Step 2 – Get Properly Insured
The second step toward financial security is to get properly insured.
Having adequate insurance is a fundamental part of your overall financial plan. It is also something that most people struggle with, as there are innumerable types of insurance with many options to choose from. At its most basic, insurance is a method to transfer risk from you to an insurance company, and you should only pay to transfer risks that you are not willing or able to shoulder. While insurance companies are happy to insure everyone and everything, in general you should only insure against large losses. Below is one man’s attempt to treat insurance with a “KISS” (keep it simple, stupid) approach.
TYPES OF INSURANCE YOU PROBABLY NEED
If you cannot afford the costs involved in any life scenario, then you should probably insure yourself against it.
While you can use an emergency fund to “self-insure” yourself against short-term disability, you will need help in the event of a long-term disability unless you are wealthy enough that you no longer need to work or you are covered by the military’s disability system. Luckily for those of us that are still active duty, the military has robust disability coverage that is usually adequate for most people.
Typically, you should obtain enough coverage to replace 60-70% of your income up to the age of 65 in the event of total disability. Ideally, the policy will cover your specific occupation, what is called “own occupation,” and will not rely on you finding alternative means of employment. You will also want coverage if you can only work part-time. Key components of the ideal policy include:
- Non-cancelable – they can’t cancel your policy or raise your premiums
- Guaranteed renewable – no medical exam is required to renew
- Residual benefit protection – pay you part of your benefit, or “residual benefits” if you are partially disabled
- Cost-of-living allowance – the amount you are paid is adjusted for inflation
If your the military or your employer’s coverage is inadequate, look for a private policy, which may be expensive. Some companies that specialize in disability insurance can be found at unum.com, northwesternmutual.com, and affordableinsuranceprotection.com. In addition, professional associations you might belong to often have group policies available to members.
Try to reduce the expense by lengthening your “waiting” or “elimination” period. The waiting/elimination period is the amount of time you have to wait after becoming disabled until your disability payments begin. If you have a substantial emergency fund, you can lengthen your waiting/elimination period and lower your premiums. If you don’t, you may need a shorter waiting/elimination period and will likely pay higher premiums. If you are just going to go with the military’s disability plan, this is a non-issue.
Most of us are covered by TRICARE so this is a non-issue. If you are not, unless you are wealthy enough to “self-insure” and pay your own medical bills in the event of a serious illness, you need medical insurance.
If you can get it from an employer, then that is probably the best way to limit your out-of-pocket expenses. If you can’t get it through an employer, try to get if from a spouse/partner’s employer, your parents, or any professional associations that you belong to as they often have plans available to members that are cheaper than purchasing it yourself, which may be your only option. Another way to lower your rates is by having a deductible and co-pays on the policy that are as high as you can comfortably afford. Filing for a low-cost claim is often not worth the hassle, and higher deductibles and co-pays will lower your premiums. Make sure that you understand the rules for seeing specialists, how co-pays work, and what happens if you see a provider outside of the preferred network.
You need homeowner’s insurance to protect the structure of your house, its contents, and to insure against injuries to other people or damage to other people’s property. Make sure that the contents of your home are covered for “replacement cost” and not “actual cash value.” For example, replacement cost coverage will give you $1000 to replace the 3-year-old laptop that was damaged, while actual cash value would only give you the $300 it is worth after 3 years. In addition, you will likely have to purchase a “floater” to cover any high-value items, such as jewelry, expensive electronic equipment, or other valuables.
If you rent, you’ll need renter’s insurance to protect your belongings, but it also offers liability protection, similar to homeowner’s insurance.
You need auto insurance in case you have a serious accident and damage your car, injure yourself or others, or damage someone else’s property. Lower your rates by having a deductible on the policy that is as high as you can comfortably afford, and carefully evaluate how much collision and comprehensive coverage you need, which covers physical damage to your car. If you are driving an older vehicle that isn’t worth much, paying for this coverage may not make sense.
Umbrella Liability Insurance
You want to have liability insurance coverage equal to your full net worth (which you are tracking if you followed Step 1 – Track Your Net Worth). You can usually get enough through your homeowner’s, renter’s, and auto insurance policies unless your net worth is greater than $300K to $500K. Once you are above this limit, you’ll need umbrella liability insurance.
Umbrella liability insurance protects you in case you get sued and adds liability coverage on top of your homeowner’s, renter’s, and auto insurance. It will come in handy if your dog bites someone and they develop a severe infection, the mailman slips and falls on your front porch and can no longer work, or a neighborhood child drowns in your pool. It is typically sold in $1 million increments and is relatively inexpensive. A $1 million dollar policy will typically run $150-300 per year.
What if you are early in your career and have very few assets but you make a lot of money (doctors, dentists, pilots, etc.)? You should still have umbrella liability insurance as future wages can be garnished in some judgments against you.
TYPES OF INSURANCE YOU MIGHT NEED
“More money is wasted on life insurance than probably any other insurance product….It cannot be overemphasized that cash-value life insurance is probably one of the biggest scams around.” – Paul Sutherland in the AMA Physicians’ Guide to Financial Planning
If you were to die, would anyone suffer financially? If the answer is “no,” then you don’t need life insurance. If the answer is “yes,” then you need life insurance, and probably a lot of it.
There are two types of life insurance. First, there are products that combine insurance with an investment account, often referred to as “cash-value” or “permanent” life insurance. Many insurance agents and companies will try to sell this, but it is probably not the kind of insurance you need. It does have some tax advantages, but the downside of these policies is that the insurance agent/company who sells them collects high fees. In addition, early premiums go mainly toward sales commissions and other expenses and not into your investment account.
The second type of life insurance is “term” insurance. It provides a death benefit only and does not build any cash value or serve as an investment. This is likely the only kind of life insurance that you need. To quote again from the AMA Physicians’ Guide to Financial Planning, “I cannot emphasize enough the importance of sticking to simple, unencumbered term life insurance – it fits 99% of insurance needs.” It is less expensive than cash-value/permanent policies and you can take the difference and invest it in a retirement account or other low-cost investment vehicle. You don’t need an insurance agent to purchase this and should simply go to my guide on how to purchase life insurance when you’re in the military.
When you buy term insurance, ensure that it is renewable without a medical examination. You can also consider decreasing term insurance, where the death benefit progressively decreases. As you age, the need for life insurance typically declines as dependents age and your investment portfolio grows. Eventually you will need no life insurance at all, which is why many arguments for “permanent” life insurance should fall on deaf ears.
Long-Term Care Insurance
Sometimes called “nursing home insurance,” this is usually purchased by people over the age of 50 to pay for nursing or at-home care. If you are under 50, you should probably consider additional disability insurance instead of long-term care insurance.
The rates and terms of these policies are highly variable, and whether you want to get one is an individual decision. The earlier you purchase it, the cheaper it is, but the total money you’ll pay out over the life of the policy is obviously higher. If you are a successful investor, you will probably have enough assets to self-insure in the event you need prolonged care, so I would suggest that many who are reading this blog will not need this, but circumstances and goals obviously vary, so it is something to consider. If it is important to you that your nest egg is passed to your heirs, you may want to consider this insurance so it is not passed to a nursing home instead.
Homeowner’s and renter’s insurance do not cover flood damage. To find out if your home is at risk of a flood, go to floodsmart.gov. There you can also find out information about the government’s low-cost flood insurance programs.
If you live in an area at risk for earthquakes, you’ll need earthquake insurance in addition to your homeowner’s insurance. California’s earthquake website, earthquakeauthority.com, is a good place to start.
TYPES OF INSURANCE YOU PROBABLY DON’T NEED
Life Insurance for Children
While you will be sad if one of your children dies, you do not rely on his/her income; therefore you are unlikely to need life insurance for children. The same thing is likely true for a spouse/partner who does not have a job, unless you would need money to replace the childcare he/she provides.
Rental Car Collision Insurance (Loss Damage Waiver)
They always ask if you want collision insurance or a “loss damage waiver” when you rent a car, but a lot of auto insurance policies automatically cover your rental cars. In addition, some credit cards provide this too if you use their card to pay for the rental car. Make sure you find out if your policy or credit cards have this before you step up to the rental car counter and are put on the spot.
Flight Accident Insurance
If you need life insurance, buy it. Don’t buy insurance on a whim when purchasing tickets in the off chance that your plane goes down.
This is a common credit card benefit when you use them to pay for your trip, so check with your credit card company. Even if you don’t have it, it is unlikely to be worth your money for domestic flights. You can consider travel medical insurance for international travel, as some health plans won’t cover you if you get sick internationally. Some credit cards offer this as well, so check with your card or health insurer to see if you need this. Here is the link about TRICARE coverage and international travel.
Credit Protection Insurance
This is designed to protect your credit by insuring your credit card or mortgage payments in the event you become unemployed, disabled, or dead. If you have life or disability insurance, this is probably unnecessary.
Most products that offer extended warranties are not costly enough to insure with an extended warranty. If the new TV happens to break shortly after the warranty expires, you’ll probably be able to afford a new one. Most of these offers are a waste of your money.
GENERAL INSURANCE ADVICE
Insurance companies occasionally go under, so you want to make sure that you only get insurance from quality companies with strong financials and that you diversify your larger policies. You can find information on the finances of insurance companies from AMBest.com, FitchRatings.com, Moodys.com, and StandardAndPoors.com (NOTE: most of the sites require you to register to access their ratings). For example, if you need $2 million in life insurance, you should strongly consider diversifying and getting 2-3 different policies from various companies.