Insurance. What’s It For?

Insurance is to provide cash to replace an asset that has been lost due to some covered condition.

People seem to understand that when they are buying fire insurance on their house.  Collision damage and theft insurance on their car are clear too.  Same thing for lost or stolen jewelry.  These hazards are generally thought of as casualty insurance.  I had the asset, now it is gone or damaged, please give me money to replace it.

Life insurance, disability income insurance and critical illness insurance are like that too.  The asset in this case is less tangible but nonetheless valuable.  Your ability to earn income is an enormously valuable asset.  If that ability is lost, it would be nice, even necessary, to have money to replace it.

Some people think of a health or dental plan as insurance but mostly it is not. It is just a prepaid cost plan.  Convenient, but other than the massive claims that can arise in some medical treatment situations, it is not really insurance.

Insurance can have another use that does not involve replacing an asset.  Life insurance, disability income insurance and critical illness insurance can be thought of as a way to protect some other assets from being liquidated to meet an immediate need.  For example, a retired person who has neither the interest in nor the ability to work does not need life insurance to replace that asset.   Their need is more subtle.

They may hold assets that are not easily liquidated.  A business, a family home, farm or cottage, other personal assets.  When there are tax liabilities and costs involved at death, there may be insufficient liquid assets to meet the obligation.  Life insurance then is a tool to protect illiquid assets from a forced sale in a potentially negative market.

In this case, life insurance does not replace any asset, but rather it creates an asset in a form that is useful, cash, when other assets cannot easily meet that requirement.

In a similar way, disability income insurance, critical illness insurance and high limit drug plans, protect other assets from liquidation.  Other forms of insurance like, liability insurance or errors and omissions insurance behave the same way.  Having them prevents the loss of other assets.

Insurance has two purposes.  To provide cash to replace an asset or to provide cash to prevent the liquidation of some other asset.

Be sure your insurance portfolio can be attached to these two purposes.  Both the amount and the form of the policy should be considered.  The insurance must fit a real need.  Failing that you can be insurance poor in several ways.  Too much insurance, wrong kind, or not enough.

Not enough is the most common kind of insurance poor and the cost won’t show up until you need the coverage.  Avoid that.  It is not possible to fix it after the fact.

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Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: don@moneyfyi.com

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