Underinsurance is a problem.  Not one of those nagging, in your face kind of problems like traffic jams or a stain on your business shirt.  It’s one of those low probability, high consequence kind of risks that you carry around every day without much thought.

I’ve seen so much underinsurance over the last two years I thought it was worth some of your time (and mine) to identify why and then discuss why it matters for your financial wellbeing.

One thing is clear – we aren’t underinsured due to a lack of information or resources.  After all, property and casualty insurance businesses spent $6.5 billion in 2015 to advertise.  You likely have friends who sell insurance for a living and talk to you about it.  Heck, you’re even reading this article.  You know this is something that is important but you’re probably going to finish reading this and take no action.

Why aren’t you buying?

Two reasons – inertia and a lack of trust with insurance agents.

Bottom line, people don’t spend their day thinking about being killed or robbed.  I can’t blame anyone.  It’s depressing and unproductive to imagine all the ways your day can be ruined.  So, we bury this topic in the back of our brains, cross our fingers, say a prayer and hope nothing happens.

Once in a blue moon, we have a near miss (e.g. health scare) which triggers us into action and throws insurance to the front of our brain.  Even then, a lack of trust remains a barrier.

Insurance Agents are one of the least trusted professions.  According to a recent Gallup poll, less than 11% of Americans rate their trust of insurance agents as Very High or High.  Thank God for politicians (9%), otherwise insurance agents might occupy the bottom spot.

In conclusion, insurance is a topic that people don’t think about and when they are forced to do so (through ads or solicitation) run away as fast as possible.  Not exactly a shocker that I come across family and friends that are one disaster away from financial distress.

So that’s probably why you’re not buying.

Why is it important?

Let’s take a few minutes to educate on what insurance is, how to determine the “right amount”, and why you should stop reading this article right now and fix this gap in your personal finances.

First, let’s dip our toe into the insurance world and talk about the types of insurance.  Put simply, if there is a potential “loss” then there is likely an insurance company that will insure against the loss. Here are some common ones:

 

Loss: Death Insurance type: Life insurance

Loss: Auto accident Insurance type: Auto insurance

Loss: Improper or illegal medical care Insurance type: Malpractice insurance

 

The type of insurance you need is dependent on the types of potential loss you are carrying in your daily life.    The amount you need is much less straightforward as the answer comes with the dreaded words, “it depends.”

My interpretation, and what I tell my clients, is that you should insure against any type and amount of loss that is legally required or would threaten your financial wellbeing.  For those living paycheck to paycheck that could mean insuring their laptop they bought at Best Buy.  For the wealthy, that usually means insuring against higher dollar amount losses such as loss of life, disability, or harm to a small business.

Since many of the cases that we see at Cirrus are life insurance related, let’s take a look at a very straightforward example:

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Case Example (illustrative purposes only):

Background: 35-year-old, attorney, earning $100,000, $300,000 in assets, with two kids and a partner (also 35 years old) that stays home with the kids.

How much life insurance is needed?

Assumptions:

• The $100,000 of income translates into $80,000 of take-home pay, of which $20,000 is saved, the remaining $60,000 is spent.
• We need $60,000 to cover expenses right now and in perpetuity
• We need to fully cover the cost of college tuition for both kids starting in 12 years

Asset pool needed to generate $60,000 in perpetuity safely – $2,000,000 (~3% withdrawal)

Cost of in-state tuition, room and board in 12 years for two kids – $300,000

Answer:  Assuming time value of money plus a little contingency our attorney needs approximately $2-3M of life insurance.  This is overly simplistic and we are ignoring a lot of the particulars for this individual.  That said, this gets you in the ballpark.

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That amount might surprise you, it certainly surprised me the first time.  Particularly if you are one of the individuals that buys life insurance through work at a multiple of their salary like I used to do.  For people in that position they are likely carrying $300,000-500,000 of coverage.  Imagine the financial stress of trying to keep a family afloat on 25% of what they need to make it long term?

One of my colleagues shared a quote that has stuck with me.  You only buy life insurance if you have one of two situations – you owe people money or you have people you care about.  I’m guessing if you’ve read this far, you are one of those people.  So, take a moment, reflect and determine if you’ve adequately protected those you care about.