The Short Answer: Bear the risks you can afford; insure those you can’t.
At Bragg we are often asked, “Should I buy this life insurance policy?” Or, “Do I need long-term care insurance?” And perhaps most common, “Should I keep paying premiums on this existing policy?”
Before diving into the details, we think it is important to remember the short answer from above regarding whether to insure any risk. Bear the risks you can afford; insure those you can’t. Insurance is a risk-spreading mechanism: Many people pay small amounts to insure against large losses incurred by few people.
Before paying premiums to insure against a loss, ask yourself if you could easily absorb the loss, should it occur. Large losses (premature death, long-term disability, liability claims, and major medical expenses) can be financially devastating, and insurance plays a critical role in protecting us from these experiences. Small losses (teeth cleaning, home appliance failures, auto repair bills, pet illnesses, iPhone damage, etc.) are to be expected and should be budgeted for and paid out of pocket. Most of us think rationally about those “official offers” we receive to extend the warranty on our car and we toss those in the trash. We know the insurance company has the bigger calculator and that these offers are generally a bad deal. But sometimes the answer is less obvious.
Back to our specific examples: “Should I buy this life insurance policy or this long-term care policy I’m being offered?” Or, “Should I keep paying premiums on this policy I already own?” These steps can help you make the decision.
First define the financial cost of the potential loss – death, long-term disability, or long-term care, for example.
Then, consider how much capital you have that you could comfortably apply towards that loss without jeopardizing your other financial goals.
If your capital is adequate you can self-insure the risk. If inadequate, you should insure it.
Life Insurance and Long-Term Disability: Death or permanent disability would be financially catastrophic if occurring before the mortgage is paid off, the children are educated and the retirement fund is accumulated. The magnitude of this potential loss is measurable, however, and it should be insured. If we are fortunate, we reach a point where our accumulated capital eliminates the risk of catastrophic financial loss—once you’ve saved enough, the need to insure this risk is reduced or eliminated.
Long-term Care Insurance: Most of these policies will offer a daily benefit once a claim is approved. A typical policy will cap the cumulative benefit at some dollar amount, typically between $200,000 and $400,000. While this is not a small amount of money, in many cases, high net worth individuals can self-insure the risk that this type of care is required. In fact, for many, the cost of assisted living or long-term care is actually less than the cost of living while active and healthy. In essence, the money that heretofore had been spent on an active life of travel, dining, entertainment, gifts, home maintenance and spending freely on grandchildren or other loved ones is now simply re-directed to the cost of medical care. I know, I know, I’ve painted a depressing picture…if only we could all go out in a sudden blaze of glory! Absent the “quick exit,” we’ll plan to live a long time, we’ll write large checks to our caregivers and we still won’t run out of money. To summarize, in many cases it’s easy to “just say no” to the offer of new insurance when you have sufficient capital to self-insure.
Dropping a Policy: But, what about the decision to let an existing policy go? This is often more complicated. You should start with the simple, most important question, a morbid one: “Would the insurance company insure me today?” If, for health reasons they would not, then you have an advantage that is rare in the world of insurance and you should probably keep the coverage. If the answer is unclear, you might ask us to run some numbers so that you can understand the return on investment under various scenarios. Sometimes this requires getting projections from your insurance company or your agent. We are good at this analysis so let us know when you need us.
Some other examples of coverage you may be able to forgo if you have a tidy nest egg and good cash flow:
Dental/Vision insurance – In many cases these policies only cover the basics. Save up for your cleanings. Buy the glasses, not the insurance.
Rental car coverage – Often your existing car insurance covers some or all of this risk. Find out from your agent before your trip. Also, the credit card used to rent the vehicle may offer some coverage.
Cancer insurance – Any insurance designed to cover specific diseases is often overpriced. Buy traditional health insurance that will pay regardless of your illness.
Mortgage insurance – This coverage pays off the mortgage if you die prematurely. Traditional term life insurance is almost always cheaper.
Insurance is an important component of any financial plan. When making decisions about coverage, put your emotions aside, remember the basic rules of insurance and let the numbers drive your decisions. We can help!
In the meantime, here’s hoping your premiums are low and your losses are few!
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.