Insurance

An integral part of Financial Planning is “Risk Management”. Insurance is the “vehicle” by which one manages or controls various risks to which they are exposed. Click on the appropriate insurance below, for description, pertinent information, prudent applications, and "what to look out for" when choosing coverage. 


Credit Life Insurance

 

 

 

For a better understanding of the underlying premise and history of insurance, read the following:

INSURANCE - A SHARED RISK CONCEPT WITH ANCIENT ROOTS
    BY William Peterseim, Licensed Insurance Agent, Certified Financial Planner

Perhaps more than any other financial product, insurance is the least understood and, to most consumers, the most confusing. It doesn't have to be.

So, let's begin by understanding that insurance is our friend. The entire concept is that you are able to pay someone else, some other entity, to share a risk you have. So, why resent that? Why feel that they are robbing you with what they charge? No one owes you anything and you’re the one with the risk.

It is also interesting to note that not all risks are insurable. That's right. There have been many instances where an individual or company sought to insure themselves against a specific risk of loss but couldn't find any company willing to underwrite (insure) the risk.

This is usually because there is no way to accurately assess or determine the risk. The insurance underwriter is unable to quantify the probability of an occurrence. This is often because their actuary (the professional employee who keeps records, maintaining statistics on frequency of loss) has inadequate data.

As I recall, when America was first attempting to go into space, no one would insure a launch or a satellite against failure. Why? We had no record to run on. The underwriter couldn't go to the book and see that, for instance, out of the previous 20 launches with this particular rocket, only 3 had failed. You see, if he could, then a loss probability could be calculated and an appropriate premium to charge determined. At that point, the risk of loss could become insurable.

 

Another factor that would prevent insurability or at least lead to a high premium would be if the statistical “population” was deemed to be insufficient to accurately determine probability. In other words, using our example, there haven’t been enough launches yet to get a good “feel” for true probability.

 

For instance, let’s say the first three launches ended in disaster. But, something is always learned from these failures and corrected. No one would insure the next launch though. Let’s say the next launch was a success. It still doesn’t mean any company will insure the next for maybe it was a fluke and you just got lucky. However, if 9 of the next 10 launches are successful, odds are, as long as the current standards are adhered to and nothing new and untried is thrown into the equation, an insurance underwriter may offer coverage.

 

Once an offer is made, you can expect the premium to be higher than the perceived loss ratio initially because one failure (in the numerator of the ratio fraction) can cause a much wider variance in the answer with a fairly small denominator.

 

Conversely, the larger the statistical population (denominator) over time the closer the premium can be set to actual loss ratio. Let’s look at an example.

If you lost one satellite out of five launches, your loss ratio is 1:5 or 1/5 or one fifth, which is 20%. An insurer wouldn’t set a premium close to 20% of the cost of the satellite at this point because if the next launch is a failure, you now have a loss ratio of 2/6 or one third (33.3%) and the insurer would lose big time.

 

But, if you’ve lost 1 in 20 (5%) and lose the next one, 2/21 the ratio increased but is still less than 10% and not that much greater than 5%.

 

The result is that today, not all, but a number of launches or satellites themselves can be insured because the overall track record in space has been a good one and failures are relatively rare today, predictable, and thus insurable.

 

Before moving on, let me just add that the roots of the concept of shared risk which underlies all insurance goes back to ancient China to roughly 5,000 B.C. so is long established.

 

I am always amazed when it comes to life insurance that insurers are willing to insure us and so many of us resent paying premium or remain un-insured or under-insured. Why?

 

Well, if you buy a car, you insure it against loss, unless it is a junker, you can afford to write it off as a total loss, and you don’t have a loan on it. You insure it even though, in most areas, you have a relatively small probability of any significant loss due to fire, theft, accident, or vandalism…maybe only about a 15% probability. It still makes sense to insure higher priced vehicles to prevent the serious financial damage to you over a loss should one occur. (I’m not referring to the mandatory liability insurance you must have)

 

Same thing with your home. You carry Homeowners Insurance to protect yourself (and the lender) from financial ruin due to fire, flood, or storm. Even though the potential for a serious loss may be less than 5%, it still makes sense. Remember, it’s kind of like a weather forecast. If the weatherman predicts a 5% probability of rain but it rains right on top of you, as far as you’re concerned, you didn’t get 5% damp…you got 100% soaked.

 

So, now I have to ask you: With the exception of The Rapture, what are your odds of dying……eventually? Pretty good, right? Like 100%. Yeah. Not happy about it but no one’s yet figured how we get out of life alive. So, two questions:

 

 

Well, insurance companies can and do insure most of us based upon a number of factors that relate to the actuarial data base because that data base is extremely large and predictable, thus making our risk of death calculable and insurable.

 

In concluding my remarks on insurance, as a whole, you need to know that not always, but most of the time, you have three choices to make on many things you choose to undertake in life and assets you choose to own. These choices all focus on how you will handle the financial risk involved with each activity or acquisition.

 

You must choose (and you do choose even if you put it off or pretend that you are deliberately choosing NOT to choose) between these three options on handling risk:

 

 

Example: Let’s say you see a great video on sky diving. You are really excited about it. You have several choices to make because, as a pilot, I’ve often been asked why anyone would jump out of a perfectly good airplane. Good question. Obviously there’s an appeal to many people. But, as to you personally, let’s look at your options and apply them.

 

Retain the risk yourself. Ok, you go climb in and jump out of the plane. That’s one.

 

Or, you choose to transfer some of the risk. You first take lessons, pass the training and THIS TIME jump….with the chute. (Oh! You need to re-read the first illustration)

 

Or, you choose to transfer most of the risk. You do all of the above, but do a tandem jump and only after you get your life insurance to where it needs to be with full disclosure about your intended jumping.

 

You avoid the risk entirely. You get your brother-in-law to jump while you practice your needlepoint in the car. (Works for me)

 

By the way, I did say that refusing to choose to choose still involves a choice. If, for instance, you purchase a brand new exotic sports car and, because you have it, you pay cash for it. Well, no bank can tell you that you have to insure it. And, you’re so excited and anxious to show your friends that you choose not to think about insurance at this time. Furthermore, this is your first car so you don’t have auto insurance in place. But, there’s plenty of time to check on insurance. You choose NOT to choose. BUT, like I said, doing so, you still chose….to retain all of the risk.

 

On the way home, you get into an accident and total the car. And, it’s your fault. You are out all of the money for the car. You lose your driver’s license in most states for at least 90 days, and I’m not even going to talk about the potential financial ruin if others were hurt or killed. YOU ALWAYS CHOOSE ONE OF THE THREE.

 

 

Most folks who attempt to wisely employ financial planning in their lives will properly address Risk Management by acquiring the prudent amount of insurance to protect their wealth and ability to produce wealth.

 

In so doing, they are opting to utilize a small amount of their earnings to pay premiums to purchase enough of the right kinds of insurance to transfer a sufficient amount of their various risks to ensure the financial viability (that’s more than mere survival) of their family if and when certain events occur.

 

The willingness to do that is all a part of good stewardship.

 

When we love our families we choose to protect them. Prudent insurance is showing that love.