Financial Peace University Lesson 7 – Clause and Effect
The Role of Insurance in your Financial Plan
This week’s lesson was about insurance – all kinds of insurance. Ramsey introduced the various types of insurance that he recommends for each person and also briefly touched on the types of insurance coverages to avoid.
The purpose of insurance is to transfer risk
Insurance is an essential financial planning tool as some types of losses can financially devastate you. For instance, if your house burns down or you are permanently disabled, these are events that can be catastrophic to your financial well being. The point of insurance then is to transfer these huge risks away from you and onto someone else. Ramsey states, “I want them to catch the catastrophes.” You can survive bills of a few thousand dollars if you have an emergency fund and good financial habits….the issue is the very rare but very large problems that your emergency fund won’t even come close to covering.
Types of Insurance that Ramsey Recommends
- Homeowner’s or Renter’s Insurance
- Auto Insurance
- Health Insurance
- Disability Insurance
- Long-Term Care Insurance
- Identity Theft Protection
- Life Insurance
Ramsey spent the majority of the lesson giving some information and tips on each insurance type.
Homeowner’s and Auto Insurance
The best way to lower your insurance premiums is to raise your deductible. If you have a full emergency fund, then raising your deductible from $250 to $500 or even $1000 should save you a significant amount on your premiums.
He also recommends carrying adequate liability coverage (at least $500,000) or carrying an umbrella personal liability policy to protect your assets (if you have significant assets to protect, that is).
Health Insurance
Again, the key to reducing your premiums is to increase your deductible, coinsurance, or maximum out of pocket expense – but never decrease your maximum lifetime benefits. Another option that Ramsey recommends is an Health Savings Account (”a really, really, really good idea”). This is a tax-sheltered savings account that you never pay taxes on (going in or coming out) if you use it for medical expenses. It is paired with a high-deductible insurance policy. Depending on your situation (especially if you are healthy), you can save a lot of money using one of these policies.
Disability Insurance
Disability insurance replaces your income if you are unable to work. The best type of disability insurance to buy (though it is usually more expensive) is occupational or “own-occ” insurance. This means your insurance payments will kick in if you can not perform the job you were educated to do. He recommends you purchase coverage for 65% of your current income. Remember, your income is your biggest asset so it is a really good idea to protect it!
Long-Term Care Insurance
LTC insurance pays for nursing home, assisted living facilities, of in-home care if you need it. Ramsey states that 69% of people over the age of 65 will require long-term care at some point. He recommends that everyone purchases LTC insurance on their 60th birthday (but not before).
Identity Theft Protection
The average victim of identity theft spends 600 hours cleaning up the mess (”you now have a new hobby”) so he recommends enrolling in a protection plan. The plan you choose should include restoration services instead of just providing credit report monitoring. (See the right sidebar for a link to save on LifeLock’s plan)
Life Insurance
Dave is a big proponent of life insurance – but not of cash value life insurance. In fact, he spent the biggest part of the class explaining why cash value life insurance is a bad idea. The most common life insurance myth, he states, is that you have a permanent need for life insurance. Imagine this scenario: twenty years from now your children are grown up and out of the house, you are completely debt free including your 15 year mortgage, and your investments have grown to a considerable sum – you are now self-insured. In this scenario, why do you need a big life insurance policy if you die?
Not only does he think that there is no permanent need for life insurance, he also points out that these life insurance policies are not a good way to invest. The biggest reason is the myriad fees that are tacked onto them. These high fees act to drastically reduce your long-term return. If you are eligible, a Roth IRA is a much, much better way to invest your money.
To be fair, I have heard other arguments for purchasing permanent life insurance such as for estate planning reasons and as another tax-advantaged way to save money – but these are both for high net-worth people. Ramsey did not touch on these reasons, possibly because they only apply to a small segment of the population.
Dave’s recommendations for purchasing life insurance:
- Buy low-cost level term insurance – term is for a specified period of time and is substantially cheaper.
- Insure your spouse – even if he/she is a stay-at-home spouse.
- Stay away from fancy options such as accidental death, return of premium, waiver of premium.
- Children only need enough for burial expenses – usually can be purchased inexpensively as a rider on your policy.
- Purchase coverage of about 10 times your income
Insurance coverages to avoid
- Credit life and disability - to pay off your loan if you die, they are generally extremely expensive compared to life insurance
- Credit card protection
- Cancer and hospital indemnity – health insurance should cover this
- Accidental death – stick to standard life insurance
- Any insurance with cash value, investments, or refund
- Pre-paid burial policies – pre-plan your burial and save up for it if you want, but don’t pay for it until it is time to pay for it.
- Mortgage life insurance – If you can’t get normal life insurance, then this might make sense; in general, though, it is decreasing term insurance that is about 10x too expensive.
- Any kind of duplicate coverage – for instance, having two health insurance policies will not ensure you have full coverage, in fact, you will end up with no coverage as the two companies fight over who is the “primary” insurer.
So, that was the lesson. There was a lot of detail in this lesson, and a lot of railing against permanent life insurance! Of course, it is not possible to provide enough detail on each individual type of insurance I mentioned in this post to be able to make an informed purchasing decision. But take the list of recommended insurances as a starting point to evaluate your current coverages and see where you may need to do a little more risk transference. Just remember to do some more indepth research before modifying or purchasing any policies.
Check out my previous FPU posts:
- Introduction
- Lesson 1 – Super Saving
- Lesson 2 – Relating with Money
- Lesson 3 – Cash Flow Planning
- Lesson 4 – Dumping Debt
- Lesson 5 – Credit Sharks in Suits
- Lesson 6 – Buyer Beware
- Financial Peace University Lesson 10 – From Fruition to Tuition...
- Financial Peace University Lesson 6 – Buyer Beware...
- Financial Peace University Lesson 12 – Real Estate and Mortgages...
- Financial Peace University Lesson 11 – Working in Your Strengths...
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I think that your advice regarding health insurance is spot on.
Too many people get low or no health deductible policies that are too expensive. They are pricey because they cover the little things that would cost the typical consumer less to cover that it costs the insurance carrier.
When comparing a no or low deductible health insurance plan with a medium deductible or high deductibe policy, the higher deductible policy almost always is the better deal for the consumer.
Alston medical insurance ´s last blog ..Medical Insurance, No Deductible