What Types of Insurance do I Need?
Everyone needs insurance to protect themselves from financial ruin due to loss or liability. We suggest looking into health insurance, life insurance, homeowner’s/renter’s insurance, auto insurance, long-term disability, long-term care, and umbrella policies to mitigate the financial perils of risk.
I’m going to level with you.
I enjoy most of the topics we’ve written about on our site.
Insurance isn’t one of them.
Insurance also happens to have the ironic characteristic of being a product that is purchased by people who hope they never use it, sold by people who hope they never do.
Regardless of the entertainment value of discussing personal risk management (or lack thereof), we would be remiss if we failed to address this all-important topic of personal financial management.
We do cover insurance at a very high level in Milestone 9 of the Next Dollar Roadmap, but a more thorough explanation is due.
Below we’ve listed 7 categories of insurance we think you should own or consider in order to protect your financial well-being, along with a description of how these policies work and how much coverage you should carry.
I’ve also listed them in my perceived order of importance, though this is debatable depending on your circumstances.
Finally, I feel obligated to inform you that although I own insurance, I don’t sell it and won’t earn a commission if you decide to buy it somewhere. But this guy can help you out…
Remember Me? Cuz I sure as heckfire remember you!!!
Without any further ado, let’s dive into the wonderful world of insurance, shall we?
Choosing an Insurance Company
One of the absolute worst things that could happen in the world of insurance is for your coverage to fail to meet your expectations when you need it.
This could happen as the result of several circumstances:
- Your insurance company fights tooth and nail to prevent having to cover a claim.
- Your policy lacks coverage for certain events or circumstances that you were not aware of. Thus, your policy isn’t what you think it is.
- Your insurance company isn’t financially capable of meeting its coverage obligations when you need it.
Insurance is a highly competitive industry and there is no shortage of salesmen eager to over-promise on the capability of their policies.
Like most products, customers tend to seek the lowest cost options which can cause insurers to operate on pretty slim margins or get creative in how and when they pay out benefits.
For me, insurance is a clear case of you get what you pay for. Going cheap here may leave you with a lot of regrets.
To help evaluate the overall performance and stability of an insurance company, look up their ratings by Standard & Poor’s or Moody’s.
The rating systems are different, but they can give you an idea of an insurance company’s overall worthiness based on its financial stability and the quality of its policies.
Health Insurance
Health insurance exists to cover the exceptionally high costs associated with medical treatment, should you require it.
I predict many will ask why on earth I’ve listed this as a priority ahead of life insurance. After all, death is a little more serious than a health problem, right?
Yep, that’s true. But, as it turns out, it’s much more expensive to keep someone alive than it is to bury them.
The average funeral will cost between $7,000 and $12,000, while the average lifetime healthcare cost of a person is $316,600.
No, life insurance isn’t designed to just pay for a funeral. It’s designed to replace income.
However, a major medical incident such as the treatment of cancer or a heart operation can be even more costly than losing a source of income; sometimes into seven-figure territory.
And you still have the future risk of the patient dying, which is somewhere around 100% in case you were curious.
In summary, we feel that a medical incident has the potential to do more damage to your finances than even the loss of income through someone’s death (not that life insurance isn’t important).
In fact, 67% of people who file for bankruptcy cite medical costs as a major contributor.
So, if you have the option, get medical coverage.
We don’t really have the bandwidth in this post to cover every medical insurance option available under the sun, but we will distinguish between two types that most people commonly see offered by their employers.
The first one we’ll discuss is a High Deductible Health Plan or HDHP.
High Deductible Health Plan or HDHP
An HDHP is a health insurance plan that carries a higher deductible for covered individuals resulting in lower risk to the insurer.
The insured is compensated for carrying this extra risk in the form of a lower monthly premium for their insurance coverage.
HDHP deductible amounts and out-of-pocket limits are set by the federal government. In order to qualify as an HDHP, a health insurance plan must meet these limits.
For 2023, an HDHP must have a minimum deductible of $1,500 for individuals or $3,000 for families. The maximum deductible for 2023 is $7,500 for individuals and $15,000 for a family.
Once you reach the maximum deductible, 100% of in-network care expenses are covered by insurance.
For comparison, the average PPO deductible in 2020 was $1,204. For HDHPs the average was $2,303.
In summary, HDHPs place more risk on the insured. The trade-off is a lower overall premium.
For carrying this additional risk, the government allows HDHP holders to receive a greater tax benefit and have more control over their savings for medical expenses through a Health Savings Account or HSA.
HSA’s are my favorite tax-advantaged savings vehicle. If you are not familiar with them you should check out this post in which we compare HSAs vs FSAs.
If you are healthy and rarely find yourself at the doctor or pharmacist, then an HDHP may be for you. My family and I have used one for years through my employer and have been very happy with it.
If you prefer a safer route, then the next, more traditional option may be for you.
Preferred Provider Organization or PPO
A PPO is basically a traditional healthcare plan.
If you obtain medical coverage through your employer, they are using the volume of people in their workforce to negotiate lower insurance coverage costs for their employees by agreeing to have their healthcare plan hosted by a single insurer.
The insurance company maintains a preferred network of medical care providers with whom they typically have some form of pricing agreement in place.
The deductibles for PPOs are typically much lower than HDHP’s (they can even be $0.00), but the premiums are generally much higher.
Your overall financial risk is much lower with a PPO because the insurer is carrying that risk on your behalf, but you are compensating them for that with a higher premium.
You cannot contribute to a Health Savings Account (HSA) unless you are covered by an HDHP, but if you use a PPO you are eligible for an FSA if one is available to you through your employer.
Life Insurance
As we’ve already pointed out, the purpose of life insurance is to replace the value or income that someone creates for dependents. As a result, it’s not necessary for everyone to have it.
If you don’t have anyone who is dependent upon your income, you do not need life insurance. You may elect to take out a policy for the benefit of a loved one or charity of choice, but it isn’t a necessity.
It’s necessary to point this out because the insurance industry spends a lot of time and money convincing people that they need life insurance (among other products) when they don’t.
For example, there are a lot of insurance companies that will sell you a policy on your minor child’s life.
I love my children and I hope to outlive them, but in the tragic event that I don’t their deaths would not create a sudden financial strain in our household because they don’t produce an income or generate any other monetary value to speak of.
In most cases, you’ll only need life insurance for yourself and your spouse.
If your spouse does not work outside the home but generates value in other ways, like childcare, then you should probably take out a policy on his or her life as well.
This is because you would incur significant expenses replacing the value they create for the household in the form of childcare.
An in-depth look at life insurance is too large to squeeze into this post, so we wrote a unique one. In our Whole Life vs Term Life post, we walk through each insurance type and discuss when they should be utilized.
We also walk through our real-life insurance evaluation and why we chose term for our family. Check it out.
Auto Insurance
If you drive a car you need liability insurance at a minimum.
There’s just a lot of inherent risk that comes with operating a 1,000+ pound hunk of metal at high speed in proximity to other 1,000+ pound hunks of metal operating at equally high speed.
Accidents are an inevitability which means damage to property, and worse, to people is going to occur.
The fact is auto accidents can be very expensive and you need protection in case you damage someone or something more expensive than you can cover out of your own pocket.
According to the National Safety Council (NSC), on average an automobile accident could cost anywhere from $4,700 to $1,750,000 depending on the severity.
That level of liability could easily spell financial ruin for most of us.
In addition to the possible liability to others, if you can’t afford to replace your own vehicle out of savings (or don’t want to), you should probably carry coverage for your own car.
Granted, if someone else hits you, their insurance should step in to make you whole, but what if you’re in a hailstorm or your car is stolen?
What if someone hits you, but doesn’t have insurance and can’t afford to repair your car? After all, you can’t squeeze blood from a turnip.
Comprehensive and collision coverages will cost a little extra, but can provide protection from these events.
Finally, there’s wisdom in checking your policy coverages, limits, deductibles, and other features from time to time.
Many of us can’t remember the details years after insurance is arranged, but our circumstances and needs change all the while. Don’t have a blind spot here.
Homeowner’s/Renter’s
If you have a mortgage, you probably have no choice but to carry homeowner’s insurance. As a homeowner, you should anyway.
After all, a home is not easily replaced, but the monthly premium for homeowner’s insurance is much cheaper dollar for dollar as compared to automobile insurance.
If you’re a renter and you have anything of value that needs to be covered, then you should have renter’s insurance. I feel this is especially true if you live in a multi-tenant space.
Renters are notorious for exercising a lower level of caution in their behavior while dwelling in a structure they don’t own.
Landlords are bursting with stories of tenants repairing car engines in their living rooms, grilling indoors, and using ovens to heat a space, among other questionable and unsafe practices.
If one of your neighbors starts a fire or finds some other way to destroy the building you live in, your renter’s insurance may save your bacon.
Long Term Disability
According to the Social Security Administration, a 20-year-old has a 25% chance of becoming disabled before reaching full retirement age.
The average length of a disability? 34 months.
Even if the disability isn’t permanent, an injury or illness could leave you out of work for months or years at a time. Financially, the results could be catastrophic.
Long-term disability insurance is designed to replace your income, or some portion thereof, in the event that you become sick or injured and cannot work.
Like many insurance products, long-term disability insurance can be provided for a period of just a few years or all the way to full retirement age.
Typically, those seeking long-term disability insurance will buy coverage up to some portion of their current income. The most common is 60%, but it is available in nearly any quantity you’re willing to pay for.
Most people would do well to purchase coverage through their employer, though long-term disability coverage is available on the open market with premiums generally around 1% to 4% of your annual salary.
One benefit of joining a group plan through your work is the avoidance of a medical review. If you are in questionable health, an employer-provided option may be a significant benefit.
If you do elect coverage through your employer, you may have the option to pay the monthly premium on an after-tax or pre-tax basis. Whichever you select, the opposite tax condition will occur if and when you begin receiving benefits.
In other words, if you pay premiums with after-tax dollars, the benefit would not be subject to taxes. If you pay your premiums before taxes or your employer pays them for you and does not report the premium on your W-2, your benefits will be subject to applicable taxes as you receive them.
It’s like disability insurance has a Roth or Traditional option.
In the event you become disabled, you’ll have to clear an elimination period (usually 6 months) before long-term benefits kick in. This is yet another reason to have a fully funded emergency fund or some sort of short-term disability coverage.
Long Term Care
Not to be confused with long-term disability insurance which replaces income, long-term care insurance is designed to provide coverage for long-term care either in a facility or at home care provided by a professional.
The cost for these services can be quite significant, running into the hundreds of thousands per year. Thus, the possible need for insurance.
Premiums for long-term care average $225 per month and increase with age and total benefit amount.
Given the high cost, many people avoid coverage altogether or delay it as long as possible. In 2020, an estimated 7.5 million Americans had long-term care coverage of some sort. That’s about 1 in every 50 people, three-quarters of which are over 55.
One popular point of view is if you can afford the coverage, then you might as well self-insure because you must have plenty of money to afford the premiums. On the other hand, if you can’t afford the premium, you’re exactly in the financial situation where coverage would be most beneficial.
It seems that with long-term care, you’re darned if you do and darned if you don’t.
Personally, I do not have coverage and hope to self-insure when I am older.
Umbrella Insurance
Per the name, umbrella insurance provides an umbrella of protection over and beyond the liability limits of your existing insurance. So, if you are sued and the award amount exceeds your existing insurance coverage, an umbrella policy would step in where basic insurance leaves off.
For example, assume your dog bites the neighbor and they are awarded a lawsuit in the amount of $600,000. If your homeowner’s liability policy topped out at $300,000, your umbrella policy would cover the balance.
The same would be true if someone in your household incurred a liability for an auto or boating accident. Also, if you own a rental property, an umbrella policy typically provides extra liability coverage for that as well.
As we’ve already indicated, umbrella policies typically cover everyone in the policyholder’s household.
Effectively, what an umbrella policy really protects is the assets that might be vulnerable to a judgment against you if you are sued. Without an umbrella, your savings, retirement accounts, and even your home could be sold or seized to pay for a judgment against you.
As a result, umbrellas are a necessity for those with any measurable wealth worth protecting, but not a bad idea for anyone with possible exposure to the risks we’ve listed above.
Fortunately, umbrella insurance is very inexpensive for the coverage it provides. This is partially because the insurer will likely have minimum liability coverages on your basic homeowner’s and auto policies, thereby limiting the risk to them.
We found it easiest to purchase our umbrella from the same company that we use to insure our home and automobiles. We were given a small discount for doing so and it made the administrative burden much lighter when we took on the policy.
Conclusion
Life is full of inherent risks. Those risks are a significant danger to your financial well-being. Thankfully, they can be mitigated through a thoughtful insurance plan.
Spend some time considering the coverages above and what is or isn’t appropriate for your own situation.
If there’s an insurance product you’d like to learn more about, shoot us a note from our contact us form and we’ll write a post about it.
