One of my jobs as a financial planner is to identify and mitigate financial risks through insurance. For example, a sudden death of a family member could derail your family’s goals, making it a serious risk to your family’s financial well-being. This risk can be mitigated through life insurance.
Although it’s important to have insurance to protect against different risks, there is a cost—not just in dollars—to being over-insured. So let’s discuss a few rules of thumb to prevent you from being over-insured.
The biggest area where I see people over-insured is through life insurance. Most of the time, a person is sold a cash value life insurance policy as a good retirement savings vehicle. Although this may be good to have from a tax standpoint, by taking out a massive life insurance contract, the insured has just made him or herself more valuable dead than alive.
I watch a good amount of Dateline, and it seems like once a month there is a story about someone who was murdered with the goal of obtaining their life insurance proceeds. Although it is important to have life insurance to provide your family with a source of income in the event of your death, being over-insured can provide an incentive for you to be dead, which is obviously not ideal.
And there are so many life insurance riders; I can’t cover each one in detail. However, I can safely say that riders wouldn’t exist if the life insurance company didn’t make money off of them. Know which riders meet your unique needs, and steer clear of riders that are too complex or sound too good to be true (because they usually are).
Know that the replacement cost of your house and the market value of your house are two separate amounts. The value of land is included in the market value of your house, but should not be included in the replacement cost. When you insure your house, you are insuring the replacement cost, or the cost it would take to replace your house. Having your house insured for the true replacement cost of your home rather than the value of your home can reduce your premiums.
You should have personal liability insurance on all cars you are driving, but having comprehensive and/or collision coverage on a beater is pointless. Ask yourself the question: If this car were totaled tomorrow, could I afford to replace it immediately with little to no impact on my finances? If the answer is yes, I recommend skipping the comprehensive/collision coverage and pocketing the reduced premium.
Long-Term Care Insurance
Long-term care insurance is designed to cover some, or all of the additional costs of needing long-term care. About 20% of the cost of care in most nursing homes is for essentials (meals, laundry, cable, meds) that you would already have, hence the 80% rule. For example, if the average expected cost of a private nursing home room is $215/day, purchase $175/day of coverage, not $215/day. Be sure to take into account other factors that are unique to each person such as no longer having travel expenses. This will result in significant reduction of premiums because changing the daily benefit up or down on long-term care insurance policies changes the premium by the exact same percentage.
For the most part, the cost of being over-insured is the increased cost of premiums and riders that you pay for but don’t need. By eliminating these unnecessary costs, you can potentially save hundreds or thousands of dollars per year and reallocate those savings toward other, more exciting spending goals.