Insuring Certainties Is Expensive

There are four pure insurable conditions

High Cost – High Probability of Loss

This one is the easiest to decide. You don’t have to think at all.. No insurance will be available.

Life insurers decline to insure people with active pancreatic cancer. Boating in Stony Lake is not a decline, but it may include exclusions, high deductibles, higher premiums or all of those. Flying a private plane in a war zone is likely uninsurable.

The best course of action is avoidance of the risk.

Low Cost – High Probability

Also easy to decide. Do little.

If you can afford the loss, there is little point adding the insurer’s overhead and profit to your cost. No one likes losses, but some are going to happen. Group dental coverage falls here. Some dental costs are certain. Some are unpleasantly expensive, but not quite unaffordable. Some people like the idea of a convenient way to deal with it. Thus dental coverage. They especially like it if their employer will pay the premiums.

The employer can optimize their cost by including deductibles. Even small ones matter.

Low Cost – Low Probability

The easiest of all. Do nothing

Should I insure the loss of a pair of socks at the gym? Not likely. The cost to complete the required form would be outside my tolerance. An insurance claim involves more cost than the premium you have invested. I know business owners with deductibles on their property coverages that are more than $25,000. Because it would not be worth the premium and hassle of making a claim for less.

I suspect I can find someone to insure anything. At a price. The premium will reimburse them for all of the claims, plus all of their costs to process the policy and the claims, plus their profit and taxes. Far more than just paying as you go. Don’t insure things that are likely and near certain.

High Cost – Low Probability.

From a cost benefit standpoint, this is the only kind of risk to insure.

High cost implies that an event would destroy something you have and value. Possibly catastrophically. It could be a building destroyed by fire, your savings destroyed by a liability claim, or your future earnings destroyed by an accident, illness, or death. None are easily replaced.

Insurance premiums tend to be quite affordable when compared to the loss. $500 for a million of life coverage. A few dollars a month for extra liability coverage on your car policy. The insurer can afford to offer these prices, because most of the time they collect the premium and pay no one. Over a long time they pay some, but they earn investment income in the interim. That investment income is untaxed to you and the claims tend to be tax free too.

Life insurance is a form of income splitting and for some people, quite an attractive investment.

Risk management begins with Cost Assessment

Know the cost of your possible loss, like a million dollar car accident, or the loss of a $20,000 monthly income, (roughly $4,000,000 if you’re young.) Then move to probability. Include all the costs. Like processing the claim.

If you are a “standard risk” – being like everyone else of similar characteristics, you can expect a premium that fairly addresses the price of the loss.

If you think the price is too high, you might want to stop and think. If an insurer wants a premium that you think is too high, maybe they are non-competitive. Any broker can survey the field and tell you. If you discover that all insurers charge about the same, you are underestimating the nature of the risk side. It is likely more probable than you care to admit.

The fundamental rule of insurance

All insurance of a type costs the same for the insurer, although the premiums may be different.

For example, the probability of a 35-year-old male non-smoker in ordinary health dying this year is small. It is the same regardless of the insurer and policy chosen.

The premium relies on several factors. Probability of death, investment yield, cost of doing business, taxes and lapse. All insurers face the same set of variables. Given actuarial science, they will all arrive at about the same premium.

So how come there are differences?

If a policy is cheaper than another, it is because it is not the same. It may have restrictive covenants, like pre-existing health conditions. It may build cash values more slowly with a bigger lapse effect. It may have claims adjudication that is aggressive and tries to deny every claim. You don’t know and in many cases can’t know. With insurance, price is not a very good indicator of value.

John Ruskin advises you to know value before assessing the price

“A thing is worth what it can do for you, not what you choose to pay for it.”

I help business owners, professionals, and others understand and manage risk and other financial issues. To help them achieve their goals, I use tax efficiencies and design advantages to acquire more efficient income and larger, more liquid estates.

In previous careers, I have been a partner in a large, international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you. 705-927-4770

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