moneyFYI
Financial Freedom Is Merely Organized Common Sense
All Insurance Should Address a High Cost / Low Probability Situation
Insurance transfers the cost of the risk from you to someone willing to have it. They charge you a fee for that. The premium. The premium will depend on the face value, amount insured, and their estimation of how likely the event may be.
Most insurers will try to define the conditions under which they will pay so as to minimize their risk. They are good at estimating but know they are not perfect. They use underwriters and inspection of important variables before they will issue a policy. Medicals screen out the sick. Drivers license checks dial out the bad drivers. House inspections eliminate the ones with needless fire risk.
The policy will define the meaning of many terms and you should notice those. For example, would an accidental death policy pay if you climbed a high tree to see if you could fly while wearing a red cape? Probably not. The death was not accidental but “reasonably foreseeable.”
Insurance is a risk management tool.
Its about exposure. Sometimes the cost is large and there is little ability to avoid the risk. Exposure is certain. We transfer the cost of that probability to others when we can.
To make it affordable there must be two factors present. High cost and low probability. Otherwise the premiums are unaffordable. How much would you charge to insure a ship sailing into a war zone? A lot.
We all buy insurance.
The policies will fall into categories and the characteristics of each may be different.
Property and casualty.
Things like house or tenant insurance. Loss by fire, wind, flood, theft and vandalism. Loss by liability to another on our property. These policies are difficult to understand. You need a competent professional to assess your options, risk, cost, and exposure. They can help with deciding how much risk you can keep in order to get a premium reduction. A deductible is what they call it. The idea is to pay for the small, higher probability losses yourself, and have the insurer pay for the big ones.
Cars, boat, airplane, motorcycle. These policies cover loss by damage or theft or vandalism, but the big component is liability. What if you harm another or their property? Again, the details matter.
Group insurance
Things like prescription drugs, out of country medical, dental, and possibly vision care. These are cost reimbursement plans. You should treat them as a convenience instead of insurance. The insurer operates with overhead costs that are significant. The essence of these plans are you send the insurer four quarters, they send back seven dimes. The premiums are then more than you can expect to get back, so use deductibles to minimize them. Avoid the insurer’s overhead on affordable claims. Everyone has some small claims. Leave big ones to the insurers . A $100 deductible will reduce the premium by more than $100.
Group life and disability insurance is more like individual insurance in terms of risk
In some jurisdictions medical insurance is a high cost, high need issue. In Canada we have government medicare so I am unable to offer guidance. Be sure to look at it on the basis of cost and benefit.
Disability insurance
In my experience this is the most complex policy. It is a promise based on pages of definitions and conditions. It is not a trivial contract and you will be poorly served if you assume they are all alike. They most certainly are not.
The idea of the policy is the insurer provides an amount if you are unable to work because of illness or injury. The variables include how long will they cover you and what “elimination period” have you chosen. Elimination period is like a deductible on your house or car policy. If you are willing to self-insure disabilities lasting less than 60 days you will enjoy a signifcant premium reduction. More even for 90 days but not as much more as going from 30 to 60 days. Most disabilities don’t last long. For example, if you have a heart bypass and you are not ready to go back to work after 60 days, the insurer will want to know what the complications are.
Disabilities that last more than four months tend to last a very long time.
Duration of coverage could be 2 years, 5 years, or to age 65. Longer possible coverage costs more. The insurer is taking on more potential cost.
Definitions matter.
Many policies will refuse to pay if the injury happened while committing a criminal act. You never do that so no big deal. Well maybe? Suppose you are a truck driver and sometimes you drive more than the 12 hours you should. In some jurisdictions that is not a crime, in others it is. Suppose you fall asleep in the 13th hour and hit a bridge abutment. Are you covered for your loss of income? In some states yes, in others no.
Premiums for these coverages can vary widely. This is one policy where cheap is expensive. Be sure you know what is not covered as well as what is. Be sure you know the company’s claim record.
You weigh the premium cost against the value of a claim. Most people don’t do it very well. Seek help and ask a lot of questions.
Life insurance
Life insurance is far easier to deal with than disbaility coverage. You can generally tell if a person is dead. Not so much with disability. It is far harder to fake death to your advantage.
The idea here is in the event someone dies, the insurer will pay a sum to the beneficiaries. The sum is arranged when the coverage starts and the premiums are predetermined. The premium will depend on the insurer’s idea of the probability of a death while the policy is in force.
The factors they consider are predictable:
- Gender. Typically females are less expensive than males because they live longer.
- Age. Older people are more likely to die than younger people after about age 10
- Health. Insurers sort out health risks and deny the coverage or charge them extra.
- Smoker status. Non-smokers are immensely cheaper. If you are 40, being a smoker is expensive. $1,000,000 of term insurance renewable in 10 years has a premium of about $140 monthly from a major carrier. $53 or so for a 40-year-old non smoker. Cigarettes are far more expensive than you think. Don’t be a smoker.
- Other factors include driving record, hobbies, and occupation. It would not pay you to be an oil-well fire fighter, who scuba dives, flies a light plane, uses cocaine, and has two careless driving charges and an impaired in the last five years
Policy form
Casualty insurance has some standard policies, while life insurance has several formats. The formats address predictability of premium and duration of need. For most young people term insurance is the best premium to coverage compromise. The need a lot but don’t have a lot of money to buy with. Eventually the policy will become to expensive to continue or it will expire. Match the duration of need to the format
Whole life, being a policy that does not expire, will have a higher premium because the claim will occur if the premiums are paid. Some of these have “cash value” which results from paying level premiums for life. You overpay in the early years and that builds a reserve for the high price of insurance in the later years. If you quit you can get back all or some the overpayment, as cash value.
Universal life is a mixture of term and whole life. It is guaranteed for life but each year the charge for the insurance part gets bigger. You build your own cash values to deal with escalating costs or you choose a term to 100 option. Level cost but no recoverable cash value if you quit.
Life insurance requires help. Amount is not as easy as people think. It is usually far more than they expect. Duration of need is contextual. A 50-year-old with a business, debt and large tax liabilities at death is different from a 50-year-old who has one remaining child to educate.
Availability is quite restricted. Most insurance is unavailable without someone to deliver it to you.
Always look first for the coverage need, then the duration, finally the format with a premium you can afford.
Group, association and creditor life and disability coverages
All are flawed and you should avoid them if possible.
- They can be cancelled by the carrier
- You must be in the group or association to have coverage. They are not portable.
- They are expensive compared to similar individual coverage.
Before you decide compare. Most people are surprised. I know of a business owner who replaced his bank offered insurance with individual coverage. The saving exceeded $1,000 per month and the loan was less than $1,000,000.
Be a good shopper
Treat price as secondary. Be sure you get the coverage you need. If one policy is cheaper find out what makes it so. All pure insurance costs the insurer the same.
I help people understand and manage risk and other financial issues. To help them achieve and exceed their goals, I use tax efficiencies and design advantages. The result: more security, more efficient income, larger and more liquid estates.
Please be in touch if I can help you. don@moneyfyi.com 705-927-4770
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