Bad things happen, sometimes profoundly so. This post is all about risk and how you can mitigate it through insurance.
Some risks are small enough that they can be self-insured. For example, you can reduce the impact of a trip to the emergency room by keeping a sizable emergency fund. Other risks have such huge financial consequences that covering the cost yourself isn't really an option.
Insurance exists to transfer some risks to another party (e.g., the insurance company) in exchange for payment, called a premium.
Certain insurances are required, like auto liability insurance when you receive a driver's license or homeowners insurance when you take out a mortgage. While health insurance is no longer mandated, it is much easier to obtain (and more affordable) since the Affordable Care Act was passed. Most people probably already have some or all of those three common types of insurance.
Other kinds of insurance are just as important, but – because they are not required – many people choose to do without. Why pay for something you might never need, right? Better rethink that one...
Everybody likes to save a buck here or there, but often the risk to your livelihood (or the impact to those around you) is so severe that going uninsured is just not worth it. What if you were a few years – maybe even months – away from financial independence when something potentially catastrophic happened? The loss of a primary income earner, a disability that keeps you out of the workforce, an unexpected lawsuit, or a large stock market drop could completely derail your plans. While paying insurance premiums might seem like a chore now, it will seem like the smartest thing in the world when you need it.
Managing risk with insurance can help you preserve everything you have worked to accomplish. Here are some important insurance questions:
Do you have adequate life insurance coverage?
Do you have adequate disability insurance coverage?
Do you have an umbrella liability policy?
Is this the right time to purchase a Long-Term Care policy?
If any of those questions are a "no" (or even "I don't know"), then it's time to explore the kinds & amount of insurance that are best for your situation. Not everyone needs all of those types of insurance, but almost everyone could benefit from some. We'll dive a little deeper into those questions and different types of insurance below.
Have a question about your insurance coverage? Shoot me an email.
Do You Need Life Insurance?
Quick question: in 5 words or less, what do you think is the best use of life insurance?
It's not an easy question to answer, because the truth is that there are lots of reasons to own life insurance. And, while life insurance isn't necessary for everyone, almost anyone could benefit from having at least some coverage.
Here are a few of the most common reasons to own life insurance:
Replace household income – if you are still in your earning years, what would the loss of your income could mean for your family? Could your significant other manage the burden of your shared expenses on only one income? Life insurance can cover the difference if you pass away unexpectedly.
Provide for survivors – this is especially significant for people who have not already built up a significant net worth. What would you hope to do in the future that you would be unable to do if you died prematurely? Life insurance can pay for a child's education, eliminate outstanding debts for loved ones, or leave an inheritance beyond your current means.
Leave a legacy – life insurance proceeds can be donated in your name to a charity of personal significance, given to your alma mater, used to establish an educational grant, or help provide for your community.
Make cash available during estate settlement – even if you have enough money that all of your loved ones will be well taken care of, many of those assets could be tied up in lengthy (and potentially costly) probate or trust administration. Since life insurance is contractually obligated to pay out separately from any estate settlement, even a modest amount of coverage can free up cash to help pay for things like cremation, a funeral, and estate settlement costs.
Protect your business – life insurance can help take care of employee payroll & facilitate a smooth transition of ownership (or winding down of the company) after the sudden loss of an owner.
So do you need life insurance? That all depends on how well you think the people you care about can handle the financial burden of your loss. If you're a single person with no dependents, you might not need any life insurance or might consider a small policy to help with funeral expenses & estate settlement. Likewise, you may need little to no coverage if you're already past your working years and have already made arrangements for sufficient cash to be available to help with those kinds of expenses.
For everyone else, at least some kind of life insurance is a huge plus. It can provide for your loved ones long after your gone or, at the very least, it can make the short-term easier to manage by taking away some of the financial burden of estate settlement.
There are different categories of life insurance, and some will be more appropriate based on what you need the proceeds to cover.
Term – this is the most common and also the cheapest. As the name implies, term life insurance is only valid for a specified length of time. If you die before that ending date, the policy will pay what's called a death benefit (kind of an oxymoron, right?) to your named beneficiaries. Once that period of time expires (or the policy lapses from non-payment), though, the policy becomes worthless. In other words, you can't "cash out" a term life insurance policy. This is typically most appropriate for people who want to cover replacement of income, provide for kids until a certain age (through college years, for example), or protect their businesses, but are less concerned about what happens after that.
Permanent – permanent life insurance lasts the rest of your life. Since you are guaranteed to die eventually (and therefore the insurance company knows they will have to pay out), permanent life insurance is more expensive than term. On the plus side, permanent life insurance allows your policy to build up cash value based on your payment history, so you can limit your losses if you decide to surrender the policy at some point. There are several types of term life insurance, including whole, universal, and variable. A deep dive into those three is beyond the scope of this particular newsletter, but the biggest differences among them are how the premium is calculated, how the cash value is determined, and whether the death benefit is fixed or flexible. Permanent life insurance is typically most appropriate for people who want to leave a legacy, cover estate taxes (only for very wealthy people – as of 2024, estate taxes only kick in above $13.61 million), or make cash available for estate settlement.
Have a question about your insurance coverage? Come to weekly Office Hours.
What's Up With Disability Insurance?
Imagine your current life right now: how you spend your time, the things you do for fun, the food you eat, your standard of living, etc. Now imagine that your income unexpectedly stops and you're not sure exactly when it will restart. If you've built up an emergency fund, you know that you'll be covered for at least a few months. But it's still pretty stressful, right? And what if your income hasn't restarted when that emergency fund runs out?
That's what disability insurance is for. Disability insurance helps alleviate the risk that you will be unable to work for an extended period of time by paying a portion of your missed income once you meet certain requirements.
While it won't replace all of your earned income, most policies will cover about 50-60% of earned income to help you navigate ongoing expenses when you are knocked out of the workforce. Sounds pretty great, right? It is – but it's not cheap.
You may remember from last week's look at life insurance that the more likely a thing is to happen, the more expensive it is for you to buy insurance against that thing. And, unfortunately for every working person, the odds of being unable to work for an extended period due to injury or illness are quite high.
According to the Social Security Administration, about 1 in 4 (about 25%) of all U.S. adults age 20 and above will be unable to work due to injury or illness at some point before the age of 65. For contrast, the World Health Organization lists the adult mortality rate (the probability of dying between ages 15 and 60) in the Americas as about 12.6%. In other words, the average person is about twice as likely to miss work due to illness or injury than they are to die during working years. Again, the more likely a thing is to happen, the more an insurer will charge for that coverage.
What about people who can do their jobs with minimal physical effort? While it's true that occupational disabilities (i.e., disabilities that are caused by something at work) are overwhelmingly injury related (82%, according to the California Department of Industrial Relations), the opposite is true for non-occupational disabilities: 79% of disabilities caused outside of the workplace are from illness and only 21% from injury. So even if your job involves sitting at a desk with little physical work, there is still a large risk that an illness will knock you out of the workplace.
Here's a quick overview of the terms you need to understand when evaluating a quote for disability insurance.
Benefit: this is the amount that the policy will pay monthly once you are determined to be unable to work. The benefit you receive is never equal to your actual monthly compensation.
Elimination period: this is the amount of time between becoming disabled and insurance kicking in. The shorter the elimination period, the more you can expect to pay. Your emergency fund definitely factors into this decision.
Benefit period: this is how long the policy will continue to pay once payments begin. The gold standard is through age 65, but some policies pay only through recovery or for a certain amount of time like 2 or 5 years.
Definition of occupation: disability insurance policies differentiate between whether you are unable to work at your own occupation or at any occupation. "Own occupation" allows you to receive benefits if you are unable to continue in the same job, even if you are able to work in another capacity or industry. "Any occupation" is the least favorable, since the requirement is that you be unable to work at any job (even one you don't want) before benefits begin.
Exclusions: the insurer may agree to pay under most circumstances, but carve out certain types of disability that will not qualify like pre-existing conditions such as back pain or mental illness. Limitations, on the other hand, allow for the benefit amount to be paid but with a shorter benefit period.
So is disability insurance right for you? While the benefits of disability insurance would help almost any working person, the costs may be enough to give pause. Here are some factors to consider:
Does your cash flow allow it? If you earn plenty of income, the cost of the policy may not be a deciding factor. But the truth is that many lower income earners will simply find the cost of the policy to be more than they can handle.
How close are you to financial independence (i.e., retirement)? Disability insurance only covers people still actively in the workforce. If you are close to being able to support your lifestyle without work, how much would being knocked out of the workforce set you back? Remember that disability insurance typically only replaces 50-60% of your earned income, so if you're 90% of the way to financial independence, you may decide that 90% of retirement is better than paying the premiums to potentially receive 50% of your income.
If you have a spouse or partner, could your household get by on just one income? This is an especially important question when one partner earns significantly more than the other. If the higher earner couldn't work, would you still be ok? If the answer is no, then disability insurance is strongly recommended.
Is there money available from another source – even if you don't feel comfortable asking for it now? While it might not feel good to bring it up under normal circumstances, it's worth considering whether a family member could afford to help out.
Have a question about your insurance coverage? Shoot me an email.
What About Umbrella Insurance?
Some kinds of insurance help manage financial the risk of something bad happening to you. We looked at two of those already: life insurance and disability insurance. Certain sections of a homeowners insurance policy spell out what you could expect to receive if your home, the possessions therein, or any other structures on your property (like a garage) are damaged or destroyed. And comprehensive auto insurance policies (sometimes called collision or bumper-to-bumper insurance) protect against damage to your vehicle.
But then there's everyone else. What happens when something bad happens to someone else – and it's your fault? That's where liability insurance comes in.
Every auto insurance policy includes basic liability coverage, which pays out when you are found liable for causing damage or injury while driving. Homeowners insurance also includes a section for liability if a person gets injured while on your property. Business owners insurance similarly covers damage or injury to others while visiting your business, and many industries require specific types of insurance to operate (like malpractice insurance for doctors & lawyers).
Here's a basic example. Let's say your auto insurance covers $50,000 per accident for injury and medical treatment. That sounds pretty good – $50k is a lot of money, after all. But what if you have an accident and cause $60k in damage? That means you are personally on the hook for that extra $10k.
Or worse: what if an accident for which you are liable causes injury or even death and find yourself facing a lawsuit for hundreds of thousands or even millions of dollars? That $50k policy won't go very far if you are ordered to pay $1 million.
I'm sure you can quickly see how similar risks exist for every other kind of liability insurance (homeowners, business owners, malpractice, etc.): you could find yourself facing liability claims that exceed your policy.
"Umbrella insurance" exists for exactly this reason. Umbrella insurance is extra liability insurance that supplements all other types of liability insurance (it's an "umbrella" over everything else) and only kicks in when your other policies are maxed out.
Let's look back at that auto insurance example, but this time let's add a $1 million umbrella policy. If you find yourself facing a $1 million liability due to injury, medical expenses, or death, you would first pay your deductible, then your auto insurance would kick in, then the umbrella policy would cover the rest. Other applicable insurance needs to be tapped out before the umbrella policy becomes active.
So who needs an umbrella policy? While anyone can be subject to a liability lawsuit, people who already have a decent net worth built up are the most at risk. If you don't have much money, the odds are that you won't get hit with a high-dollar lawsuit; there's just no chance that you will be able to pay out. But if you have several hundred thousand or million dollars to your name, someone might be more likely to press a claim against you.
The good news is that umbrella policies are not super expensive relative to other kinds of insurance. Remember that the more likely something is to happen, the more expensive it is to insure. Since it is unlikely that most people will find themselves faced with a very expensive liability lawsuit, the cost to insure against it is not very high.
Want to discuss your own insurance coverage needs? Drop me a line. (FYI – I never receive any kind of commissions or kick backs for any recommendations, so you don't need to worry about me recommending things to you just to line my pocket. My first and only motivation is to recommend what I think is best for you & your situation.)
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Thanks,
Timothy Iseler, CFP®
Founder & Lead Advisor
Iseler Financial, LLC | Durham NC | (919) 666-7604
Iseler Financial helps creative professionals remove stress while taking control of their financial lives. We'll help identify current your strengths and weaknesses, clarify and refine your long-term goals, and prioritize decisions to improve your financial well-being now and later. Reach out today to take the first step.
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