How to Assess Your Insurance Needs
You manage risk at the portfolio level; here's how to address it in other parts of your plan.
This is an updated version of an article that originally published on July 20, 2019.
One of Warren Buffett's most famous maxims is that there are two rules of investing. The first rule is to not lose money, and the second rule is not to forget the first rule.
From an investment standpoint, Buffett isn't saying to avoid volatility altogether; you need to be able to withstand periodic fluctuations in your investments in order to make money in the long run. Instead, it means managing risks in an intelligent way: diversifying sensibly across asset classes, reducing risk as retirement draws close, and setting aside liquid assets to meet unanticipated expenses.
Nor can you avoid risk altogether in the rest of your life: Disaster can strike at any time. Your best defense against such unanticipated risks--whether to your home and autos, your physical well-being, or your human capital--is to insure against them. That way you can help ensure that one bad break doesn't derail your whole plan.
When making insurance decisions, one of the best pieces of advice is to not insure yourself against risks you can afford to cover. For example, if you have ample savings, you're not going to be sunk if your computer goes kaput and you need to buy a new one. (Sorry, extended-warranty sellers.) On the flip side, you'll definitely want to insure against bigger, more costly risks.
It's a given that we all need health insurance, of course. Here are the other key insurance types that can help ensure that small (or large) mishaps don't break your financial plan.
Homeowners insurance protects what is the biggest asset for many of us (our houses) and all the contents in it. It also provides some liability coverage in case you are sued. (You may want additional coverage, however, as discussed below.)
Take a close look at your policy. Would a higher deductible help lower your premiums? Ask about discounts for smoke detectors, fire extinguishers, deadbolts, and alarm systems. Does your policy provide for 100% guaranteed replacement value for your house and its possessions? Have you updated your policy if you've remodeled your home significantly over the years? Is there an inflation clause? Be careful not to overinsure by including the cost of the land. Is there "loss of use" coverage that pays for expenses while you can't live in your house? What are the limits on items such as computers, cameras, jewelry, or furs?
If you have special items like musical instruments, art, antiques, expensive jewelry, or rare coins, you may need an additional rider on your policy or you may need a separate personal articles policy. And if you are at risk for either flood or earthquake, you'll need additional coverage beyond the standard homeowners policy.
Check out the ratings of your insurance company; this article provides some details on how to do that. A financially strong company is much more likely to be able to pay your claims if the need arises.
If you rent your home, you should also be covered by renters insurance. The building owner's property coverage will not pay to replace your apartment's contents.
Finally, to help document your home's contents, take an inventory of the contents of your house, preferably on videotape. Then put that tape in your safe deposit box or a flame-resistant home safe; be sure to revisit your inventory periodically, to take into account new possessions.
Go find your auto insurance policy. First, it needs to cover liability. You may also need medical coverage, but check your health policy to make sure you are not duplicating coverage. Be sure you have protection from uninsured or underinsured drivers.
Physical damage is another important aspect of car insurance. There are two basic types of coverage: collision and comprehensive. As the value of your car goes down, it may not make sense to continue collision coverage. You can check out the value of your car according to Kelley Blue Book. If you know you'll replace your car if you have an accident, you probably don't need the collision protection. Comprehensive covers all risks other than collision (fire, theft, storm damage, etc.).
Like homeowners insurance, consider increasing your deductible to $1,000. You can self-insure that amount with your emergency funds. Also ask about discounts for alarms, air bags, or automatic seat belts.
If you're still working and have dependents, your largest asset is your own ability to produce income in the future. Thus, it's essential that you have adequate life insurance coverage. And if your spouse stays at home and cares for the kids, you may also want to investigate life insurance for her/him. Life insurance agents may disagree, but term insurance is often the most effective (and certainly the most cost-effective) solution for many individuals. If an insurance agent recommends a more permanent type of policy, make sure you thoroughly understand the reasons why he finds this type of coverage preferable to a term policy.
Fully 1 in 4 of today's 20-year-olds will become disabled before they retire. If you couldn't do without your income for an extended period of time, it's imperative that you purchase disability coverage. Your employer may offer cost-effective coverage; sign up to pay for it using aftertax dollars, meaning that your benefits will be tax-free.
Personal liability insurance (an "umbrella" policy) is one of the most cost-effective ways to purchase peace of mind. These policies usually sit on top of your homeowners and auto policies, and cover you in case you're sued for an accident that occurs on your property. If you have contractors, housecleaners, baby sitters, or dog walkers on your property--and even if you don't--an umbrella policy is a must.
Long-Term Care Insurance
Not everyone needs long-term care insurance. Those with a lot of assets may be able to cover their own long-term care costs, and those with small portfolios may be covered by Medicaid. If you expect to fall somewhere in the middle of that spectrum, however, you might consider long-term care, because the costs of nursing home or in-home care can quickly gobble up your nest egg. The long-term care insurance market has been troubled; policyholders have been forced to choose between huge premium increases or dropping coverage. This article provides tips for creating a long-term care action plan.