Insurance is neither inherently good nor inherently evil, but it can be used for either one.
Personally, I have a lot of insurance and I’m incredibly grateful for it. But as a financial planner, I also see lots of people who have been sold inappropriate policies for too much money, and that side of it never ceases to frustrate me.
Insurance is a complicated subject, and new parents especially find themselves with a lot of new needs and new questions about the kinds of coverage they should and shouldn’t get.
To help you answer those questions, I’m making April insurance month on the blog. We’re going to be talking about what insurance is and isn’t good for, what types of insurance to consider, and some common pitfalls to avoid.
My goal is to help you protect your family without spending unnecessary money on insurance you don’t need.
Why I love insurance
My top financial goal is making sure that my wife and boys always have the financial resources they need, no matter what happens to me.
That’s a big reason why I prioritize building up savings like my emergency fund and my irregular expense accounts. Those basic protections have helped to keep life as normal as possible, even in some difficult circumstances.
But the reality is that there are certain things that could happen that I don’t yet have the savings to handle on my own. And it’s for exactly those kinds of situations that insurance is such a beautiful thing.
- I don’t currently have enough money in savings to replace my income if I died. Instead, my life insurance would be there to provide for my family.
- I don’t have enough money in savings to replace my income and pay the medical bills if health issues kept me out of work for an extended period of time. But my long-term disability insurance would provide a monthly check to pay the bills.
- I don’t have enough money in savings to pay the damages if I injured someone in a car accident and they were out of work for an extended period of time. So I have liability insurance to pay the damages instead.
- I don’t have enough money in savings to pay for 100% of the treatment necessary for certain chronic medical conditions like cancer or diabetes. Health insurance would ensure that my family got all the care it needed.
When it comes down to it, insurance is really the only way that I can provide my family with the kind of financial security it deserves.
And when I look at it that way, I’m more than happy to pay the premiums.
Why I hate insurance
With all of that said, I get really frustrated with insurance sometimes. And most of it has to do with the way that it’s sold.
See, the insurance industry is a for-profit business with no legal obligation to act in the best interests of its customers, and over the years they’ve come up with a number of ways to get you to pay more money than you have to for coverage you don’t need.
One of the biggest culprits here is whole life insurance. It’s a type of life insurance policy that’s often sold as a can’t-miss investment opportunity when the truth is that in most cases it’s actually an incredibly poor use of money (though it does pay the agent a big commission). The same usually goes for similar products like variable life insurance, universal life insurance, equity-indexed annuities and the like.
Another trick that agents like to pull is selling you more coverage than you actually need. And again, life insurance is a big culprit here.
A common sales pitch you’ll hear from your insurance agent is that term life insurance is a waste of money because it rarely pays out. This is used as an excuse to once again push whole life insurance, which they claim pays out 100% of the time.
Let’s ignore for a second the fact that whole life insurance DOESN’T actually pay out 100% of the time. We can even ignore the fact that life insurance not paying out is a GOOD thing (you didn’t die young!).
The simple truth is that most people only need life insurance for a temporary period of time, usually until the kids are out of school, after which the coverage is unnecessary. So why are they being sold insurance that lasts forever?
I hate seeing people who are just trying to make the best decisions for their family carrying around insurance policies they don’t need because some insurance agent wanted a bigger commission. After all, those premium payments could be used to actually help these people reach some of their most important goals.
So how can you prevent something like that from happening to you? By understanding what insurance is and isn’t good for.
Here’s what insurance is good for
Basically, it all comes down to this:
- Insurance is great when you purposefully buy it to protect against specific risks.
- Insurance can be a waste of money when it’s sold to you by an insurance agent who is more interested in earning a commission than helping you out.
Which means that in order to get the right insurance and avoid the wrong insurance, you have to know what it is and isn’t good for.
So here’s a quick rule of thumb for you. Actually, this is more than a rule of thumb. This is the exact rule they teach aspiring financial planners working towards the CERTIFIED FINANCIAL PLANNERTM certification.
Insurance is good for things that meet all three of the following criteria:
- Would result in a big financial loss
- Is unlikely to happen
- You actually need the money
Big financial loss – Death or long-term disability are good examples here because it’s virtually impossible to have the savings to handle that on your own when you’re starting out. On the other hand, something like a broken cell phone would be much better handled by savings.
Unlikely to happen – Insurance is priced partially based on how likely you are to have a claim. When something is highly likely to happen, insurance is going to be less cost-effective than either having the money in savings or avoiding the risk altogether.
Need the money – One of the reasons I decided to cancel the collision and comprehensive coverage on my old car was that I had the money to handle the damages if needed. Similarly, if you’ve saved well over the years and your kids are out of the house, you probably no longer have a need for life insurance. If the insurance proceeds would no longer be necessary, it doesn’t really make sense to keep paying for the coverage.
If something meets all three of the criteria above, it’s probably a good idea to look for insurance coverage. If not, you can skip the insurance.
A tool is only as good as its user
In the end, insurance is neither good nor bad. It’s simply one tool of many that can potentially help you reach your financial goals.
But when it is done right, it’s one of the most valuable tools out there.
Next week, we’ll go into more detail on the four types of insurance that most new parents should have so that you know exactly what kinds of policies you should be considering.