Investing Specialists

What Types of Insurance Are Essential? Inessential?

Christine Benz

Because Morningstar.com is an investing site, our focus is on helping people grow their assets. But protecting what you've managed to save in case the unexpected strikes--fire, catastrophic health-care costs, or premature death--is equally important.

In a recent thread in the Personal Finance forum on Morningstar.com's Discuss boards, I asked users to share their personal philosophies on insurance. Which types of insurance products would they never live without, and which do they consider inessential?

A useful discussion ensued, with posters opining about and sharing personal experiences with a broad swath of products, from life insurance to disability to long-term care. Readers also shared guidance for deciding whether to purchase insurance or self-insure. That's valuable because ultimately the decision is a personal one that depends heavily on your household's financial situation. To read the complete thread or share your own views, click here.

'The Financial Equivalent of a Magnitude 9-Plus Earthquake'
When it comes to deciding which risks to insure against and which to pay out of pocket, Mwleach advised, "Insurance is supposed to be for unusual and catastrophic risks--not ordinary moderate-cost risks."

To illustrate what constitutes an unusual risk that should be insured against, Chief K shared the following example. "Unusual risk: A flooded home (unless you live in a 25-year flood zone). Usual risk: A water pipe or appliance malfunctions and water ruins a rug."

As Chief K's post illustrates, what's an affordable unexpected expense will vary by household. He provided this useful guidance. "In general, if paying for the expense means forgoing discretionary spending for a month or two, I would not insure. If paying for a problem meant six months, or more, of austere living, I'd probably strongly consider insuring. Obviously medical costs can easily fall into the catastrophe category. The less leeway you have, the more I think you need to insure. More leeway, less need for insurance."

FidlStix provided some practical examples of where to draw the line. "We skip what I call nickel & dime insurance like flight insurance or extended maintenance on autos, electronics, and appliances. [But] if an uninsured event would be the financial equivalent of a magnitude 9-plus earthquake, then we carry insurance."

In a post that was widely "amened" by other users, Douglas Johnson shared this guidance. "Never buy insurance for a risk you can afford to take." This poster went on to opine that for those risks you do decide to insure against, it's best to have a high-deductible policy with high upper limits on coverage. "Low-level losses are relatively common, so it is expensive to insure against them. High-level losses are rare, but devastating when they occur, so it is both cheap and important to insure against them. Thus, high deductibles and high upper limits."

'Carry the Best Health Insurance You Can Afford'
Most posters in the thread agreed that a handful of insurance products are essential no matter who you are or what your financial situation is--home, health, and auto were universally agreed upon as essential types of coverage. Umbrella policies, which are add-ons for homeowners' policies to provide coverage in case you should be sued, also received repeat mentions.

Rossinator summed up the basic case for these core insurance products. "For my purposes I have health, auto, and homeowners. I think you should always have health insurance, you need auto if you drive a car, and homeowners if you have a house (or renters if you rent--it doesn't seem to be very expensive)."

I asked posters to share any advice they had gleaned during their years of purchasing insurance, and several shared worthwhile guidance in the area of health care.

JHAsheville notes that for him and his partner, a high-deductible health-care plan has made sense. "As far as health care we [have a policy] with a high deductible and lower rates and pay for annual stuff with cash. It works for us, but we have it set up that we should be protected if the worse happens." (This article explains the basics of a health-savings account used in conjunction with a high-deductible health-care plan.)

WesternMass, meanwhile, urged seniors to carry supplemental coverage to defray those inevitable expenses not picked up by Medicare. "Medicare has high deductibles and only covers 80% of cost. I am not a big believer in overinsuring; however, my wife talked me into a Medicare Supplement Plan when I retired this year. This plan, along with a Part D Drug Plan, cost me $200 per month. This year I had three unexpected trips to the hospital. Total cost $37,000. My cost for deductibles and co-pays $0. This plan paid for itself already. I can go to any doctor and any hospital in the U.S. I do not need a referral or a primary care doctor. Lesson to be learned--carry the best health insurance you can afford. You never know when disaster will strike."

Rossinator warned health-care insurance shoppers that COBRA coverage, which allows one to stay on a previous employer's policy after leaving the job, can be unnecessarily costly. "If you leave your job and you are in reasonable health, don't stay on COBRA, get an individual policy right away! I retired early, and lollygagged around making COBRA payments for many months. I was told an individual policy was cheaper, but I did not realize how much cheaper. My individual policy is 40% of what my COBRA payment was for similar coverage, and the prescriptions copay is less!!!" ‚Äč

'Disability Insurance Is Often Ignored'
Although not quite in the category of health and homeowners' insurance, disability coverage received several shout-outs as an important insurance type.

Mwleach wrote, "I have to put in a word for long-term disability insurance for those still working--the average middle-age worker has a better chance of being disabled before retirement age than dying before retirement age, yet disability insurance is often ignored while overpriced life insurance continues to be pushed on unwary consumers."

But because disability insurance replaces income in case you become disabled, it doesn't make sense when you're retired.

Douglas Johnson wrote, "I dropped disability when I had enough assets to retire."

Chief K helpfully pointed out that the best types of disability policies cover you in case you can't do your normal job, not just any old job. He advised, "You should look hard at getting disability insurance during your early work years, and pay attention to the coverage."

'The Risk and Returns Are Not Impressive'
Posters in the thread were more divided on the need for long-term care insurance. Many acknowledged that this type of coverage would provide valuable peace of mind, but they've had trouble making the numbers work. (A previous thread focused exclusively on the long-term care decision; this article summarizes the comments.)

Mwleach shared, "The reason [my spouse and I have gone without long-term care insurance] is not because we do not recognize the potential need. However, we were never able to find any policy of the type we would have wanted--one with a long (three or more years) elimination period, but 100% inflation-adjusted coverage for life for all costs thereafter." (The elimination period is a time period during which the insured party must pay costs out of pocket before the coverage kicks in. The longer the elimination period, the more affordable the coverage tends to be.)

This poster went on, "In addition, after doing considerable due diligence on the subject for an extended period (I've held a current certified financial planner designation for 20 years), I very reluctantly came to the conclusion that the long-term care insurance industry does not have a viable business model. I'm apparently not alone in this conclusion, since a number of the major insurance companies who had been providing such coverage have decided in recent years to exist the business and are no longer issuing new policies."

Retired2020 has come to a similar conclusion, "I also considered long-term care insurance, but decided to chance on it as the risk and returns are not impressive."

RetiredinFL pointed out that long-term care coverage can become unaffordable if one waits too long, and wealthy folks might not need it all. "Long-term care insurance is reasonable in cost for those in their early 60s. Those with net worths above $3 million are generally thought to be better self insured."

FidlStix figures that at this point, coverage would be unaffordable for him, but he's not ruling it out for his spouse. "Age-wise I'm knocking on 70s door, and the premiums would be devastating on our budget. I'm healthy, have good genes, and I'm going to take the chance that I won't ever wish I'd bought it. My wife is in the same boat (although at her age--57--we can still change our minds on long-term care for her)."

Yet Smaharba69 offers a countervailing point of view. "Those who think they don't need long-term care are delusional. I urged my mother to buy it at age 60; she never did. At age 84, she required a nursing home. That was in the fall of 2008. By the time we were able to liquidate assets for a Medicaid plan, the value of her portfolio had declined 60%. The discounted dollars one pays for long-term care would have been a drop in the bucket compared with the hundreds of thousands she lost to bad market timing (they were liquidated in March 2009)."

'Your Dependents Depend on Your Income While You Are Alive'
Readers also offered disparate viewpoints on life insurance. The "buy term and invest the difference" contingent was alive and well in the thread, but more permanent types of policies had their proponents. (This thread focused exclusively on readers' life insurance strategies.)

Put SugarDaddy in the "buy term" camp. "If one wants life insurance (not necessary if you have no one to support) only chose term policies. Invest the savings from whole life policies and you will do much better."

Matching the term of a term life insurance policy to one's anticipated need for it is a practice espoused by W004dal, who has young children and is his family's sole earner. "My life insurance policies are term life to handle all expenses through when our youngest child will be in college, should I die before then. My wife's life insurance policy covers a term until our youngest child will be about 10, for child-care expenses."

Likewise, several posters who are in or near retirement noted that they dropped their term coverage when they retired. Monkeylover wrote, "To me, the only time you need life insurance is when your dependents depend on your income while you are alive. When my kids graduated from college I dropped all life insurance."

RZH123 wouldn't rule out a whole-life policy, but notes that it will only make sense for some people. "Buy term life unless you can be sure you can go 20 years of whole life payments. I would think you would want enough life insurance (including emergency savings?) to cover at least three to five years of basic expenses until your family can get re-established. That would be very expensive to do with whole life only for most people."

Counterpoint, meanwhile, wondered aloud whether some might be underestimating the tax benefits of whole life insurance. "I generally agree [about the virtues of term insurance] but I'm wondering if other types of life insurance might deserve another look given its tax shelter potential and all the new taxes that appear to be on the horizon."

Smaharba69 concurred. "As estate taxes phase back in, life insurance will also be an essential part of estate planning. You can either let your heirs pay up to 55% of the estate value in taxes, or you can finance the taxes with the discounted dollars of life insurance premiums. Anyone with assets, heirs and good health who passes up the opportunity to protect the assets for their heirs with life insurance is leaving money on the table."

No matter what decisions one makes about insurance coverage, Retire2020's post underscores the importance of giving the topic due attention before it's too late. "One thing about insurance is that one doesn't appreciate its value until one needs it."

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