Why is Insurance Such a Key Part of Your Overall Financial Plan?

Kent McDonald is one of the qualified Simply Budgets consultants you could go to if you wanted help with your budget. He is based in Brisbane and is a qualified financial advisor. I asked him if he would write an article about insurance to go in this month's newsletter because I noticed that this was one of the issues that you told me was of interest to you in a survey earlier this year.

Here is what Kent had to say.

There are few financial topics more important (and, sadly, more mundane) than insurance. No matter how diligently you build your financial empire, failure to purchase adequate insurance can put you in a desperate hole within the time it takes for a 'heartbeat'. On the other side of the coin, few things will attack your investment returns more insidiously than paying too much for insurance or, worse, paying for insurance you don't need.

So, you may be thinking now, "I don't need insurance." To that I say: Most likely you do. If you own things that will be very hard to replace without facing severe financial hardship, these things ought to be insured. In general, think of insurance as "hardship avoidance," not "convenience" or "hitting the jackpot."

On the one hand, insurance has all the lure of a state lottery. Individual tickets don't cost much (relatively speaking), and if your number comes up, hey, you get the big cheque! Trust me though. You don't want this cheque.

Before you actually get the cheque, you'll have to complete your end of the bargain. No major issue. You just have to get some stuff stolen from your home, or damage your car, or become disabled, or die.

Fun or no fun, however, insurance is one finance topic that you don't want to overlook. Contrary to some common perceptions, insurance is not a rip-off. For most people, it is a necessary and valuable financial service.

Whatever you do, don't lose your insurance bets by skipping premium payments. Since insurance has little impact on daily life, it's easy to overlook these payments. If you really need the insurance, these premiums should fall behind only food and shelter in your list of priorities, and certainly ahead of investing.

The three key factors that should be considered are:
1. What types of insurance do you need?
2. How much insurance do you need?
3. How do you get all of this coverage at the lowest cost?

Let's get started with some basic questions and answers...

What things should I insure?
How's your health? Could you afford to lose it? If you become sick or disabled, temporarily or permanently, would you be able to support yourself? For most people, the answer is "no," yet a large number of people -- even some with quality health insurance -- are not insured for disability. This is foolish.

How about your life? If you were to die suddenly, what kind of financial hardship would result? Would there be dependents left without basic support? Would your burial costs impose undue hardship on others? Morbid as they may seem, these questions are at the root of life insurance decisions. If there are people who can't afford to lose you, you should buy life insurance.

Sometimes, you buy insurance to protect lending institutions. If you have a home mortgage or a vehicle loan, you have little choice. The lending institution will force you to get insurance and will dictate the coverage levels. In this case, it's not your financial hardship that lenders are nervous about; it's their own. You have their money, and if you can't pay them back, they'll want the car. If you've crashed the car and have no insurance, well...

In the same way, private mortgage insurance (PMI) protects the lender, not you, should you default and stick them with a house worth less than the balance of your debt.

What if you own a car, home, or other personal possessions outright? Start by thinking about which of these are the most valuable. If these valuables were damaged or lost by accident or theft, would this lead to severe financial hardship? If so, you should purchase enough insurance to replace them. Most homeowner's policies cover the loss of personal possessions.

The most complicated topic among these is liability insurance. You buy this to protect yourself from others. If your negligence or error should lead to damage of their property or, worse, their health, you should be prepared to cover these costs in case you are sued. Such liability coverage usually comes with your car and home or landlord's insurance. So-called "umbrella policies" are also available for more general liability. Coverage limits, in these cases, are usually based on your net worth and -- here we go again -- how much of it you can afford to lose.

Is price all that matters? Nope. Remember, you buy insurance for times of need. You may hate to make the payments, but imagine how angry you'll be if, after making all the payments, you can't get anywhere on a claim. There are three key issues beyond price.

First, make insurance bets with healthy companies. This is particularly important when establishing a long-term relationship, as with life, disability, or long-term care policies. Even if you're buying a term life policy of short duration, you want any guaranteed renewability and convertibility promises to last indefinitely.

Second, you want top-drawer claims service. Low premiums is just the input side of the equation. If the output side is stingy and adversarial, low premiums can be worse than no premiums.

The third key to consider, beyond price, is actually about price (make sense?) and convenience. Many insurance companies will give you a great deal on premiums if you buy multiple policies from them. Also, when it comes to agents, premium payments, and company red tape, there are advantages to keeping things simple. If you've had good experiences with a particular company or if your search unearths a few companies that could cover the whole raft of problems for you, be sure to check for multiple policy discounts and compare quotes accordingly.

Hopefully this will give you some insight into this very important yet not so popular financial area. If you want to contact Kent you could visit his web-site at www.bettermoneymanagement.com.au or e-mail [email protected].

 

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