Have you ever felt like you were over-insured? No one wants to waste money on unnecessary insurance premiums because every dollar wasted is a dollar that could have been invested or spent on something a lot more exciting than insurance.
On the other hand, not having the right types or amounts of insurance can be very detrimental to wealth building and enjoyment of life. How can we find the proper balance? The key is to cover only the potentially catastrophic risks we cannot completely avoid. The following types of insurance cover risks in that category:
- Auto Insurance
- Homeowners Insurance
- Umbrella Liability Insurance
- Medical Insurance
- Long Term Disability Insurance
- Long Term Care Insurance
- Life Insurance
These types of insurance are critical because uninsured losses we may experience in these areas have the potential to financially devastate us.
For Example: Car Insurance
If we carried only the minimum required auto insurance liability limits and seriously injured or killed someone in a car accident, how would we pay for the vehicle damage, medical expenses, and income loss of the other driver, which could add up to hundreds of thousands, even millions of dollars? How could we pay medical bills for unexpected cancer treatments, surgeries, and long-term hospital confinement if we had no medical insurance?
The Importance of Sufficient Medical Insurance
Many years ago I met a man in his fifties who had incurred hundreds of thousands of dollars in medical bills twenty years earlier because his wife had developed a serious illness at a time when they had no medical insurance. She eventually recovered physically, but he told me he does not think they will ever fully recover financially from the effects of that huge unexpected blow. He pleaded, “Make sure you always carry medical insurance for your family and tell all your clients to do the same. I severely underestimated the potential for medical bills to wipe us out financially for the rest of our lives.”
If we choose not to have insurance in any of the areas listed above, we need to create a realistic plan for how we would cope if disaster struck. For example, if we choose not to acquire disability insurance, we would be foolish to say, “I do not need it because I am never going to get sick or hurt.” Of course no one ever plans to get sick or hurt. It happens when we least expect it.
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A realistic alternative plan might be the following: “If I cannot work because of sickness or injury, we will move in with my in-laws and use our retirement and college savings to pay for my wife to go back to school so she can earn enough to support us. We will no longer help our children pay for their college education, and we will postpone retirement for another 10-15 years beyond what we originally planned for.” If we cannot think of an alternative plan that is realistic and acceptable to us and those who financially depend on us, then transferring the risk to an insurance company might be the best strategy.
In my opinion, every other kind of personal insurance – aside from those listed above – is optional: dental insurance, short term disability insurance, accident insurance, home warranties, extended warranties on cars and appliances, credit insurance, travel insurance, and many others. These are nice to have if someone else is paying for them, but the premiums tend to be very high for the benefits provided, and no loss in any of these areas has the potential to ruin us financially. Therefore, if we are underinsured in the essential areas but are paying for coverage in optional areas, it may be wise to terminate nonessential coverage and use the premium savings to increase critical coverage.
The Right Amounts of Insurance
How can we know how much is the right amount for each type of essential insurance? The short answer is as much as the insurance company is willing to give us, for the lowest possible cost. I want full replacement value for all of my most valuable assets. If my home burns to the ground, I want the insurance company to pay to rebuild the whole house, not just the kitchen. If they would not rebuild my house the way it was before the fire, what is the point of even having insurance? I also want to retain as much of the risk as I can afford to retain through high deductibles so my premiums will be as low as possible without sacrificing high coverage limits.
Although everyone’s insurance needs are unique and should be reviewed by a competent advisor, here are some general guidelines:
Liability limits are the biggest priority. I normally recommend the highest available liability limits, which are typically $250,000/500,000/100,000, and the highest available deductible, which is usually $1,000. If your coverage is currently significantly lower than this, you may be surprised to discover how inexpensive dramatically increasing your coverage will be, especially when you simultaneously raise your deductibles.
Be sure your home is insured for full replacement cost, but no more. You should periodically ask your agent to complete an updated replacement cost estimate to determine whether your coverage needs to be adjusted. Keep in mind that your home may need to be insured for more than it is currently worth because replacement cost is not directly related to market value, rather the estimated cost of labor and materials for rebuilding your home from scratch. I also recommend the highest available liability limits and at least a $1,000 deductible.
Most homeowners insurance policies automatically come equipped with plenty of general personal property coverage. However, watch out for exclusions and limitations on certain types of personal property. Typically insurance companies will not pay much for stolen or damaged jewelry, musical instruments, art work, or other valuable collectibles unless you add an endorsement to specifically cover these items for their full value. It might also be helpful to keep receipts, pictures, or videos of your personal belongings in a safe place offsite so you could easily prove to an insurance adjuster what you are entitled to in the case of a loss.
Umbrella Liability Insurance
What is an umbrella? It covers any personal liability that exceeds the limits of auto and homeowners insurance policies. It also covers other types of personal liability, such as libel or slander, but does not cover business-related activities. Coverage options range from $1,000,000 to $10,000,000. Typically I recommend at least $1,000,000 for people making a good income even if they do not yet own many assets, to help prevent the risk of their wages being garnished in the case of a major judgment against them. Of course people with substantial assets may be wise to acquire higher limits relative to their net worth.
Does that seem excessive? Wouldn’t a $250,000 liability limit per person be more than enough to cover any auto accident? True, it would cover most accidents, but not every accident.
What if the person you hit is killed or sustains injuries so severe that she cannot work for the rest of her life? How much should her family be entitled to receive? That depends on her age and income.
Let’s say she is 35 years old and makes $100,000 a year. Would it be unreasonable to suggest that she could have worked at least another 20 years if you had not hit her? Income of $100,000 per year for 20 years would be at least $2,000,000 total potential income lost. What about the cost of medical expenses, pain and suffering, and vehicle damage, on top of the income loss? What would you want for your family if you were the victim in this situation? Would you be greedy for wanting at least $2,000,000, or would that be reasonable compensation for your loss? I think it would be totally reasonable, and so do the courts.
How Capstone Capital Can Help
If you need advice on finding the right amount of insurance coverage for you contact us for a free consultation. We can evaluate your situation and provide sound, qualified financial advice as well as professional asset management.
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