“I’m insurance poor!”
Whenever someone raises the twin topics of insurance and affordability, a little red flag goes up in my little brain.
In 99% of the cases I see, the problem is not affordability, but effectiveness. Will the coverage you have actually DO what you want it to DO when the car wrecks, or the house burns? The question you should be asking is, “What coverage can our family afford NOT to have?”
On that note, allow me to broaden the discussion a bit to the larger topic of financial benefits (which is what insurance is). Most of us trade money for financial benefits. But because we don’t know how to think about them, we don’t have a common-sense frame of reference to inform us of when we are getting a good value and when we’re not.
Let’s say you own a house worth $250,000 and you pay $1500 a year for homeowners insurance. As long as you own the house without a mortgage, you could skip the homeowners insurance and keep the $1500. You could save up the replacement cost of your house in…166 years! OK, maybe skipping the homeowners insurance isn’t such a great idea after all.
By giving the insurance company your $1500 each year, you are transferring the risk of experiencing a $250,000 loss. The insurance company can do something you simply cannot – spread out the risk that any single house will burn among hundreds or thousands or other homes in similar situations as yours. The clear benefit you receive is risk transfer.
But the various forms of “catastrophe insurance” are not the only financial benefits available.
Tax credits provide a dollar for dollar offset against your income tax bill. Therefore, if you could buy $10 worth of tax credits for $6, you’ve saved $4. That’s a good deal.
Zero coupon bonds are bonds you can purchase in which the interest payment a bondholder would normally receive has been sold off to someone else. The only thing a zero coupon bondholder gets is the principle value of the bond itself at maturity.
Therefore, a $100,000 bond paying maturing in ten years and paying 4% interest might be sold for a discounted value of about $66,000. The buyer knows that his $66,000 is going to be worth $100,000 in ten years.
Series E savings bonds work in a similar way. And guaranteed income annuities also represent the trading of dollars today for a stream of income tomorrow that will last as long as you live.
One of the least understood, yet most advantageous keys to successful financial planning, is understanding how to evaluate and take advantage of financial benefits.
Maximum financial performance is achieved when you optimize the balance between money supply and money benefits.