Join Ken Boyd for an in-depth discussion in this video Planning for risks, part of Setting Your Financial Goals.
- An important part of your financial plan involves planning for risk and to avoid outcomes that you don't want. In other words, taking action to manage risk. Now, risk assumes that you have something to lose. As an example, you need to protect against assets being damaged or stolen. You also need to protect your ability to earn an income. You can think of this concept in the short term and the long term. In the short term, you need medical care to get over an illness and get back to work.
Over the long term, you need to protect yourself against being disabled and unable to work. Finally, you need to have a plan in place to ensure that your income can be replaced in the event of your death. We'll discuss each of these topics. In most cases, you manage risk by purchasing insurance. However, there is an important point to be made about the cost of insurance, based on the advertising that is everywhere these days. You may see ads that talk about cheap versus expensive insurance.
That's an incorrect way to think about insurance. Here's why. Insurance is all about probability. In fact, the insurance industry hires hundreds of math majors to become actuaries. Actuaries make predictions about future events. If XYZ Insurance sells car insurance, they want to predict the number of people who will file a claim based on having a car accident or their car stolen. That prediction is based on the driver's age, type of car, where they live, among other things.
This prediction works into the cost of insurance for each driver. The insurance company looks at the probability that someone will file a claim along with the dollar amount of the potential claim. That's what drives the cost of insurance. Here's my point. In many cases, cheap insurance is simply insurance with less coverage or insurance that pays less when you file a claim. Expensive insurance, on the other hand, provides broader coverage and pays more when you have a claim.
The insurance industry is a heavily regulated industry. There are not huge differences in profit between insurance companies. Their pricing has more to do with the coverage offered than the amount of profit the company makes. To plan effectively for risk, look closely at what is covered in your insurance policy. That's what you're paying for. Find an insurance agent who sells coverage for a variety of companies. Have that individual help you decide on a policy that is right for you.
While there's no exact order of priority, this discussion starts with the risks that are most important to cover. Start with protecting assets. Any expensive asset that you purchase should be insured against damage and theft. Most states require you to have car insurance, so that's probably an automatic. If you're renting an apartment or home, you should strongly consider getting renter's insurance. This area of insurance is often neglected. While you may not own the place that you live, you have valuable contents inside.
Many insurance agents recommend taking pictures, room by room, of the contents of your dwelling. This may sound extreme, but it's the most effective way to prove what you've lost, in the event that your home's contents are damaged or stolen. Consider taking this step when you rent or own your home. Once you have the assets insured, the next step is medical coverage. At a minimum, everybody needs coverage for catastrophic illness. One purpose of medical insurance is to get you healthy so you can get back to work.
If you choose not to have sufficient coverage, you may put off paying for insurance out of pocket. By delaying getting medical help, you may prolong your illness, which may limit your ability to work. This is another reason to have a discussion with an insurance agent. Beyond medical insurance, you should consider disability insurance. The purpose of this coverage is to replace a percentage of your income when you cannot work. Some people are able to get this coverage through work. It can be very expensive to purchase on your own.
If you're self-employed, you'll need to prove several past years of income before the insurance company will provide a quote for disability insurance. Finally, consider life insurance. Life insurance can provide a lump sum that can be invested. Income from the investment can replace income you earned to care for your spouse or children. Everyone who marries or starts a family should have life insurance. All of this risk management comes with a cost. Your next step is to meet with an insurance agent, who can help you with all of these types of insurance.
Make it a priority to meet with an insurance agent. Once you decide on insurance coverage, the cost of that coverage should be part of your overall financial plan.