defensive play in the fourth quarter and stripped the ball out of Tom Brady’s hands ended up victorious. Go Birds.
Life is no different. Defense isn’t sexy. We all want to score points, but if you don’t play any defense, one little fumble can cost you severely. So protect against the things that matter most. You won’t be able to prevent all risks, but with most of the big ones you can mitigate the financial impact by having appropriate levels of insurance protection.
