Why buy insurance at all? Why not be self-insured and save the profit margin that carriers earn? After all, everybody knows that if you live to age 85 or so, the return on a life policy (represented by the death benefit) for the investment of premium is around 3%. Long-term investors can achieve much better results than that! Sure. But the “return on investment,” or death benefit, can come anytime in life, and your investments may not accumulate to total anywhere near what the death benefit would be, especially if your investments had serious losses or you had a briefer life than you assumed.
The point of insuring is this: For an individual, an uninsured loss is a financial catastrophe, especially before a large investment fund can be grown. But for the carrier, paying a large death claim on that individual after receiving just a few premiums is not a catastrophe. This is because the carrier knows that, out of large numbers of policyholders, this is rare, and it factors such losses into premium rates. The carrier will make a stable return from a large and predictable group because it knows the average mortality rates, including instances when it is likely to lose on a particular claim. So we buy insurance to hedge what is to us, individually, a catastrophe, and the carrier correctly prices premiums to consider the average results of all policyholders. It would only be wise for an individual to scoff at insurance if he or she could actually predict his or her lifespan and health over all of those years.
Disability Insurance (DI)
Let’s first consider disability coverage.
The usual reason most people ignore, or will not engage in, discussions about personally owned DI is that they incorrectly believe it is taken care of via employment.
The first problem with this misconception is that once you switch employers, the group DI cannot be continued and may not be available at another employer. One minor problem with employer plans is that the benefit, once on claim, is usually taxable. Depending upon the plan, in some policies it is difficult to qualify for the benefit. But the most surprising and serious problem, by far, is this near-secret: In every group policy ever set in force, the definition of disability changes after one to two years on claim to a definition that makes continued benefits difficult to qualify for. Sometimes benefits stop or are severely cut when the employee can perform lower-paid jobs but not his or her own higher paying profession/trade. Usually, a group policy’s benefit is reduced by the amount of Social Security disability benefit one can claim. This occurs even if Social Security denies the claim (the standards for filing a claim are effectively lower than for claim approval—yikes!).
Obtaining Enough DI:
An insurer will never allow an incentive to not work or recover. So most carriers will limit how much they will sell. The total of group plus private coverage cannot be greater than 80% of your gross income. But most carriers will assume that Social Security will not pay, indirectly maximizing what you can buy. They also offer riders that pay what Social Security would, up to limits, and this benefit is not taken back if you win a denied or delayed Social Security claim. Personally owned policies have none of the drawbacks of group coverage, so you can count on them more reliably in your planning than group plans. Also, and contrary to popular belief, optional group insurances are usually more expensive than individual coverages because the underwriting requirements are more lax in optional group coverages; individuals can often qualify for favored rates. Returning to DI: An individually underwritten DI policy is purchased with after- tax dollars. This is so even for “list-billed” policies offered optionally through an employer (one bill monthly for all employees opting for payroll-deducted purchases). So the benefit is tax-free, maximizing the buying power of the benefit
when it is needed most. The benefit definition for most policies does not change with time on claim. Many private policies have case management that results in some extra payments for therapies that are likely to shorten your time on claim. Many policies offer riders that enable you to increase coverage without proof of insurability later in life (you will have to show increased income).
Your expenses usually rise—sometimes dramatically— during a disability; meanwhile you have no or reduced income. A disability can halt your income from which you will want to continue savings and all of your outlays. The bottom line is that after basic health insurance, DI is the most important coverage.
Ponder These Tips:
First, if you cannot replace more than 80% of gross income with DI during a disability, shouldn’t you make sure your budget for non-savings outlays never exceeds 80% of your gross? Now you’re thinking! The math is simple: Agents will do this for you, but know the total of all your outlays. Second, the cost of DI is dramatically less with a longer “elimination period” (the duration of disability before claims payment starts.) Use a large cash reserve to enable you to select a very long elimination period. The cost for a policy with a six-month elimination period is about half the premium as for the same benefit with a ninety-day elimination period!
Business DI and Disability Buy-Out:
There are forms of disability insurances that protect a business—perhaps your business—from folding during a key employee’s disability; there are even buy-out arrangements that can be funded by insurance.
Mortgage DI and Life:
Let’s not forget mortgage disability coverage and the life insurance often combined with it. These are a poor way to plan, and often a poor consumer value.
First, this coverage reduces what you can buy in personal DI.
Second, it pays only the interest due—not the principal—to protect a lender while you are disabled.
The way these are marketed should tip you off: You are repeatedly mailed or called with wording that implies this is a usual part of your new mortgage paperwork, as if you forgot something that must be corrected. Always avoid sellers who use sly or vague wording, especially those that might come off as a government agency or as an affiliate of your lender. Instead, have a trusted and independent agent calculate your insurance needs—both declining and possible ongoing insurance needs.
Mortgage DI underwriting standards are often a bit more lax than fully underwritten policies, and they charge heavily for this slightly greater risk that the carrier accepts. The only advantage of this coverage is slightly easier qualification rates, but the cost per thousand of coverage is always high.
Mortgage disability policies, like their life insurance counterparts, decline in coverage as the debt amortizes (is paid off). Other personally owned DI policies can last up to age 67; most last to age 65 because those are the normal retirement ages.
One last resource on mortgage/credit insurance: https://www.consumer.ftc.gov/articles/0110-credit-insurance.
Health Coverages
Health Insurance: This market is in flux, as we all know from watching the news. COBRA continuation for group health insurance, for example, is likely to be replaced by universal portability for coverage. Policy structures and options, too, are shortly to change. Your best bet in evaluating health policies (other than my comments in the retirement planning chapter) is to have a trusted health insurance specialist who has access to all carriers in your market. But you will always have choices of deductibles (what you pay per year before insurance pays anything; then the insurer pays the bulk of covered expenses, e.g., 80%). Many plans have minor copays, such as flat amounts for office visits. The total of these two amounts you pay is called the out-of-pocket maximum. You select this “OoPM” (out-of-pocket maximum) in your purchase decision also unless you are covered at work or as a dependent. Up to this OoPM, you are basically self-insured. The OoPM is per individual, after which the plan pays 100% of covered expenses in that year for that individual. But if the family reaches the “Family OoPM,” then the plan pays 100% of covered expenses for all covered members in that year. What is often not fully covered is out-of-network services and products, so always evaluate whether the network in your area includes your favorite doctors and institutions. Remember to negotiate fees for those big chiropractic/physical therapy shops that are often in no networks at all.
To help you pay up to your OoPM, most employers accept non-taxed contributions from your pay and place these in a Healthcare Savings Account (HSA) or Flexible Spending Account (FSA).
An HSA can be set up by you or provided through an employer, and you determine what investments to use in the plan. It allows you to contribute pre-tax (or tax- deductible money if you wait to participate until the end of the year) and save from year to year, tax-free (unless you use it for non-health purchases; then it’s taxed and penalized). At this writing, you can put in up to $3,400 as an individual with an extra $1,000 if you’re at least 55 years old, and $6,750 for a family. This approximates high-deductible health plans’ OoPM expenses. Especially since you keep what you don’t spend, it is nicer than the older Flexible Spending Accounts.
Flexible Spending Account (FSA) assets, in contrast, are not necessarily your money even though you can contribute up to $2,600. If you don’t spend your deposits, you lose them to the company. This bugs many, but companies do have administrative expenses, and some employers put their own money in to help you (this is called a health reimbursement arrangement). Most of these plans provide you with a debit card that can act like an actual credit account: Most employers allow you to access a year’s worth of these deductions in advance, with no interest charge. Because of this and the fact that it enables non-taxed dollars to pay close to half of your OoPM, you should always contribute—even for plans that would sacrifice your deposits in the event that they are not all used by year-end. Why risk cash loss at year-end? You will always have the ability to use that money up and not lose it, even if you’re in good health: Use medically prescribed massage therapy or purchase over-the-counter drugs; join a gym, get proper glasses and tests when you might otherwise rather not discover you have some disease. If you have a high- deductible plan, you can use an FSA up to its limit and then an HSA up to its limit, less your FSA contribution.
You might think of these plans as part of your cash reserve; fine. Just be sure to budget well and fund this expense item.
Health Services Discount Associations: Discount cards, at least for someone with actual health insurance, merely make things cheaper on the way to reaching your health policy’s out- of-pocket maximums. If you are likely to reach that number, the association’s discount card will turn out to have been an unneeded expense; it may have value if you are unlikely to reach your out-of-pocket maximum.
Cancer Policies:
These policies are generally priced quite high, even if you are fully underwritten medically. This is because many people do not clearly know their relatives’ cancer history and under-report this on applications. Many forms of cancer are not covered in these plans; most policies do not cover melanoma, for example, and these policies list specific cancers they cover, rather than covering all cancers and then excluding named ones. FYI, these policies pay upon diagnosis and verification rather than on death.
This excerpt is taken from “The Secrets of Successful Financial Planning: Inside Tips From an Expert,” by Dan Gallagher. To read other articles of this book, click here. To buy this book, click here.
