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Financial Peace University Lesson 7 – Clause and Effect

November 13, 2009 · Filed Under Financial Peace University · 4 Comments 

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

  1. Homeowner’s or Renter’s Insurance
  2. Auto Insurance
  3. Health Insurance
  4. Disability Insurance
  5. Long-Term Care Insurance
  6. Identity Theft Protection
  7. 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

  1. Credit life and disability to pay off your loan if you die, they are generally extremely expensive compared to life insurance
  2. Credit card protection
  3. Cancer and hospital indemnity – health insurance should cover this
  4. Accidental death – stick to standard life insurance
  5. Any insurance with cash value, investments, or refund
  6. 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.
  7. 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.
  8. 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:

Money Saving Tip: Check out your Auto Insurance for Roadside Assistance

January 30, 2009 · Filed Under Frugality · 17 Comments 

Hopefully you have not, but I’m sure we have all experienced the dreaded breakdown on the side of the road.  It could be from your battery dying or something more sinister (and pricey), but there occasionally comes a time when your trusted (or maybe your not-so-trustworthy) automobile leaves you stranded and you need some help.  At times like that, it is certainly a relief to be able to pick up your cell phone and get someone routed out to come give you a hand (or a lift).

For years we’ve been members of AAA and have used the service quite a few times (unfortunately).  Luckily, it has not been happening as much lately since we’ve been able to afford, shall we say, more "contemporary" cars!  Even so, I have had the batteries die on both of my cars within the past few years and have called them up for a jump-start.

So, a few weeks back when I got a letter from AAA informing me the credit card they used to renew my yearly membership had expired,  I almost immediately picked up the phone to call and pay up for another year.  As I started to dial the phone, however, a thought crossed my mind of a vague memory from a long time ago…"Didn’t my auto insurance provide roadside assistance?"

I remember declining the roadside assistance when I first got my insurance coverage a few years back.  I didn’t need it, of course, since I had a AAA membership.  I thought to myself, maybe, just for fun, I should call up my insurance agent and ask him about their coverage (doesn’t everyone think calling insurance agents is jolly good fun?). Besides, my AAA membership costs $99.25 a year and I was secretly hoping that I could save a few bucks.

Well, I did call and asked about the coverage.  He told me I didn’t need it if I had AAA because it’s basically the same thing.  "But what if I didn’t have AAA?" I asked.  Well, he informed me that they basically provided the same roadside services as AAA.  In fact, the coverage is slightly better because there is no mileage limit to how much they will tow you if you go to an "approved" location (whatever that is).  Even if you go to an "non-approved" location, there is no towing limit and the maximum they will charge for the tow is $50.  Plus, like AAA, the coverage goes with you even if you are not in your own car.

This all sounded pretty good, so I waited breathlessly while he went and checked the price…."It will be $5 per car."  Just to confirm, "so, you’re saying it’s $10 per year?"  It seemed to take him a  lot longer to figure this out than I thought it should take an adult to multiple 5 times 2, but after a brief pause came the affirmative response (just to be fair, maybe he had to look up how many cars I had covered or something).   "Ok, yeah, let’s do that!" I shot back.

Sure, you don’t get AAA maps or travel agency services (do they still do that? I haven’t used a travel agent in at least a decade), free passport photos, or AAA discounts. But with Google maps and Mapquest (and probably most of you reading this have GPS systems anyway) and digital cameras and such, I think I’ll pocket the $90 savings!

Of course, the wisdom of this decision will not be determined until I have a break down and see if I have any problems with my insurance’s roadside assistance.  Depending on how that works out, I may have to rethink the plan. For now, however, I definitely think it’s worth a try.

Photo Credits: freeparking and peasap

Talking about Insurance is Boring! (but Necessary)

September 29, 2008 · Filed Under Insurance, PF Basics · 4 Comments 

In the Personal Finance Basics series I’ve (very slowly) been working through, it is now time to talk about insurance.  So, what is insurance? (it’s boring! – well, ok, that might be true, but that’s not what I mean here).  I mean, what is the definition of insurance?  Actually, I don’t mean that either.  I mean what does insurance accomplish?  I think it makes sense to think of it as a transference of risk.

Insurance is a transference of risk

photo by NIOSH

In exchange for a small amount of money, the insurance company will give you a large amount of money in the rare case that you need it.  You are therefore transferring the risk of having to pay a large amount of money to the insurance company.  I think this definition works well for most types of insurance, but not perfectly.  For instance, it does not apply strictly to most health insurance plans in the US since we want our insurance to cover all office visits and procedures, not just the very expensive and rare ones (though it does do that also)

Do I really need insurance?

Determining whether or not you need a certain type of insurance is a very important first step.  Each person’s individual circumstances will determine which types of insurance are necessary.  You should discuss this with a qualified professional and/or a trusted person (or persons) who can give you good counsel.

The least expensive (at least in the short-term) form of insurance is always self-insurance (I mean no insurance).  Of course, if you end up needing the insurance payment, then self-insurance becomes significantly more expensive.  But if you can afford the payment if the risk is realized, then you don’t need to purchase insurance.  For instance, if you have the money to rebuild your house (and replace everything in it) if it burns down, you don’t need homeowner’s insurance.  If you can afford to lose a lawsuit, you don’t need an umbrella policy.  If your family can afford to continue their current standard of living if you die, then you don’t need life insurance.  If you can’t afford any of these, however, then insurance is a good idea (a very good idea)

Again, each person has reasons for whether or not they need a certain type of insurance  – there is no one size fits all answer to this question.  I’m listing some common insurances that you should consider – it doesn’t mean you should buy them all (I don’t currently own all these types) nor does it mean there aren’t more that you should consider.

Common types of insurance

  • Health – At the very least, you should have a major medical policy that will pay for expenses like surgeries or serious illnesses that can quickly generate enormous bills for you.  Even if you have to pay for office visits ($) out of pocket, the risk of a huge hospital bill ($$$$$) is too much to ignore.
  • Home Owner’s or Renter’s – These policies pay for rebuilding or repairing your house and/or your personal belongings in case of a disaster such as a fire or robbery.  Having such a policy is a very good idea for almost everyone (and most mortgage companies will require one).  Just note that some disasters, such as floods or earthquakes, are not typically covered under home owner’s policies.  Also, look for a policy that provides "replacement cost" for your items.
  • Auto – Auto insurance is mandatory in most places in the US, I believe.  Even if it was not, it is still a good idea for everyone who drives.  Not only do most policies provide payments to cover damage to your car and other cars in an accident, they also cover liability issues that may result.
  • Personal Liability (Umbrella Policy) – If you want to ensure you are very well protected, purchase a personal liability policy.  This policy acts like an "umbrella" to cover your liability over and above that which is provided by your auto and home owner’s insurance.  As Dave Ramsey says, the best way to protect your assets in the case of a liability suit is to put a big, fat, ugly insurance company between you and the other party.
  • Disability Insurance – The greatest asset that most people will have in their lifetime is their ability to earn an income.  Disability insurance is what protects this asset.  If you are unable to work, disability income will replace some or most of your income.  There are two flavors, short and long term.  Long-term is extremely important if you were to suffer some sort of debilitating injury or illness and not be able to work for years.  The best (and most expensive) type is "own occupation" insurance.  It means the insurance company will pay-out as long as you are unable to work in your current occupation.  In other words, if you have a professional job, they are not going to force you to get a job at McDonald’s and stop paying you benefits.  On the other hand, if your job entails sitting in an office in front of a computer (like mine does), if you can’t do that there’s a pretty small chance there would be some other kind of job they could make you do.
  • Long-term care – Long-term care insurance pays for care in the event that you can no longer care for yourself.  Due to the enormous (and ever-rising) costs of long-term care (in a competent facility), LTC is probably a good idea for most people.  Though inexpensive for young people, the recommendations I’ve seen are to wait until between the ages of 50-60 to get a policy.  There are a lot of options and policy types for long-term care – too many to go into any detail in this post.
  • Life – Life insurance is very necessary for some people and quite unnecessary for others.  If you are single and have enough money for a proper funeral, you don’t have much need for life insurance.  Likewise, if you are married with no (or grown) children and a large enough net-worth for your spouse to continue his/her current lifestyle, again you don’t have much need for life insurance.  On the other hand, if you are the sole breadwinner of a family with a few small kids, your needs are enormous.  I’ve heard that the general rule of thumb for life insurance is seven times your annual salary – but personally, I think that the actual need varies greatly by your specific situation.  There are numerous life insurance needs calculators you can find online.  If you need life insurance, my advice to you would be to get a 20 or 30-year term-policy and get a lot of coverage (term policies are very inexpensive, so load up on the coverage).

Of course, there are many other types of insurance out there (but I’m already over 1100 words on this post) but I feel these are the most common that are needed by most people.  Would you suggest any other types for most people to consider?

Photo Credits: NIOSH

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