I’m back to finish my series on The Founding Four principles of good money management. This is the sixth of the 9-part series in which we dig deep about the four most important topics to tackle in your financial life. To get the most of this series, please read them in order.
Part 1 gave you an overview of all four principles and how they fit together. Part 2 explained the need to save for short-term needs, including an Emergency Fund. Part 3 explained how to save in a way that generated a better rate of return than a typical savings account. In Part 4, we discussed the various types of consumer debt, and explained briefly the difference between “smart” debt and meaningless, sabotaging debt. Part 5 showed you how to structure a Debt Acceleration (“snowball”) plan.
Let me congratulate you for not only working through this series but for your patience as I took more time off than I’d hoped between Part 5 and the rest of this series. You’ll get the rest of the series over the next four weeks.
I know, I know: insurance is not the most fun subject to read up on. Frankly, it’s not even that much fun to write about. But insurance is a major part of an iron-clad financial plan.
Today’s part of the Founding Four is all about protecting the rest of your financial life from catastrophic loss. Whether that’s the loss of an asset due to damage, a lawsuit, or other hazards, or protecting your earning ability (and your family’s need for it), insurance is a way pass the risk of something you couldn’t afford to go through yourself, onto a company for a smaller price.
In fact, that’s literally what insurance is: you as an individual, agree to pay a small amount upfront to protect against the loss of something much bigger that only might happen (but if it did, it would devastate your finances). You enter into a written agreement with an insurance carrier, and you pay your premiums.
I’m sure you’re familiar with this concept, but if you’ve ever had to file a claim against your insurance, whether it’s for hail, wind or fire damage to your home, an auto accident, or a medical bill, you’ve experienced the importance of insurance firsthand.
There are a variety of insurance policies out there, and even companies that create custom insurance based off of very unique needs.
If something is of value and can be quantifiably measured, it can have insurance to cover it. And there have been some really strange insurance policies over the years.
- Julia Roberts once insured her smile for $30 million.
- Jennifer Lopez insured her “backside”.
- A dutch winemaker insured his nose (sense of smell) for $8 million.
- KISS singer Gene Simmons insured his trademark tongue for over $1 million.
There is wedding insurance, travel insurance, alien abduction insurance, and bed bug insurance. There is insurance in case you win the lottery (and don’t want to be sued by someone). There is even insurance for dogs, cats, and, yes, chickens.
Even your bank and investment accounts are insured. After the economic crash that began in 1929 and brought on the Great Depression, the Federal government created a new federal insurance carrier and required banks who accepted your money to become insured for all of the money they hold for you. You know it as the FDIC (Federal Depositor’s Insurance Corporation). Credit Unions have a similar mandated insurance, as does any broker/dealer or investment custodian. (Keep in mind, this kind of insurance doesn’t protect against investment losses due to trading or market activity, but does protect your money if the bank or custodian itself fails.)
Like I said, anything that can be measured or quantified, and has some sort of value to the person paying the premium, can be insured.
Obviously, we aren’t going to be talking today about the strange, fringy kinds of insurance coverage, though plenty of Rich Guys buy plenty of insurance on anything they don’t want to cover themselves. Today, we’re only going to be talking about the type of insurance coverage you need to have to get your basic financial house in order.
The two risks insurance is meant to protect against.
There are two basic risks insurance is designed to mitigate for you:
- The risk of PERSONAL LOSS (death, injury, loss of your property due to damage, loss of income due to disability, etc.)
- The risk of CAUSING LOSS TO OTHERS (this is called “liability”)
In many cases, you can cover both potential risks in the same insurance coverage, like an auto insurance policy.
And these insurance coverages can be VERY important. For example, in my financial firm (nVest Advisors), I carry Key Person Life Insurance, because I’m the primary person in my practice and my skills and insight are critical for its success. If I die, the insurance will compensate my company for my loss. I also carry insurance called “Errors and Omissions” liability insurance, which protects me against claims made by a client that I was negligent in my duty as a financial advisor. We also carry Cybersecurity Insurance, which lets us pass off the costs of any security breach or hack on to the insurance company.
The only reason to buy insurance.
There’s a simple question every Rich Guy asks him (or her) self as they look over their business dealings, their work life, their family, and their personal life:
“What risks, if they happen, can I pay for myself, and which ones can I either not afford to pay, or don’t want to pay?”
We buy insurance only to protect us from the events in life we either could not pay for, or don’t want to pay for. I’ll get to the second part of that in a moment, but let’s look at the first part: if something unexpected actually happened to you, and you would be financially devastated by it if it happened, you must have insurance to cover it.
For most Average Guys, this means, at minimum, the following insurance coverage:
- Insurance against the loss of my income (for me and those who depend on it – this requires multiple approaches)
- Insurance against major property damage (floods, fires, theft, etc.)
- Insurance against the chance I might make someone else lose their income or suffer major property damage (and therefore become significantly indebted to someone else)
- Insurance against the risk of significant cash outlay later on (like needing to hire an attorney on short notice)
We will tackle a basic discussion of these four insurance needs now, and next week, I’ll finish up with specific resources for you to determine how much insurance you might need, and where you can shop for the best insurance rates and coverages.
Insurance against the loss of income
Losing expected income, whether as a result of a job loss, injury, medical issue, accident, or even an unexpected death can be financially devastating for a family.
Assume you are married for a moment if you’re not. You and your spouse have a house, kids to raise, two car payments, college to think about, retirement to get ready for, medical bills, utilities, vacations…. you name it.
Let’s also assume you both work and make $60,000 a year, each. Let’s also assume you’re 30 years old and plan to work until your age 65.
Although your spouse is infinitely more important to you than just their income, you relied on each other’s income to meet half of the money required to meet all of your financial obligations and goals. And, assuming you each earn $60,000 per year for the next 35 years, that means you both are worth $2,100,000 to each other (and actually even more than that because of inflation).
Now, imagine that one of you died tomorrow in a car accident.
In addition to the trauma and immense grief of losing a spouse and life partner, the surviving spouse must also try to piece back together the financial life you both planned on. Usually, that means giving up on dreams and goals, scaling back their lifestyle, taking on more work or other hardships, in addition to just dealing with the loss of their loved one.
Quite a different story could be told if you had a $2,000,000 life insurance policy on each of you today.
I’ve painted a quick but all-too-common scenario to show you the need for Life Insurance, but death isn’t the only way you could lose your ability to earn a living. You could become unable to do the job you are trained for, due to sickness, disability or injury. Sometimes those income losses are quickly resolved and you’re back to work again soon, but other times, they can linger for months, years, or even permanently.
Every Average Guy aspiring to be a Rich Guy needs to protect his or her potential to earn their income for your entire working life. This will include the following insurance (much of which is usually offered through your employer plan for a nominal cost):
Health Insurance – I’m okay with what’s called a LPHD (low premium / high deductible) policy when you’re just getting started, but that decision should be reviewed every renewal period. I’ll tackle health insurance in a future article, but for now, know you need health insurance.
Quick note: some carries like Aflac offer very specific medical insurance policies that are NOT health insurance. They are policies if you get specific illnesses or disease (Cardiac and Cancer policies are most common) that cover some of the expenses related to specific medical treatments for the disease (they don’t pay out simply if you GET the disease). I generally think, if your primary health insurance is good, you don’t have a particularly strong family history of these diseases, and you’ve got some money saved for emergencies, these aren’t necessary.
You need life insurance: for you, your spouse (even if they don’t work outside the home), and at least the cost of burial for any dependents. The amount you need will be unique to your situation, and will actually change over time (we’ll go over how to calculate your needs in the next post, as well as give you a cool option to scale your coverage up and down to meet your life circumstances without getting a new policy.) You can cover some of this insurance need by what is offered at work, but remember, when you leave your job, you leave your insurance behind, too. I generally advise you to get as much of the coverage you need in your own policy as you can afford. (More on this next week.)
A caveat: I can’t stand most life insurance salespeople. They are paid by commission and the industry is extremely bad at policing sketchy sales practices. Their regulators came out of selling the stuff for years first, and they look the other way – a lot – for their pals. The industry also puts a lot of money into the pockets of politicians, so it’s always been able to avoid serious attempts to reform the worse parts of its business practices.
Case in point: there is currently a trend for these people to sell life insurance as a way to “bank on yourself” or “be the bank”, essentially turning life insurance into a crappy, third-rate savings vehicle. This exposes you to high fees, taxable savings, surrender charges (or you have to borrow your own savings back at interest), etc. But the agent can make as much as 10% commission on what you put in.
If you have to hide the truth about your product to sell it, you need to seriously reexamine your choice of vocation.
There are ways to get the insurance you need without dealing with these kinds of sketchy sales pitches. I’ll show you next week.
Another quick note: you may also be offered something called “Accidental Death & Dismemberment” (AD&D) insurance. I usually don’t believe it’s necessary (because payouts are so specific – $310 if you lose your left eye, that kind of thing), but it’s usually so cheap when it’s part of your employer’s plan, there’s no harm in tacking it on if you’re not paying more than a few dollars per paycheck for it.
This is often cheapest through work but is also available as an individual policy. You might also need to “buy up” your coverage at work by adding on additional benefits. For example, some disability policies only cover half your pay. Can you survive on that? If not, consider, for a few dollars more, increasing the benefit to 80% or even 100% of pay, if it’s available.
Disability Insurance, like life insurance, is unique to your situation and number of working years left, but we’ll go into some basic calculations next week.
Insurance against major property damage
This insurance is more cut-and-dry for most people. It’s easy to understand the idea of protecting your house or car (or boat, RV, motorcycle, etc.) from damage. But how much you should get, and what deductible / copay you want to work with, is unique to your situation.
Here’s a basic Average Guy insurance plan to tackle the risk of major property damage:
Everyone is familiar with this insurance because it’s mandated for anyone who owns or operates a motor vehicle, so we won’t spend a ton of time on it.
Bottom line: you need it and you are required to have it if you own or drive a car, period.
The biggest issues with auto insurance tend to be coverage amounts and, obviously, price. The price will depend greatly on your driving record, your credit score (it’s true), your age and sex, your marital status, and your driving history. It can also be greatly affected by the amount of deductible you choose. A policy that doesn’t pay the first $1,000 or $2,000 of a claim is far cheaper than one that pays out after the first $250, for example.
Every state has a minimum amount of coverage in order to be legal on their roads, and most people tend to go with just the bare minimum, which tends to be a certain amount of liability coverage for property damage and injuries to people you may cause if you are at-fault (that’s what is commonly called “liability” or “liability only” coverage).
Because injuries and property damage can very quickly rise above the minimum requirements of most states, I highly recommend you purchase the highest amounts of coverage you can afford. For example, I was in a serious auto accident a few years ago that easily rose to the hundreds of thousands of dollars in medical bills, and that was just the four of us in our car.
If you cause damage or injury above your insurance coverage, you can be sued personally for the difference.
You can help offset some of the cost of higher insurance limits by raising your deductible to $1,000 or more (which, again, means you need some emergency funds saved up – see parts 2 and 3 of this series again).
Uninsured motorist coverage is required in some states but is available in all states. I recommend you obtain this coverage. This protects YOU against damage and injury costs if the other party is at fault but doesn’t have any (or sufficient) insurance. An underinsured driver is considered uninsured if you need to make a claim.
Collision insurance means your vehicle will be repaired by your insurance (after your deductible). This is usually required on cars that still have a loan on them, but is optional for vehicles you own outright.
Comprehensive insurance means your vehicle will be covered for damage from causes other than accidents: hail, theft, vandalism, etc.
Auto Insurance Pro Tip: make sure you shop around for the best rates you can, and don’t remain loyal to one company for very long without price-shopping. As your driving record improves, you get older, your credit score goes up, etc. your rates can drop substantially. Also, check to see if you can get discounts for being a student, being a good driver, or bunding your other insurance needs with your auto policy.
This policy is usually required if you have a mortgage on your house, and is meant to replace your home or any portion of it due to catastrophic loss. These policies generally include an amount of liability insurance if you or a visitor are injured at your home.
Every homeowner needs this insurance, but be sure to shop around. Prices can vary widely by carrier, and often can include multi-policy discounts if you combine your home and auto policies with the same carrier. Don’t be loyal to one company for a long time, either. Shop around annually – you’ll be amazed that the difference in price out there.
Quick pro times on homeowner’s insurance: Be sure your roof replacement is what you want in your policy before you buy. The most common claim on a homeowner’s policy is for roof replacement, and many policies pay only a pro-rated portion of that cost if you need it. For example, if your 15-year roof shingles need replacing in 10 years, they’ve gone through 66% of their life by the time you replace it. Your policy may pay only 33-34% of the cost of your roof replacement unless you specify you want full replacement costs included in your policy.
Also, many homeowner’s policies insure the entire value of the property, not simply the replacement costs of the structures on it. Let’s say you have a property worth $700,000 and the house on it is worth $450,000 (the rest is land). Don’t pay for a $700,000 homeowner’s policy if you’re insuring a $450,000 house. Pay for the replacement value of the HOME, not the LAND. Your house may burn down but why would that affect the yard around it?
Similar to a homeowner’s policy without the house, renter’s insurance covers your personal property and liability to both the property you’re renting and to inhabitants and visitors to your rented home or apartment. If, for example, the apartment building has a fire, or water damage, your personal property would be replaced. It’s not a replacement for health insurance, and usually has a sizeable deductible.
Many apartment complexes and landlords now require renter’s insurance as a condition of tenancy. The good news is, it’s usually very cheap.
Personal Property Insurance
Personal property coverage makes up a significant portion of a homeowner’s or renter’s policy already, but it can be bought separately for general property coverage needs.
Flood & Windstorm Insurance
Note: Covering water damage is often not covered by a windstorm insurance policy. They are separate and although relatively expensive, flood insurance is absolutely necessary if you live in a floodplain. Do NOT assume your windstorm insurance will cover water damage from flooding rains that come with a hurricane, for example. Windstorm insurance will usually handle water damaging your property from a damaged roof or window, not from water seeping in from ground level.
Appliance Insurance and Extended Auto Warranties
I generally don’t think you should waste the money on these coverages unless you have no hope of building some emergency savings, as we discussed in Parts 2 and 3 of this series. Extended warranties and appliance insurance might be useful in certain circumstances, but ask a financial advisor or planner who doesn’t sell these things if they make sense for your situation. (I’d eat my hat if anyone could find an extended warranty salesperson who would actually advise you not to buy it.)
Insurance against the risk of liability to others
In the broadest sense, this is to protect you from claims other may make, whether they are legitimate or not. The sad truth is, we live in a very litigious society, and the wealthier you are perceived to be, the more likely you are to be sued.
There are even stories of people winning the Lottery who find out shortly thereafter that they were sued from a family member or coworker, or had a neighbor who never came over suddenly “trip” over something on the sidewalk in front of their house.
Rich Guys protect what they’ve built. The way they do that is by passing off the liability risk to an insurance company.
General & Umbrella Liability Insurance
General liability insurance is often used for businesses and high net worth individuals to protect against all kinds of business or personal liability. It’s an essential part of auto and homeowner’s insurance already, so you may not need additional amounts of general liability coverage above what you have already. However, you can supplement this insurance if you feel the coverages you have aren’t high enough with additional insurance called “umbrella liability”. This type of insurance doesn’t kick in until your other liability insurance is exhausted during a claim, and adds coverage above that. Because it may not be used until all of your general liability coverage has been used, umbrella liability policies are surprisingly inexpensive.
You need umbrella coverage if there is any chance you can cause damage or injury in excess of your other liability policy limits. For example, if you have a home-based business that meets clients at your home, and that client falls and injures themselves, that accident happened at both a home and a place of business. Your homeowner’s policy may or may not cover enough of it if the person (or their attorney) feels they can sue a successful business with deeper pockets instead of pursuing the homeowner. Or if you have teenaged kids at home, and they are driving, you might easily hit policy limits with a couple of accidents.
There are some times when, to make a general and umbrella insurance policy work correctly, you may need a third type of insurance called “gap” insurance. Gap insurance does exactly what I sounds like – it bridges a “gap” between two other insurance coverages.
For example, if your auto policy has $100,000 of liability coverage, and your umbrella liability policy kicks in at $250,000 and covers up to $5 million, you are not covered from $100,000 to $250,000 in that damage claim. That’s your responsibility. So either make sure your general liability coverage runs right up to the start of an umbrella policy (like the auto policy covers up to $250,000 and the umbrella liability policy kicks in at $250,000), or purchase a gap insurance policy to make up the difference.
Professional Liability Insurance
Depending on what you do for a living, you likely have one or more types of liability insurance available to you (or mandated by your state that you need to have). These can be anything from a Surety or Guaranty Bond for a car salesman or tow truck driver, to various kinds of professional white-collar liability insurance.
Insurance Agents and stockbrokers have liability and “errors and omissions” insurance. Doctors and dentists carry malpractice insurance. Couriers can have package delivery indemnification insurance. Companies can insure against their employees committing a crime. Many of us now carry cyber-risk insurance.
The bottom line of this is, protect yourself. Do it properly. Shop around for the best price but don’t skimp on coverage to protect yourself from harm you may cause (or others may allege). It can happen any time.
Insurance against the risk of significant cash outlay for services
The last kind of protection an Average Guy needs to consider is the risk of needing to suddenly outlay more money than you have for services. It won’t happen often, but expenses in these categories can range from being a serious annoyance to having catastrophic consequences to yourself or even your heirs.
I’m actually a firm believer in buying prepaid or subscription legal services. I didn’t think I needed it for many years, until I did. Having a lawyer at the ready to draft a letter, negotiate a traffic ticket, review a contract, and more, is invaluable. Plus, these services can be surprisingly inexpensive.
Plus, there is just an amazing amount of peace of mind knowing, “I’ve got an attorney.”
I personally use LegalShield for my prepaid personal and professional services. My law firm is local and the attorneys I’ve dealt with have been friendly, quick to respond, and very professional. When I need service that exceeds the annual limits of my plan, the hourly rate is extremely affordable. Plus, they have a huge number of pre-made forms, legal in my state, ready for download and printing. And I pay barely more than $30 a month for a family and small business plan.
(Plus, cool bonus – LegalShield has a ton of members-only benefits and perks that more than make up the cost of my membership. Everything from discounted travel and car rentals to low-priced gym memberships and so much more, it’s a steal.) Give them a look.
Note: LegalShield, like many other services, offers a credit protection plan, also. Some people really find these valuable, but I’ve always found it easier to just check our credit ratings through my credit card apps, so I save the money on credit protection services.
Long Term Care
If you are young and healthy, this worry is a long way off, but the uncomfortable truth is, nearly all of us will need some assistance with performing daily tasks (called the Activities of Daily Living or ADL) during the last four years of our life.
Without a plan for long-term care, you place your entire life’s savings, your home, your investments, even your cars, into the hands of the state in which you live. They’ll take care of putting you in a nursing home (not home care or assisted living), but will essentially and totally legally bankrupt you to do so. Thankfully, there are ways to do this either with a Long Term Care Insurance policy, or by adding it to your basic life insurance in what’s called a “rider” (add-on feature).
Planning for this need ahead of time is critical, and something we address in a full, personal financial plan (which, if you need one, I offer a basic, personal financial plan for as little as $29 a month – check it out).
I won’t get into the weeds on this subject here, but please put it in the back of your mind – you need to decide how you will pay for your care in your old age, and the sooner you do it, the cheaper it’ll be.
The cost of a final illness can devastate a family’s finances. It’s bad enough to lose your income after you pass away, but most of us aren’t working up to the last day of our lives. Someone fighting a terminal illness needs to focus on far more important things, so generally work stops months before, and the hardship of lost income along with medical bills can literally destroy a family financially.
There are ways to insure against this, as well. Generally, I like to incorporate what’s called a Terminal Illness Benefit (rider) into a life insurance policy to make sure you have access to the death benefit before you die if you are diagnosed with a terminal illness. We’ll cover that more in the next article in this series.
It’s a rough subject but a necessary one.
No one likes to think of the thoroughly unfun subjects like liability, lawsuits, death, disability, accidents, or nursing homes. Yet they are a real part of life and one that I see cause serious harm to people and businesses every day.
So investigate the insurance coverages I talked about here, talk with your financial advisor (I strongly advise against starting with an insurance agent until you have a good idea of what you need), or feel free to reach out to me for a free 15 minute Q&A phone call to get your questions answered.
Then, join us in Part 7 of our 9-part series, where we show you how to determine your specific insurance needs, and where to go to find quality, low-cost coverage.