One of my jobs as a financial planner is to identify and mitigate financial risks through insurance. For example, a sudden death of a family member could derail your family’s goals, making it a serious risk to your family’s financial well-being. This risk can be mitigated through life insurance.
Although it’s important to have insurance to protect against these “risks”, there is a cost (not just in dollars) to being over insured. Below are a few rules of thumb to prevent you from being over-insured:
Don’t be More Valuable Dead than Alive
The biggest area I see people over-insured is through life insurance. Most of the time, a person is sold a cash value life insurance policy as a good “retirement savings vehicle”. Although this “retirement savings vehicle” may be good to have from a tax standpoint, by taking out a massive life insurance contract, the insured has just made themselves more valuable dead than alive.
I watch a good amount of Dateline, and it seems like once a month there is a story about someone who was murdered with the goal of obtaining their life insurance proceeds. Although it is important to have life insurance to provide your family with a source of income in the event of your death, being over insured can provide incentive for you to be dead, which is obviously not ideal.
Avoid Unnecessary Riders
There are so many life insurance riders; I can’t cover each one in detail. However, I can safely say that riders wouldn’t exist if the life insurance company didn’t make money off of them. Know which riders meet your unique needs, and steer clear of riders that are too complex, or sound too good to be true (because they usually are!).
Understand the “replacement cost” of your house
The “replacement cost” of your house, and the market value of your house are two separate amounts. The value of land is included in the market value of your house, but should not be included in the “replacement cost”. When you insure your house, you are insuring the replacement cost, or the cost it would take to replace your house. Having your house insured for the true “replacement cost” of your home rather than the value of your home can reduce your premiums.
Avoid having comprehensive & collision coverage on a “beater”
You should have personal liability insurance on all cars you are driving, but having comprehensive and/or collision coverage on a “beater” is pointless. Ask yourself the question: If this car were totaled tomorrow, could I afford to replace it immediately with little to no impact on my finances? If the answer is yes, I recommend skipping the comprehensive/collision coverage and pocketing the reduced premium.
Long Term Care Insurance
Only insure 80% of expected long term care costs
Long term care insurance is designed to cover some, or all of the additional costs of needing long term care. About 20% of the cost of care in most nursing homes is for essentials (meals, laundry, cable, meds) that you would already have, hence the 80% rule. For example; if the average expected cost of private nursing home room is $215/day, purchase $175/day of coverage, not $215/day. Be sure to take into account other factors that are unique to the client such as no longer having travel expenses. This will result in significant reduction of premiums because changing the daily benefit up or down on long term care insurance policies changes the premium by the exact same percentage.
For the most part, the cost of being over-insured is the increased cost of premiums and riders that aren’t needed. By eliminating these unnecessary costs, you can potentially save hundreds, or thousands of dollars per year, and reallocate those savings toward other, more exciting spending goals. If you’d like a second opinion on whether or not you’re over-insured, please check out our second opinion service, or call us at 630-271-0033.
By: Adam Glassberg CFP® CIMA®, October 7, 2014