Perry Glasser

PERSONAL FINANCE FOR THE CLUELESS–INSURING

In Business, Economics, EDUCATION, Finance, FINANCE FOR THE CLUELESS, Personal Finance on March 12, 2014 at 2:32 pm

 

WIZARD OF FINANCE

WIZARD OF FINANCE

 

Four Financial Functions

Of the four personal financial functions, Saving, Insuring, Spending, and Investing, Insuring may be the least well understood.

Dollar$ broods on the why this is so. Insurance is not hard to understand, but Wizards who specialize in selling financial products lie awake at night dreaming up complicated products to befuddle the Clueless, which products more efficiently separate the Clueless from their dough.And so we come to the First Dollar$ Law for the Clueless.

NEVER BLEND FINANCIAL PURPOSES IN A SINGLE VEHICLE

Someday you will meet an Insurance Broker Wizard who will tell you that the best way to save for your retirement is with a life insurance policy. You may also meet his cousin, the Real Estate Broker Wizard, who tells you to purchase a house you cannot afford because it is an investment; you will meet another Credit Card Wizard who will happily point out that with this wonderful card that costs next to nothing, whenever you incur debt, you buy free airline miles, nights in a hotel, or tickets to see Bruce Springsteen while enjoying a free trip to the Poor House!

Do not work with these Wizards. They are sharpies presenting proposition bets, but as Marlon Brando explained to Frank Sinatra, do not take a proposition bet. Ever. You willhave a wet ear.

 

Wizards charge fees for a service, to which they are entitled, but a Wizard who sells additional services will want to collect MUST do so for a higher fee than you might pay for buying each of those products separately.

Over the life of a policy, which can be decades, even small fees mount up.  You are ALWAYS better off paying for pure products.

Rather than plagiarize, Dollar$ is happy to refer you to a short, lucid explanation from CNN talking about Universal vs. Term Life. CNN concludes, “The lesson: If you need life insurance, get term insurance. If you want to invest for retirement, invest in IRAs, 401(k)s or similar retirement plans.”

Smart folks at CNN.

The Industry

To understand what you should or should not personally do, you first have to understand the industry.

Dollar$ swears the explanation will be short.

Let’s say we live on a nice, tree-lined street. Beyond ordinary town services, our neighbors agree it is to everyone’s benefit to preserve the neighborhood’s good looks, so we form The Dollar$ Neighborhood Association. Everyone throws in a few bucks every year as a matter of civic duty. From time to time, you sponsor a block party, and the DNA buys a keg of beer.

One terrible day, a storm comes through town, and three of those trees are torn up. Luckily, no one is hurt, no homes are damaged. Town workers haul the downed trees away.

The DNA checks its accounts. If we skip the beer this year, we can afford to replace the 3 downed trees.

Property values are preserved. Our lives remain lovely.

  • The DNA is a very small scale mutual insurance company.
  • The stockholders are the people of the neighborhood.
  • The beer is the annual dividend paid to shareholders.

For Profit

A for-profit insurance company works the same way, but they charge larger fees, invest all the money they get, and need millions of clients to spread the risk.  After all, a tornado could wipe out the whole neighborhood. Better to make our community at least statewide.

Whatever a for-profit does not have to pay out, is profit that they keep.

Actuaries, skilled mathematicians, calculate rates by studying masses of data and crunching numbers. Do you know what percentage of women between the ages of 11 and 40 will break a leg next year?  Neither does Dollar$, but there are actuaries who do. They also know how much it takes to fix a busted leg, and they build all those data into health insurance rates for women between 11 and 40.

For-profits may pay dividends to shareholders (who may not be policyholders). It won’t be beer.

If a for-profit does not invest well, it may go bankrupt. Consider what might have happened to the DNA if 10 trees were destroyed. What happens if a hurricane hits New Jersey, the Mississippi overflows it banks, or an earthquake hits Manhattan? Lesson: Buy life insurance only from a well-established company that has been doing business at least 75 years. Anything else is an upstart liable to go belly-up the day you need them.

Action Items

Insurance protects the purchaser from man-made or natural accidents that have financial repercussions.

Dos and Don’ts for the Clueless

Insurance is not:

  • A guarantee that a loved one will live forever;
  • A bet that should things go wrong your heirs will become rich;
  • An investment;
  • It is never a gamble you win by losing. “Great news! I died and now my family is rich!’

The more people swim in the risk pool, the less expensive insurance is for everyone. The more neighbor in the DNP, the more trees can be replaced. The more low risk people buy health insurance, the happier Democrats will be because they will be paying in, but not taking as much out. If that sounds like a scam to you, you are probably younger than 35 and have never been sick.

Do not worry: you will be sick someday.

  • Never insure your children’s lives, unless your kid is Shirley Temple and so provides a revenue stream.
  • Term life insurance is a pure insurance product. In the event of disaster, it pays big bucks. At the end of the term, it pays bubkis. Buy it.
  • Take the difference saved by buying inexpensive insurance and invest or save it to provide wealth or revenue later.
  • Buy term life for as long as dependents will need to replace any income lost to death. That’s usually 20 years after the birth of the last newborn child in a family.
  • Buy enough life insurance so that survivors can continue their lives uninterrupted—do not underestimate this. If a spouse will need to pay for childcare, insure the spouse is cared for.
  • If you have no dependents or heirs, you need no life insurance; but you should consider disability insurance.
  • Disability insurance is more crucial than life insurance. It does not have to be your fault, but if your neck breaks in a car accident, you might survive for decades and need financial resources for all that time. Social Security will no pay what you want or need.
  • Mortgage insurance does NOT protect you: it protects the mortgage holder, not your heirs. You kick the bucket, the bank collects.
  • In America, health insurance has become mandatory. This is controversial, but is no different from mandatory auto insurance about which no one complains. Dollar$ suspects the Weasel mindset is at work here.
  • Insure revenue-producing property from fire and theft. Your auto provides you with  the means of getting to and from a job. Be sure your auto insurancee will be for a renter if you lose your car temporarily.
  • Insure your house from fire and flood. Flood insurance is tricky and varies from state to state. Do your homework.
  • Insure your possessions that would need to be replaced, and insure for replacement value. If your house burns down with a 10-year-ol refrigerator in it, will you be buying a 10-year old refrigerator, or will you need a new one?
  • Liability insurance makes sense if you own assets someone else can attach in the event of your negligence. Someone trips over your rug, takes a header down the stairs, and sues for financial assistance for a lifetime in a wheelchair. Will they go after your kid’s college savings account?  (Yes.) Will you want insurance against that personal liability (Double Yes). Should you put assets in places they cannot be attached? (Maybe—now you need an attorney, but if you have that much dough, why are you reading “For the Clueless?”)
  •  NEVER buy a warranty extension on an appliance. A defective product can be returned. If it breaks too late to be returned, take the money you saved buy not buying extended warranty protection and apply it toward the purchase of a new product.
    Carry as little personal liability on your car insurance as you can. Brokers are going to disagree, but in a world where health insurance is now a legal responsibility of every Citizen, why are you paying for someone else’s health insurance?
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