Insurance was explained to me by a law school professor this way: Outside of the stock market, it is the only other form of legal bet in the country. (At the time, state lotteries and Indian casinos were totally unknown.) Essentially you are betting the company that you will face a loss before they say you will. Premiums are carefully designed to allow the company sufficient time to use your money to generate enough profits to pay your claim with your own money. They have skilled statisticians on staff to constantly update the odds.
There are many kinds of insurance; about as many as you can think of as a bet. There is fire insurance that bets your home won’t burn down. There is life insurance that bets you will live longer than you think you will. There is liability insurance that bets that you won’t cause damage to others. Theft insurance that bets you won’t involuntarily lose your personal property to others.
You might not have choices about some of the insurance that you buy. For instance, if you own a car, you must have car insurance that protects the drivers around you. The company is betting that you won’t have an accident before you say you will. To stack the odds, they will carefully determine your driving habits. (Of course, if you do get into an accident, generally you’ll get cancelled by the loser of that bet.) Your mortgage company will require that you have fire insurance to protect them against that possibility. To stack the odds, the company will inspect your home to make sure the risks of a fire are very small.
But other policies are entirely optional. Life insurance is a good example of that. No law or regulation requires that you have it. It’s not a bad idea to have some insurance so that your funeral costs might be covered. But how much insurance do you really need?
Life insurance can have several goals, only one of which is burial. You might also want enough coverage to provide for living expenses for your spouse and children. Gernerally children only need enough to be protected until that are adults. Children do not need to be the beneficiary of a million dollar policy. spouses should have enough to replace your income for a while but keep age and earning capacity in mind.
Here’s an example: If you and your spouse are 70 years old and have no dependent children and your retirement income might decrease $1000 a month for your spouse, you only need a small amount of insurance. That would be enough for a decent funeral and maybe $1,000 a month for the next 2 years. (Assuming life expectancy to be 72.) That might mean a $35,000 death benefit term policy. Such policies are normally cheap, but do increase as you get older. (Skewing those odds again.) Newborns or young children have no earning power and thus really need no insurance.
So don’t get caught up in the FUD factor (fear, uncertainty and doubt) when considering insurance. Carefully consider what you really need and how to bet against the company. Sure, you’ll lose that bet, but maybe you can make the odds a little better. To hear more check out the Debt Podcast on August 31st.
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