Insuring Your Financial Plan

Insurance is a key component of any financial plan.  When it comes to investing for the future, most people think of stocks, bonds, 401ks or IRA accounts.  While it’s important to save money for your goals, there is no point putting money away if you have to use your savings to pay for an unexpected loss.  Before you start putting your hard-earned money in the stock market, make sure to understand how you can protect your finances first.

Insurance is where one party guarantees against against a specific loss or risk.  In simple terms, it means you pay a small amount of money to cover yourself in the event of a major loss.  Examples of this kind of loss includes auto accidents, theft, fires, or medical emergencies.

Even those that have insurance can face financial difficulty.  In 2005, my own garage caught fire.  While my family had home owners’ insurance, companies limit coverage for detached buildings like a garage.  The maximum coverage for our detached garage was 10% of the total value of the main home.  Even with coverage, we were out thousands.

A fire can happen to anyone.  While you can’t predict a fire, you can prepare for it.  To do that, you first need to understand what insurance protections are available.  Once you know what protection you need, you will want to work with your financial planner or insurance professional to determine what to insure and how much coverage is needed.

Insurance Basics

Insurance is designed to prevent the randomness of life from impacting your future.  The mechanics, language and laws that make up insurance may be complicated, but the underlying concept is simple.  You don’t need to waste time trying to figure out how the industry works.  What you need is a high-level understanding to help you see the benefit of insurance.

At the most basic level, insurance is about people pooling their money together.  When a person who has contributed money to the pool needs help, the investment from the overall group helps with an individual loss.  When I teach financial literacy classes, this is the simple example I use to explain the process.

Insurance Basics

With this picture, I explain that 100 people have purchased a new cell phone.  That new phone costs $100.  Each of these people opted to buy the insurance protection, which costs an additional $1. The dots here represents their dollar contribution to the overall pool of insurance funds.   Of the group of 100, only one of the insured is likely to break their phone.  The $100 that has been contributed to the insurance pool will replace the phone for that person who suffers a loss.

A dollar contribution to cover a $100 loss is a small price to pay.  That’s the basic concept behind insurance.  The insurance providers job is to determine what the fair cost is for coverage.  Insurance companies study the costs for coverage and attempt to group people with similar insurance needs together.  That’s why you see young men driving sports cars paying more for auto insurance when compared to grandmothers that drive minivans.

Insurance needs are different from person to person.  This article will explain some of the many kinds of insurance protections available.  Depending on your needs, you may need some or all of these kinds of insurance.

Medical Insurance

Medical insurance is one of the most common types of insurance available.  The majority of people will get medical insurance through their employers, though insurance can be purchased privately, through government health care exchanges,  and is offered through Medicare and Medicaid. Choosing an insurance plan offered through an employer can be simple.  If you have questions, you should follow up with research, your human resource department, or your financial advisor.  Discussing the government options with you advisor, especially when selecting Medicare, is equally important.

In 2015, Fidelity Investments put out a report that stated that a couple retiring that year should expect to spend $245,000 on health care costs during retirement.  Even with medical insurance, medical costs can be a heavy burden.  In 2009, over 60% of all bankruptcies were the result of medical expenses.  While the Affordable Care Act has slowed medical bankruptcies, a large portion of people still face financial problems because of costs insurance does not cover.

Health Care Insurance

Personal Property

Personal property insurance includes insurance coverage for home, automobiles, and valuables.  Most people are familiar with this sort of insurance considering automobile insurance is required.  The amount of coverage can vary. Many will choose to self-insure property not valuable enough warrant coverage, such as an older car or truck.

Umbrella Insurance

Additional coverage that can help with major claims or lawsuits is called umbrella coverage.  This coverage provides pays the insured when the limits of homeowners, automotive and boat insurance are surpassed by the cost of a claim.  The coverage also protects against claims that normal coverage would not pay for, such as libel, slander, false arrest or rental property.

Life Insurance

Life insurance is another common form of insurance that most are familiar with.  The first life insurance provider offered coverage in 1706.  That means that life insurance has had over 300 years to develop as an industry.  That fact means that consumers has a wide variety of options to choose from and that the rules and regulations have grown quite complex.

Life Insurance

Life insurance is used to protect your family, pay off large debts, or provide a savings for retirement. There are several forms of life insurance available to include in your financial plan.  Term and whole life policies are traditionally what most people have worked with, though there are other options that can link account growth to the market or allow for flexible payment structures.  Policies can be designed to fit a variety of situations and budgets.

Disability Insurance

Putting money away towards retirement requires that you have savings to put aside.  If you’re unable to work, there is no way you can save.  While the possibility of a disabling illness or injury is remote, there is a 30% chance that you’ll suffer a disability that prevents you from working for three months or longer.  This risk is worrisome enough, but it can be especially devastating to small business owners, especially if they are sole proprietors.

Many companies will offer group disability plans, and they should be used as part of your financial plan.  Outside of your employer, there are individual disability and supplemental disability plans that can be purchased.  The rules are complicated and you should seek professional help when choosing a disability insurance plan.  Choosing the wrong type of coverage could be devastating to you and your family.

Long Term Care

Long term care insurance covers the costs that come from old age or long term illness that leaves one unable to take care of themselves.  This can range from residential care in assisted living to assistance at home.  Many assume that Medicare or other insurance will cover these costs, but they’re unfortunately incorrect.

These costs can be quite high.  In 2016, the average annual cost of a private room in nursing home runs over $92,000.  Home health care ran over $46,000 per year.  Most American’s do not have coverage to insure against these costs.  The reasons stem from the high cost of this insurance and an unwillingness to face the reality that this type of care may be needed.  In order to keep costs down, you need to understand what coverage you need and to purchase a policy when you’re younger.

Conclusion

The insurance industry has had hundreds of years to evolve.  This makes the subject difficult to understand at times.  This also puts power in the hands of salesmen who can use that knowledge to their advantage.  To help select the right insurance, make sure you’re working with an independent insurance broker or a licensed financial advisor.

Mortality, illness, injury and loss are never fun topics to discuss.  Luckily, insurance provides a low-cost solution to rare, high cost problems.  Insurance offers you a way to prevent the unexpected from derailing your life goals.  And while that is the main reason to include insurance protection in your financial plan, the peace of mind that protection offers is worth the price.

 

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