Personal Finance Essentials
Key Principles About Insurance
Insurance is a Foundational Element of Any Sound Financial Plan
Keep in Mind These Four Principles
A financial loss – from the destruction of your home to the disability of a key employee – can wipe out years of savings and effort. Insurance policies can reduce or eliminate those losses. And unlike savings and investments, which take years or decades to accumulate, insurance can provide substantial funds instantaneously. Those proceeds are almost always tax-free. For these reasons, your insurance needs deserve attention before almost anything else in your financial plan.
With that context, here are four principles every business owner and individual should keep in mind when managing their insurance coverage.
The Cost of a Policy Tells You Something Important
This is the central thesis of insurance: a policy is cheap when the insurance company knows it is unlikely to pay a claim. Policies are expensive when there is a higher probability that the insurer will have to pay benefits. The price is not arbitrary – it reflects the insurer’s actuarial assessment of your risk.
Think about it from the insurer’s perspective. If only one house in 1,200 is likely to burn down and each house is valued at $250,000, the insurer needs to collect enough from all 1,200 homeowners to cover the one claim. Add administrative costs and other covered perils, and the math produces a reasonable annual premium. When your premium is high, it’s the insurance company’s way of signaling that your exposure is real – and that the coverage is exactly what you need.
Do not reject a policy simply because it is expensive. Do not buy a policy simply because it is cheap. Cheap policies are cheap for a reason: the insurer knows it is unlikely to pay a claim, which often means the policy has narrow definitions, restrictive exclusions and limited benefits. The right question is not what does the policy cost? It is what does the policy cover, and is that coverage adequate for the risk I face?
Don’t Underinsure
There’s no question about it: the vast majority of Americans are woefully underinsured. This is easy to understand. People tend to assume the worst won’t happen to them. They calculate that life insurance won’t be needed because they’ll live into their 80s or 90s, and by then their children will be financially independent and their savings will be sufficient. It’s a comforting plan – and a risky one.
You might save money by purchasing less coverage, but if a loss occurs and the benefit falls short of what you need, the savings on premiums will seem very small in comparison. The point of insurance is not to minimize cost. It is to ensure that when something goes wrong, the financial consequences are manageable. Focus first on getting the coverage you need, and then work within that framework to find the best value for the dollar.
Review Your Coverage Annually
Your insurance needs are not static. They change as your life and business change. A policy that was appropriate when you had two employees and a small office may be wholly inadequate once you have grown significantly. The coverage on your home should reflect its current replacement cost, not the value from several years ago. Your life insurance should reflect your current income and family circumstances, not those from when you first bought the policy.
Review every policy you own at least once a year. Use that review not just to confirm that coverage is still adequate, but to comparison shop. Rates and policy terms vary significantly between carriers, and staying with the same insurer out of habit can cost you. The insurance market is competitive, and periodically comparing what you’re paying against what other carriers offer for the same coverage is a straightforward way to make sure you’re getting fair value.
Work with a Financial Planner, Not Just an Insurance Agent
This distinction matters more than most people realize. Insurance agents are licensed to sell insurance products, and their licenses are typically held with one or more insurance companies. Legally, they represent those insurers – not you. And like all commission-based salespeople, they earn their income when you purchase a product. This structure creates a potential conflict of interest: the agent’s financial incentive is tied to making a sale, which may or may not align with your best interest.
This doesn’t mean insurance agents are dishonest. Many are excellent at what they do. But it does mean that relying solely on an agent for guidance about what coverage you need – and how much of it – puts you in a position where the person advising you has a financial stake in the outcome of that advice.
A fee-based financial planner operates differently. Their compensation is not tied to your purchasing decisions, which means their advice is not filtered through a commission structure. Registered Investment Advisors and their representatives are legally obligated to serve your best interests – a standard known as fiduciary duty that stands in sharp contrast to the legal obligations of insurance agents and stockbrokers. A fee-based planner can work alongside your insurance agent to help you understand what coverage you actually need, ensure you’re not paying for coverage that doesn’t serve you and verify that the policies you do buy deliver what they promise.