Category Archives: Insurance

Insurance – Do You Have Too Much or Not Enough?

For many people, insurance is not a fun or exciting topic. We often mindlessly renew our existing policies and spend little time thinking about whether we have the right policies or coverage. As a result, we may have unnecessary insurance in some areas and not enough coverage in other areas.

Why should having too much insurance be a concern? While insurance serves an important function for protecting against large losses, it is not a good deal for small potential losses that you can afford. The reason for this is that insurance premiums are designed to cover not only the policyholder’s statistical share of potential claims but also the insurance company’s overhead, selling expenses, and profit. In most cases, you can do without the following insurance policies that cover relatively small potential losses:

  • Extended warranties
  • Cell phone insurance
  • Travel insurance
  • Credit card insurance
  • Comprehensive and collision coverage for older cars with low replacement value

Another way to eliminate coverage for small potential losses and reduce your premiums is to choose policy deductibles that are as high as you can afford. Is your auto insurance policy deductible $500? Unless you are accident prone or your auto lender requires a low deductible, why not increase the deductible to $2,000 if you can afford such a loss?

Why do people buy insurance for small losses? I believe it is because of two behavioral finance tendencies: (1) fear of regret and (2) assigning probabilities based on the ease of imagining the event or finding examples. It is easy to see how someone who has always had comprehensive and collision coverage could fear having his car stolen right after dropping comprehensive and collision coverage on his 15-year-old car worth $1,500 (fear of regret). Also, some people may overestimate the probability of something happening because it is so easy to imagine (e.g., misplacing one’s cell phone or getting sick right before a planned vacation).

So, what are some areas where you might have not enough insurance? First, consider the reason for insurance. The purpose of insurance is to protect you from large financial losses that you cannot afford. Most people have heard of auto insurance, homeowners’ insurance, health insurance, disability insurance, and life insurance, but there are other types of insurance that are also important. One is renters’ insurance, which is designed for those who rent their residence. An apartment renter might say, “I don’t need renters’ insurance because the things in my apartment aren’t worth much.” Renters’ insurance covers much more than the contents of your apartment. It covers your liability from bodily injury or property damage that occurs either at home or anywhere outside your home. If you are sued for this type of liability, the insurance company will provide a legal defense at their expense, even if the lawsuit is groundless. The sum of a liability judgment and attorney’s fees could become a very large loss. Of course, the details of policy terms will vary with the insurance company, but you can see the importance of having renters’ insurance.

Another important type of insurance policy is a personal umbrella liability policy, which covers your liability from bodily injury or property damage that exceeds the limits of your underlying auto, homeowners’, or renters’ policies. Some umbrella policies also cover events that may not be covered by underlying homeowners’ or renters’ insurance, such as personal injury from false arrest, slander, or libel. Although the chances of anyone filing an umbrella claim may be very small, an umbrella policy, by definition, protects you from catastrophic financial liability. Umbrella insurance is especially important if you have a sizeable net worth. Umbrella premiums are often modest, and umbrella policies are offered by many insurance companies that offer auto, homeowners’, and renters’ insurance.

Also, take a look at the liability limits of your insurance policies. Did you get a low $50,000 liability limit on your auto policy when you were a poor college student and never change it? If so, this is a good time to reassess all of your liability limits. If you have an umbrella liability policy, you can just set the liability limits on your underlying auto, homeowners’, and renters’ policies at the minimum amounts required by the umbrella policy since the umbrella policy will cover any excess liability (up to the limits of the umbrella policy).

Finally, be aware of policy exclusions. For example, homeowners’ insurance policies typically do not cover damage from earthquakes or floods unless you get add-on coverage specifically for these perils.

Year-End Financial Checklist

Can you believe that today starts the final month of 2011? Around this time of the year, many newspapers and magazines publish articles about year-end tax planning. While year-end is certainly a good time to do tax planning, it is also a good time to take stock of your financial situation and think about broader financial issues. The following are some things that you may want to consider. I will also throw in a couple of my favorite year-end tax tips as well.

  1. Evaluate your financial goals. Is buying a house one of your goals? If so, do you know how much income and savings you need to buy a home without jeopardizing your other financial goals? What if your goal is to get out of debt? Do you know how much debt you have right now? Do you have an action plan to accomplish your goal? Do you see the pattern? Get information. Make a plan. Execute the plan.
  2. Analyze your spending and saving patterns. Different people may have different goals, but many of these goals have one thing in common. You must save money to accomplish them. Do you know your average monthly spending? Can you estimate the recurring expenses that do not occur every month or every year, such as insurance premiums, home renovation costs, and automobile purchases? Do you know what percentage of your income is being saved? If you answered “no” to any of these questions, then now is a good time to get organized.
  3. Are you missing any necessary insurance policies? Do you rent an apartment but have no renters insurance? Do you have a sizeable net worth but no personal umbrella policy?
  4. Check every beneficiary designation. Life insurance policies and retirement accounts have beneficiary designations. You can also add beneficiary designations to regular bank and investment accounts through pay-on-death or transfer-on-death provisions. Check every beneficiary designation, especially if your family situation has changed recently (e.g., getting married, having children). These beneficiary designations override any provisions in your will.
  5. Contribute to a Roth IRA if you are eligible. Contributing to a Roth IRA is an excellent way to invest for retirement. Assets in a Roth IRA grow tax-free as long as you meet certain requirements when you withdraw the funds. You can contribute to a Roth IRA as long as you have earned compensation (e.g., wages or self-employment income) and your modified adjusted gross income (“MAGI”) is below certain limits. If you are single, you can contribute up to $5,000 to a Roth IRA if your MAGI is less than $107,000. If you are married, you and your spouse can each contribute up to $5,000 to Roth IRAs if your joint MAGI is less than $169,000. The $5,000 limit increases to $6,000 for those age 50 and older. You can contribute to a Roth IRA even if you participate in a 401(k) plan at work. You can make a Roth IRA contribution for tax year 2011 any time before April 15, 2012.
  6. Consider a Roth IRA conversion. If you are in an unusually low tax bracket this year (e.g., due to a break in your career or going back to school) and you have some extra cash to invest for retirement, then consider converting some of your Traditional IRA assets into a Roth IRA. You will have to pay regular income tax on the conversion amount, but that might be a good opportunistic investment if you are temporarily in a low tax bracket. Be careful, however, that the conversion does not push you into a higher tax bracket. Also, make sure that you have cash outside of your IRA to pay the income tax due on conversion. The deadline to make a Roth IRA conversion for tax year 2011 is December 31, 2011.