Wednesday, February 27, 2008

FPU 7: Insurance

Boring. Insurance. Is. Not unless you are an insurance yoda I suppose.

Ramsey's style made this necessary session bearable enough for me to take the topic more seriously than I have in sometime. Insurance planning is not as fun as going gang busters after a short term goal but insurance is a key component of a total financial plan.

The presentation from Ramsey was consistent and he ended it with a very compelling real life story of a man and his family and the benefits of being adequately insured. However, I did not like the message Ramsey sent about a certain type of life insurance - in the later half of this post I give my reasons why.

This session covered the basics of what type of coverage is needed in a standard financial plan. From the right type of Homeowners/Auto and Life to Disability Income. He also discussed what types of insurance that should be avoided (i.e. Credit Life, Accidental Life.)

I walked away thinking about how I am going to deal with major exposure to the risk of loss of income if I ever become disabled and not able to work. I remember this stat from the time in my life when I used to sell insurance and investments - 1 in 3 people will be disabled and unable to work at one point or another in their life time. Ramsey mentioned the stat in this session too. Think about it. It is staggering. I remember too when I used to sell disability insurance that it was one of the easiest sales when the prospect really got it. When they really understood the risk. I also remember the battle of convincing people that the high premiums are worth it. Even today, I sit fully exposed to the risk of loss due to disability because I feel I can not afford the premiums. Why do I (and others) think the risk is not personal relevant? I always used to tell people..."The chance of becoming disabled is 100% when it happens to you." The high premiums are the deciding factor, however.

Most employers offer a form of short term and long term disability insurance (D.I.) and most employees purchase it through payroll deduction. Dave didn't stress this point all that much but most DI employee benefits are woefully inadequate. I won't get into all the reasons but in summary there are just too many restrictions on the terms of actual payouts. Some kind of supplemental DI is needed to cover risk not meet by employer DI plan offerings. Back to where I am currently. Fully exposed. I will look into obtaining my own personal DI insurance but I already know premiums will be too high. I will at least look around and get some quotes.

Phew! This post is already too long and I haven't even got to what I really wanted to write about. So here goes it.

The single gripe I have about this session on insurance is Dave's handling of any type of permanent "cash value" life insurance (aka Whole Life, Universal Life, or Variable Universal Life.) Dave attacks this topic with more passion that I've seen so far in FPU. Dave clearly hates permanent life insurance. I understand the hatred. If you look at how this type of insurance has been erroneously marketed and sold as an investment and then you actually run the numbers and compare the the strategy of "buying term insurance and investing the difference", buying whole life as an investment is as blindly foolish as a lumberjack sawing on a branch he's standing on, but in the space between he and the tree. From that perspective, I get Dave's passion.

It's ironic though because two sessions ago Dave confessed his strange fascination with the excellent marketing of banks and credit card companies. In that session Dave attacked the marketing methods but in this session on insurance he attacked the product and the companies (and, to some extent, the agents who sell whole life insurance.) Yes, permanent life insurance as an investment is a bad, bad, bad idea. Permanent life insurance as an insurance idea is really not even close to being as bad as Dave shouts about it. The major problem with permanent life insurance is how it is marketed and sold.

Marketing methods aside, and as with any other financial product on the market, there are many reasons why term insurance is better for most people than permanent insurance. But I totally disagree with one of the reasons presented in this case against permanent insurance - that when you die the insurance company keeps your cash value and only gives your beneficiaries the death benefit. I disagree because the reason falls short of a complete technical understanding the workings of permanent insurance. Also, the unsaid implication points to thievery on behalf of the insurance companies. I know Dave is much wiser than this. Dave is a financial expert and phenomenal servant teacher. I can't figure out why he would stop short and say something to the effect that the insurance company takes your cash value and leaves your family short.

Very simply, the reason permanent life insurance contains a cash value account is because the insurance is really a declining term type coverage. As the cash value builds, the true insurance coverage actually goes down while the total payout at death stays the same. As the cash builds the risk is transfered away from the insurance company and back to the policy holder. At death, the cash value is actually part of the total death benefit. For example, on a policy that pays $100,000 at death, at first there is no cash value and so the total insurance is $100,000. Fast forward to a point when there is $3,000 in cash value. At death the $100,000 is still paid but it consists of $97,000 of true insurance from the insurance company and $3,000 of cash value. You see? The insurance company is not stealing the cash value. This simple understanding of permanent cash value insurance douses the balls of fire launched by so many haters. With all that said, permanent insurance has its place in the marketing place, not as an investment tool, but in cases where its more likely needed such as complex estate planning and executive pension planning (only two examples.)

By the way, I own term insurance because I get a higher death benefit for a cheaper premium and I am not investing the difference because I am using the difference to pay off debt.

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