Aug 22, 2023

Episode: 08-22-2023 | Using Insurance To Protect Your Net Worth

And before I jump into tonight’s topic, which is going to deal with insurance, I do have a little bit of a sad announcement to make. As many listeners know my broadcast partner, Alison has been on a summer sabbatical to recharge and reinvigorate well turned out to be so successful. She decided to extend it indefinitely. She enjoyed her time way to travel, relax, explore other life passions so much. And she’s decided to step away from the workforce for the time being, and she’s just going to take a break. So we wish her the best. I miss her already. And we hope she really finds her calling through this process. She has been a great addition to the show, and she was great to work with for the last eight years. But I’ll still be here with you every second and fourth Tuesday of the month, as usual, to dispense good, solid, objective, unbiased financial advice.

What Is The Purpose Of Insurance?

And tonight we’re going to do that, through insurance. We’re going to talk about the proper use of insurance in a financial plan and how to use insurance to protect your net worth. So you know, first of all, the concept of insurance is kind of simple. And I think at a high level, most people kind of get it. If you you’re going to bear a financial loss that you can’t afford to accept, then you transfer that risk to an insurance company in exchange for a relatively low premium amount that you send to the insurance company. You get a blanket of coverage over a particular risk. You know, it’s most common with your house, your homeowner’s insurance or car so that if you’re in an accident and your car is totaled, and it’s relatively new and old, that’s you know, a $30K, $40K, $50K, $60,000 item that no longer is operational and you don’t have that money sitting in the bank account. Well, then you go to the insurance company and say I’ve had a loss I’m submitting a claim. And I would like to be reimbursed for my damaged car. Similarly, of course, your homeowners insurance, if you have a fire, if you have a hurricane come through, causes damage, trees fall on the house, damage a roof. Flooding, yes, that’s its own category, thank you. Whatever the peril causes significant financial hardship or damage, then that’s the role of insurance. Insurance should come in and make you whole to the way things were prior to the claim, or at least close to it, depending on the structure of the policy, and the different components that make up the insurance policy. So that’s what we’re going to talk about tonight.

How Wealthway Financial Advisors Recommend Insurance

And there are a lot of commonalities with insurance. But there are also a fair number of distinguishing characteristics that people should be mindful of and also some pitfalls to avoid as well. And I should start out by saying, first of all, we don’t sell insurance. We advise at a very high level. There’s insurance needed on behalf of our clients as part of the CFP curriculum, the Certified Financial Planner, board of standards, financial planning process that we put all our clients through. So, we check on their insurance coverages, and we analyze the risks that they are assuming, and those that they have transferred to an insurance company. But then, if we find that there’s a need, then we refer that out to licensed insurance agents who would make the final determination on the right type, and company to place that insurance with. So you know, the concept of insurance and how insurance works is, you know, we pay a relatively small sum of money either on a monthly or annual basis, to an insurance company and in exchange, we get that blanket coverage to protect against some unforeseen loss.

How Does Insurance Work?

And it’s a true annoyance of insurance, that we could pay our whole lives, you know, for insurance coverage, and never actually use it. You know, in the case of life insurance, you know, most people hope they don’t have to use their life insurance anytime soon, that’s for sure. And it’s also true that you don’t need life insurance for your whole life, even though there are whole life insurance policies to do that. And that’s a little bit more of a detail we’ll get into later. The concept of insurance is to pool the risk, if you will, from many individuals into one big pot. We turn over our insurance premiums to the insurance company, and then they take that money and they reinvest it in bonds and stocks for long term growth. And then, as claims come into the insurance company, they take money out of that pot. And they turn around and pay the claim and make their policyholders whole again as prior to the claim. It’s a great concept that’s been around for hundreds of years. And when it works, it works really well.

The Math Of  Insurance

But not everyone uses insurance the most efficient way possible. So we’ll talk about some of the ways that you can improve on your insurance coverage. And make sure you’re maximizing all your financial dollars. So when you pay your premiums to the insurance company, they pull the money. And then they have very sophisticated insurance analysts. Actuaries, they’re called, they engage in actuary science, which is very complicated probabilistic math. And well, you don’t need to know the technicalities of all that. Actuaries are very, very good at determining the probability of in a large population, what percentage of that population is going to make a claim in any say given period of time, like any year. So, of all the automobiles covered, about 10% in the course of the year in the state of Virginia, are going to file an insurance claim of the average amount of $15,000. And so they’re able to sort of factor that into their analysis to determine how to price the premiums that we pay A- in order to get that insurance coverage and (if they’re good at their job and they know what they’re doing) then B-determine that the premiums we all pay into the pot cover those claims that they have to pay out. Plus, then always, of course a little bit extra for salaries for the insurance company and to you know, pay and to ensure there’s a profit. If it’s a mutual type of insurance company where the policyholders are sort of quasi owners of the insurance company, then if there’s any of the premium leftover at the end of the year, they usually pay out a dividend, give back some of that those premium dollars to their policyholders as, as somewhat of a reward for being safe and, and having low claims, paying experience. So that’s some of the mechanics behind the scenes of how insurance works at the high level at the company level. When we come back from this break, we’ll, we’ll get into some areas of when you should buy insurance, and the basic types of personal insurance.

When Is Insurance Required?

Automotive Liability Insurance Coverage Is Required

Alright, tonight we’re talking about insurance, the proper use of it to protect your net worth. So when should you buy insurance, because it’s not, well sometimes it’s mandatory, you don’t have a choice, or it’s part of a package deal and it’s required by some other entity. And then other times, a lot of it is voluntary. And you have to make your own mind whether a risk is worth accepting or transferring to an insurance company. So first of all, you should buy insurance when it’s required by law. And it’s required by law, if you own a vehicle in the Commonwealth of Virginia, then that vehicle must be covered by a certain amount of liability coverage so that if you’re in an accident, then there is insurance to pay the aggrieved or damaged party in an accident. So, in order to have the privilege of driving, you have to have your vehicle covered by certain amounts of insurance coverage to ensure that if there’s an accident, then there’s a mechanism or device to make the party whole. And that’s required by law. So when it is required by law, you have to purchase the insurance.

Homeowner’s Insurance Is Required For A Mortgage

Secondly, if it’s required, say by a lender, so when you get a mortgage, right, put 20% down payment on a house, get a mortgage for 80%. That’s a true traditional starting arrangement, your house gets struck by a bolt of lightning, gets burned to the ground. All of a sudden, the bank’s collateral just went from $800,000 down to zero. And yet you still owe say, you know, $600,000 on a mortgage. Well, the bank wants its money back, the bank now no longer has collateral because it’s been damaged in apparel. And without insurance, you could sensibly just walk away from the mortgage and say, I’m not paying it because I don’t have a house anymore. And then the bank says, well, I’ll reclaim your house and I’ll set well there’s no house to foreclose upon and resell, so the bank is at risk if there is significant damage to your house, your collateral for the mortgage. Banks require you to have homeowner’s insurance and they require you to have it in certain amounts and certain types of coverages and you’re not going to get a mortgage without one.

Automotive Insurance Is Required When Financing A Car

So it’s required by lenders – same type of deal when you buy a car. If you finance the car, and then the bank is gone. Want to make sure that you have coverage, not just liability coverage for the vehicle, but also collision and other types of damage repair, insurance protection, because if that vehicle gets damaged somehow or a tree limb falls on it, no fault of anyone else, it still needs to be repaired. And if it’s not repaired, then their collateral is now worth much less, potentially much less than what you owe on it. And they just want to be paid back as agreed. And if you can’t do that, then they want to take something of value that the loan is attached to the vehicle and, and then sell it to get paid back. Well, if your vehicle is damaged, and it is not a total loss, then that insurance company will first pay back the lender, anything that you owe to the bank. And if there’s anything left over, they pay out any value above the loan amount. Then you get to keep the rest and buy a new car or get the car repaired. If it was not a total loss, well, yes, I get it repaired first of all. And if it’s a total loss, then that’s when the bank gets paid, the loan gets paid back first. And if there’s anything leftover, then you get that to put to the purchase of a new car. So that’s required by a lender. That’s another time when you need to buy insurance.

Insurance Is A Tool That Provides Protection To Cover Unexpected Losses That Would Be Devastating To Your Financial Plan

And then finally, and probably most applicable, is the insurance that you choose to purchase yourself. That’s not required by anybody. But you feel that there are particular risks that you can’t assume or can’t afford to cover easily. And that’s really the main metric, I would say for a lot of decision making. When you’re exposed to a potential large financial loss, that would be devastating to your financial plan, your financial foundation, your net worth, then it can be prudent to purchase life insurance protection to cover any unexpected loss. Because once you get into a deep financial hole, it’s very difficult to get out of and so for the comfort and peace of mind of knowing that if a bad calamity befalls you, you have an insurance company who can stroke a check, and at least financially help you pick up the pieces and rebuild. And this is where a lot of people have, I think, misconceptions on what insurance is for and how it should be used. So you know, one of the things you want to be thinking about is when you need to buy insurance is you want to insure the losses you can’t afford to absorb.

Examples Of Health Insurance Usage

So traditional example: a trip to the emergency room in an ambulance, okay, you just fall down the stairs, you break your ankle, you take a ride in an ambulance, you go to emergency room, you get your ankle, put in the cast, and they drive you back home in a medically approved vehicle. Okay, right there, you’re looking at at least $25,000 maybe upwards of $50,000 for that one medical visit. And that’s just something relatively easy and routine. $50,000 -that’s a tough pill for a lot of people to swallow. So we have health insurance, that covers that type of calamity. And so that’s a big type of risk, or I should say it’s a low probability risk, but an expensive one if it were to come to pass. Now, because it’s a relatively low probability event, the cost to insure that type of risk is typically relatively low, because it’s not likely to happen. How many times over your lifetime are you going to fall down the stairs and go to the emergency room? Depends on how clumsy you are, I suppose. But that’s a rare event for most people. So those are relatively cheap to cover. But then we have the other types of insurance coverage. Staying with the health insurance example of a routine office visit at your primary care physician and you’re just going for a wellness visit. And to your health insurance, that wellness visit only costs you a $20 copay. Okay, well what would a wellness visit at your primary care physician cost anyway? Well, let’s see. There’s time, there’s 15 minutes. There’s no blood, the height weight. It’s good blood pressure, maybe some lab tests, that’s about $250. I can pay for that at a cash flow. So why am I ensuring that and paying only a $20 copay? Not an efficient use.

Types Of Insurances

Tonight we’re talking about the efficient use of insurance. And the effective use of it to protect your net worth. We went through sort of why you need insurance, how insurance works at the corporate level when you need to buy insurance, and when you should buy insurance. And so let’s talk a little bit about the basic types of insurance that are alluded to throughout the conversation already. So most of these are familiar to everyone who’s an adult in in the real world nowadays. So as you know, get that first job, get that first car, life comes at you real fast and there are a lot more expenses to owning a car or owning a house or even being a renter than just you know paying the basic expenses. Insurance usually tags along as with the utilities and with gas and repairs and all that type of thing. So we got residential insurance coverage that’s for a home a condo, Co-op renter’s insurance protects the dwelling that you live in and protects your stuff that’s inside the house to a certain extent. So that if a calamity were to befall the residence, then you get paid back something from the insurance company to try to replace all that all those valuables. Then of course, there’s car insurance, and other vehicles like motorcycles and boats. Sometimes some expensive bikes can be covered by insurance, if the road bikes, scooters, anything that’s going to be on a public roadway requires some form of insurance coverage usually required by the state. Then of course, there’s health insurance, you know, health insurance – that we need in case we go to the emergency room unexpectedly, and have some significant expenses where we find ourselves needing an operation of some sort, then that’s when we’re going to find out that, you know, one Tylenol pill might be $100 at the hospital, as soon as you cross the threshold. Expenses add up real quick so it’s prudent to have health insurance.

Use Of Umbrella Liability Insurance Policies

Another type of insurance that most people, I don’t think, tend to have but it’s a real good idea to have once you have a certain level of net worth is an umbrella liability policy. We often recommend this to our clients. Because they have typically fairly high net worth, you want to sort of put a blanket over all of it or as much of it as you can, at least from a liability standpoint, so that if you’re involved in a serious accident, and you were found to be liable for having caused that accident, and most likely it would end up in court, you can be sued. Then the insurance coverage for your automobile only goes so high, typically around $300,000 or something like that $300,000 to $500,000. Well, you get in if you’re sued for more than that. Then your net worth – your savings, your investments are at risk. So for very low costs, we often recommend that clients get an umbrella liability policy that covers like an umbrella covers you. It sits on top of your homeowners liability, and then covers those types of losses in excess of the basic levels of coverage, of auto and homeowners insurance. And so you usually get like a million dollars-worth of coverage for only a couple hundred or maybe $300 a year of expense. And so that’s a very efficient use of insurance, you put that big umbrella over everything you got that peace of mind you sleep easy at night and only cost you a few 100 bucks a year. So a very good efficient use of insurance as a personal liability umbrella policy.

Bundling Or A La Carte, Which Option For Buying Insurance Is Best?

And then you know by you can usually bundle different types of insurance coverages at one company. Not all companies specialize in every type of coverage. And actually, usually, each company specializes in different types of coverages. So while it can be very convenient, and easy to package, multiple lines of insurance under one carrier, and that often comes with its own set of discounts doing that. So usually that’s the right situation for most basic insurance needs.

But if your insurance needs are more complex, or they are much higher than normal, say your you know, maybe your house is 5 million $6 million. That puts you in a different category than your typical State Farm or Allstate, Nationwide homeowner’s insurance coverage. So it pays to shop around. You hear that a lot. There are also specialty insurance companies that deal in unique coverages and specialty lines of coverages, high dollar amount of coverages. Basically, almost any type of risks that you’d be willing to transfer to an insurance company, there’s a company out there that is willing to take it. And in fact, the Lloyd’s of London, which many people are sort of familiar with the name of it’s like an insurance marketplace insurance exchange, where the big companies come together and trade off risks amongst themselves. So anyway through that mechanism, that vehicle, that’s where you can get some really crazy outlandish insurance policies that are specially written for like maybe one individual. I have a couple of fun examples we might get to before the end of the show. So anyway, try to bundle where you can if your insurance needs are basic, but no, if you have out of the box types of insurance coverage, probably want to shop that around to an insurance broker that can help find the best deal for you.

Unpacking Health Insurance And Deductibles

And then I want to delve a little bit deeper into some of the most common types of insurance that we all pretty much have and that’s health, life insurance, and then maybe disability through work. So I was talking a little bit earlier about health insurance, and that’s one of the areas where we see people use insurance inefficiently. Your best efficient use of insurance is to cover the high dollar losses that are rare and unlikely to happen, but would be catastrophic to your financial situation if they did occur. So you essentially want to ensure the high end of the risks, what you don’t want to do is ensure the low end of the risk, like in the previous example about going to the doctor’s office, if it’s a wellness visit, probably, if you paid under the insurance regime, but because health care in America basically requires insurance. And that’s a whole separate conversation discussion that I can’t get into tonight. But let’s just, you know, say you need some form of insurance coverage. You need a card, right? You know, but a lot of people have really low deductibles on their health insurance. And we’ve been trained to think that an office visit is a $20 copay. And oh, god forbid, if it’s 25, or something like that, then what’s going on here? You know, that’s not an efficient use of insurance for common routine medical services and devices, because those aren’t really that expensive, in most instances. The unforeseen visit to the emergency room – yes, that’s expensive. The routine common wellness visit to your doctor once or twice a year, no, that’s typically not that expensive. So using your deductible as a device to lever the amount of insurance coverage can then determine the monthly premium that you pay. The higher your deductible, which is the portion of the insurance policy that you the insured is responsible for paying, the higher the deductible, the more risk you are willing to assume. On the low end on those wellness visits, have the prescriptions say of reasonable costs, if you’re willing to pay for those out of pocket, then you can afford a higher deductible, which means you get to enjoy a lower insurance premium. Financial planning 101, you need your emergency fund three to six months of household expenses. Okay, so that emergency fund is kind of like your deductible cushion. So when you go to a doctor and you go to the pharmacy, and it’s a couple of $100 then that should be for most people able to be paid out of pocket you don’t need a $20 copay to make up the other $180 difference there. And because if you do, if your copay is that low, then you’re just going to be paying it to the insurance company through larger premiums anyway. You are just trading dollars with the insurance company and they always win that you know, in the long run. So use your emergency fund as your deductible cushion. Allow your sub for those who have a healthy emergency fund, and then raise that deductible assume more the risk on the low end and enjoy a lower monthly premium.

Tonight we’re talking about insurance and the proper use of insurance, the efficient use of insurance, how to use it to protect your net worth. Before the break, I was delving a little deeper into the proper use of health insurance. You know, the concept of higher deductibles gets you a lower insurance premium, makes that insurance more affordable. That’s one of the reasons why we love High Deductible Health Plans. You know, when they were first coming into popularity around the time of Obamacare, there was a lot of shrieking and teeth gnashing about High Deductible Health Plans, low quality health insurance? No, no, no, it’s not. It’s just a different way of ensuring the cost of health care services. And by the way, people conflate these terms all the time. They say health care when they mean health insurance, right? You don’t technically need health insurance to get health care. Health insurance is just a mechanism to help pay for health care. High Deductible Health Plans, so that means your deductible is the portion that you have to pay, not the insurance company, you assume more of that risk on the low end. And then you use it in conjunction with your high deductible health plan, you are eligible to contribute to a health savings account. A health savings account is a special type of savings account, sort of like your emergency fund, a medical emergency fund that you can contribute to triple tax advantaged. We love that it’s extremely tax advantaged, you get a tax deduction for the money that goes into the health savings account. Any interest or growth that happens in that health savings account happens tax deferred while it’s in the account. And once you build up some critical mass, say $10,000 or more, health savings accounts provide investment options, so you can invest your health savings dollars as well for growth. And then when the money comes out ultimately for qualified health care expenses, then it comes out tax-free as well. And on top of that, there’s another bonus at age 65. You can take the money out of the health savings account for any purpose not just for qualified medical expenses. Now, if you take it out that way, you do have to pay tax on the withdrawal amount just like you would from a traditional IRA that comes out as ordinary income but there’s no penalty at age 65 or older. So we absolutely love the idea of a high deductible health plan with a health savings account, a very efficient use of tax dollars to protect against the high costs of medical expenses.

When Is Life Insurance Recommended?

Then I want to say a word about life insurance because that’s another (probably between health insurance, residential insurance, homeowner’s insurance, and auto insurance), life insurance is another big insurance coverage that a lot of us have. And life insurance is very important when we are relatively young, and we have other people who are dependent upon us, or our income generating ability for their happiness, for their own livelihood. So you know, a parent who is in the workforce earns income, has a spouse, has kids, that spouse and those kids need that breadwinner’s income in order to maintain their lifestyle. Well, you want to ensure the breadwinner’s life against an early demise. Because if that were to happen, the income stops, no pay coming into the house. So you’ve got a spouse who needs some income, you’ve got some kids, they need food, clothes, you’ve got mortgages, you might want to make sure that they have money set aside for higher education. There’s a lot of unmet financial needs if the main breadwinner meets an early demise. That’s a good use of life insurance. You want to ensure that person’s life. And by the way, that’s a misnomer. You’re not ensuring their life, you’re ensuring their income stream, but we call it Life Insurance.

When Is Term Life Insurance Recommended?

And so from our perspective, from a long term financial planning standpoint, you want that insurance coverage for a set period of time. You don’t typically need insurance coverage over your entire life. Because if you do your financial planning properly, as time goes along, as you continue to save money, you build your emergency fund, you invest in your 401K plan, you set aside other money for additional expenses in a brokerage account. You get the kids out of the house and on their own two feet, whether it’s through college or right into the workforce, then you have less dependents who are needful of you. And then you build up your nest egg, and then that need for insurance eventually goes away. So term insurance is typically our best device.

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