Money Management for the Middle Class: Insurance Planning

I know insurance is very important for a middle class family, but personally I’ve never really liked having to own it for the simple reason that it is a loser’s game.  That is, in order to make your money off insurance, things have to go wrong (and in some cases, very wrong).  Would Lissa rather have me beside her or a million bucks?  See, not a fun choice.

Despite its dark and morbid nature, insurance does have its uses when planned for and applied correctly.  There are a lot of different types of places where insurance can apply, but the most common types of insurance people experience are medical, life, disability, and AD&D (accidental death and dismemberment – woo, what a title!).  Do you need them all?  Well, just remember that insurance is setup as a fallback security.  So you need to couch everything in this post with your own risk behaviors and tolerances.  Smokers, sky-divers, and drag racers all need more insurance than your average desk jockey – granted they will also have to pay more for it.

At some point in time, your employer communicated to you just what, and how much, they offer as insurance benefits.  Factor this amount into how much insurance of each type you should purchase.  If your company provides $100,000 of insurance and your spouse would need $190,000 of supplementary income were you to die today, you need to buy $90,000 in life insurance.  If the cost of supporting you and supplementing your income would be $250,000 if you were to become disabled, and your company provides $150,000, you would need $100,000 in disability insurance.

I guess I should stop and say another important rule to remember about insurance.  Insurance companies are, by and large, in the business of making profit.  Note that this does not at all go well with handing over lots of money to you.  You will either be paying out the nose for it upfront, or in some cases - particularly on the medical side - they will delay or resist payment.  None of this makes insurance any less necessary, but it’s a fact to bear in mind.

MEDICAL

There’s not much to say here about medical insurance.  There are very few applications of medical insurance that can be considered a future investment other than medical savings accounts (MSA) and health savings accounts (HSA).  My understanding of MSAs is that they are being phased out into HSAs, and since they weren’t very common in the first place, I’ll take license to assume no one that will ever read this has one or wants advice about one.  The way an HSA works is that you have two pieces to your insurance: a savings account portion that accrues tax-free interest and a high deductible net to keep your medical expenses from hitting an excessive amount (say, $2,000 or $4,000).  If you are young, do not have a family history of sickness, and find yourself to be reasonably healthy each year, I recommend you considering an HSA as your medical insurance choice if it is available to you.  The key to success is to build your savings portion sufficiently in the early years to cover your costs with interest in the later years when you will need more medical care.  This is not necessarily a good plan to have with kids, but it is possible to be successful with it.

Outside of the savings account options, I think it’s important to stress having some kind of medical insurance.  Middle class families are typically not rich enough to support all of their medical costs alone, and can be bankrupted by unexpected or serious conditions.  I disagree with a lot of the way the insurance industry with medicine has gone, but I also don’t want to see someone lose everything because they need chemo treatments or develop a serious food allergy.  Coverage with an employer is the best way to go, but if you are self-employed (or your employer does not provide coverage) look closely at becoming self-insured.

DISABILITY AND AD&D

These two types of insurance are more commonly provided by a corporation than owned by an individual.  The key to remember with both disability and AD&D insurance is that the key to need is risk.  If your career and lifestyle are low risk, the need for these types of insurance goes down dramatically.  You don’t necessarily need to own them, and more often than not I steer away from saying anything about them.  Of course, as your risk increases your cost to purchase also is likely to go up.  In short, if you truly need to buy either of these, they probably aren’t going to be cheap.  If it is cheap, you may want to re-evaluate your risk tolerance.

LIFE

The ultimate of the loser’s game: you win the lottery as soon as you can’t spend it anymore!  However, as you grow your family, the people that are left behind will have greater loss than the already devastating loss of your presence in their lives.  You must consider your debts, unrealized retirement investments, paying for college, weddings, cars, homes, and any other expenses you had or were soon to realize when evaluating just how much life insurance to purchase.  Consider life insurance as a ripcord for your loved ones to subsidize your lost income, and consider it only as that.  Your money is better invested in “living” sources than it is in insurance for your death.  While it might be great to say you’ve got a million dollar Term plan, for example, if your need is $200,000 you will be overpaying for your insurance each payment.  If your plan is to make your loved ones richer than they currently are by your death, you may want to evaluate your outlook on life (and perhaps consider therapy – don’t be so in love with death that you want to make it an enterprising opportunity).

There are three main types of life insurance: Term, Whole, and Variable.  Term Life is set for a fixed period of time of contribution to insure that at any time during that contribution period (or other, pre-set period) a payout will be guaranteed.  At the end of the period of time, both parties walk away from the agreement; if you haven’t died by the end of the Term, they keep the money and congratulations, you’re still alive.  Whole life is exactly like term in its contribution period, but the contribution amounts will be much greater.  At the end of the contribution period, a whole life plan will then make an annuity-like periodic contribution back to you.  In most cases, Whole Life covers a payout for an extended period of time after contribution.  Typically, your contribution amount for Whole Life does not increase over time like the other two life insurance types.  Variable insurance has a Term Life period and an after-contribution payout like Whole Life but at a cost somewhere in between the two.  It’s somewhat of a hybrid of the two other types of insurance.  HOWEVER, variable insurance requires that the purchaser (that’s you) manage an investment account to grow the final payout amount.  Variable insurance also gets more expensive as you age, which will probably have an impact on your final investment account dollars.

If your savings in other places (investments, 401k, and savings account) are already significant, and you can afford it, consider purchasing Whole Life insurance as a supplementary retirement account.  Most likely, you cannot afford Whole Life and make significant investments as a member of the middle class.  Most insurance advisors recommend against purchasing Variable insurance.  The cost is somewhat significant and all of the risk of gaining a financial payout at the end is on the purchaser.  So basically, purchase Whole Life if you can afford it and are already fat with investments, purchase Term Life otherwise.

Like disability and AD&D, many companies will also provide optional supplementary insurance.  Before purchasing an independent insurance plan, evaluate whether your needs would be met through this supplementary insurance.  Typically, rates will be significantly lower through your employer than privately AND many times your deduction from your pay for supplementary insurance will be pre-tax.  However, most employers do not supply Whole or Variable life options – only Term.  If your plan is to purchase Whole Life, you will probably have to do this on your own.

Insurance for Your Kids

You should not buy life insurance for your children.  If you are looking at this issue from the perspective of  income subsidy, you have to ask if your children are bringing income into your family.  If the answer is yes, the odds that you are actually middle class are low and this post probably does not apply (and you will need a different sort of help on financial planning).  Since we’ll assume the answer is no, what is it you are doing when you buy children’s life insurance?  Too often I hear that people do it because the cost is low and they buy an add-on investment package (through a children’s Whole or Variable plan) to a term plan.  Cheap is not a good answer for whether or not it’s unnecessary.  The reason it is cheap is because the risk of a child dying is incredibly low, and therefore an insurance company rarely has to pay out.  As for an investment, there are many ways you could be better investing your money for your children.  Not the least of which would be a Roth IRA.  Honestly, I don’t have any other way to put this – is $10k or $20k really going to make you feel any better if you did lose your child?  Are you going to miss the hundreds of dollars you spent on insurance when the child moves out of the term life phase still living?  If you really take the time to think about these questions you'll probably see the ansewr is just don’t buy it.

What’s next?

So as you go through the process of making your financial plan, you will hopefully have figured out your income and cost of living, and now the amount of money you will spend to secure your finances from problems and/or catastrophes.  The next step is to look at Investment Planning.  I need to think about how much I want to say about company plans and social security, so I may break it up into two posts.  I guess I’ll see as I get there.