Did you ever hear the story of the man who thought he had enough life insurance but died anyway? Apparently he didn’t quite understand the concept, and neither do most people. I’ve seen people insure packages worth $100 at the post office while not having any disability income protection. This is nuts!
The purpose of insurance is to compensate you (or loved ones) for losses that you cannot afford to bear. The insurer takes that risk upon himself in exchange for premium payments from you. If the insurer is to remain in business, then the premiums and income generated from those premiums must exceed all of the payouts to those suffering losses as well as all of the expenses of running the insurance operation. This can only happen if the premium payers as a whole (meaning you and me) lose money on the deal.
This is as it should be. If you’re paying for fire insurance on your home, you don’t complain at the end of every year when your house hasn’t burned down. The insurer relieved you of the anxiety over that possibility for 365 days (or 366 in leap years) and is entitled to a little compensation.
Insurance is a cost. You should not think of it as an investment. That’s why most personal financial advisers, myself included, will tell you to buy term life insurance and invest the savings from not buying variable life, whole life, or universal life, which are enormously more expensive than term. Insurance agents will sometimes properly note certain tax advantages from investing inside of an insurance policy, but it is rare for the added expenses of such policies not to exceed such tax benefits. And if you’re at all sensible about how you manage your investments, you can minimize the tax costs of investing on your own. Plus, you’ll have a much wider variety of investment options rather than being restricted by the choices offered by the policy.
But there are many cases when I recommend insurance to my clients:
Term Life Insurance – to protect those dependent on your income if you die before building up an adequate level of investments to support them.
Annuities – to protect you from living too long and outlasting your assets in retirement.
Disability Coverage – to protect your earning power from a long-term inability to work.
Long-Term-Care Insurance – to cover the costs of a decent nursing home or in-home care if you require it before building up an adequate level of investments to pay for them.
Property Insurance – to protect you from damage to major assets.
Liability Insurance – to protect you from the cost of harm you do to others or their property.
Catastrophic Health Insurance – to cover the extraordinary costs associated with major illnesses and injuries and the urgent need for free Viagra and contraceptives.
We’ll discuss each of these in future lessons (except the Viagra and contraceptives), but now I want to get back to what we might call portfolio insurance and why you might consider getting gold-bond coverage. Next lesson.