Finance 123 –
Insurance (Chapters 10, 11, 12)
Overview:
Home Insurance
Renter’s Insurance
Auto Insurance
Health Insurance
Disability Insurance
Life Insurance
Personal Liability Umbrella
I.
Insurance
and Risk Management
General Terms
Insurance is protection against financial loss. An insurance company (or insurer) takes the transfer of risk from the policy holder (or insured). By spreading the risk of thousands of policy holders, the insurance company profits by collecting premiums in excess of claims (or loses money when claims exceed premiums).
Risk is uncertainty or lack of predictability. Risk is the chance that a peril may occur.
Peril is the cause of a possible loss, such as fire, hurricanes, accidents, or premature death.
Hazard is a condition
that makes a peril more likely. For
example, living in
Premium – dollar payment to insurance company for policy.
Types of Risk.
Pure Risk (insurable risk) is a risk that has only a downside (no possible benefit). These are the types of risk covered by insurance. There are three types of “insurable risks”:
Speculative Risk (uninsurable risk) is unique in that there is a chance of gain or loss. Examples include investments. These risks are not typically insured. However, not in the book, but there are ways to minimize this risk by using advanced investment strategies, such as hedging.
Risk Management Methods – the book discusses 4 techniques for “managing risk”. Some are simply not practical. Here are the four:
II. Property and Liability Insurance (namely Home
Insurance and Car Insurance)
A. Homeowner’s Insurance covers both the recovery of losses due to damage to the house (and its belongings) and potential liability due to injury to an unrelated party.
1.Recovery of Losses
due to Damage to the House (and its belongings)
2.The second major purpose of House insurance is to cover personal liability, for example, an accident in your home resulting in injury to someone else. Again, you will want to consider supplementing this coverage with a Personal Liability Umbrella (which only covers you on the excess amount).
3. Miscellaneous
Topics
Endorsements to a policy are special add-ons to the policy that address various miscellaneous matters. For instance, some endorsements give discounts for having
smoke detectors or security systems.
FLOOD INSURANCE is NOT part of a standard home owner’s policy. You MUST purchase flood insurance separately from the Federal Government.
4. Renter’s insurance
Renter’s Insurance is similar to Home owner’s insurance, except there is no need to insure the building itself. Thus, renter’s insurance covers:
personal belongings, . living expenses, and . liability for injury to others.
5.Home Insurance Cost
Factors
The cost of Home Insurance is determined by:
The coverage amount (replacement cost) and the deductible (make it reasonably high, because a low deductible is expensive, and you’re probably not going to file a claim for small damage, anyway). Consider $500 to $1,000 deductible.
The location of your home (zip code), and, resulting safety statistics.
The type of structure and type of construction (single family dwelling vs. condo, wood vs. brick).
B. Automobile Insurance
Minimum required by
state law. Must carry proof of insurance
in your car. Must also carry
Registration. Do NOT carry the Title –
put the title in your safety deposit box.
Similar to home insurance, automobile insurance can be divided into two main categories: (1) COLLISION and or COMPREHENSIVE insurance - insuring your property from damage that lessens its value and (2) LIABILITY - insuring you from liability for injuries caused to others.
We will discuss Liability first. This is what is required by state law. (You are not required by law to carry Collision or Comprehensive. However, if you have borrowed to pay for the car, your finance company will require this coverage).
1.Liability Insurance
for your Automobile
Automobile insurance is quoted as 10/30/10. The first number is per person for injury. The second number is per incident. The third number is uninsured motorist insurance. For instance, 10/30/10 means a maximum coverage of $10,000 per person, $30,000 total for the accident (for all persons injured), and $10,000 coverage for uninsured motorist (if you are hurt by an uninsured motorist).
As you know, this amount of coverage would be insignificant in a serious accident.
The standard protection purchased by persons with assets to protect is 100/300/100. Then, those persons purchase a Personal Liability Umbrella (for, say $2 million) to cover in excess of these limits.
2.Collision and
Comprehensive coverage on your Car
Your car is a large investment. You also want to protect this investment (in addition to protecting against liability). Also, if you have financed the car, the finance company will require Collision and Comprehensive.
Collision covers damage due to accident. Comprehensive covers all damage (for instance, your car is stolen).
GAP insurance is optional, even if you financed the car. However, it’s important to understand. Gap insurance covers you if the car is totaled and it’s worth less than you owe on the note.
For example, suppose you borrow $20,000 to buy a Honda Accord, and, you finance it over 72 months (6 years). After 3 years, you total the car. The blue book value is only $12,000; so the insurance company pays your finance company $12,000, plus sales tax. But, you owe $14,000 on the car.
Without gap insurance, you would owe an additional $2,000. With gap insurance, your insurance company will pay off the amount of the loan (not the worth of the car).
3.Miscellaneous Tips
about Car Insurance
You will need to decide on a deductible. Again, look at the higher deductibles. You’re probably not going to file a claim for $150 anyway since filing claims will place you in a higher risk pool (and send your insurance premiums up). Further, you can save on your premiums by declaring a higher deductible (look at $250, $500, and $1,000). The deductible is how much you have to pay before the insurance company pays. For instance, if your car is damaged, and the repair bill is $1,200, and your deductible is $500, then, the insurance company will only pay $700.
Another tip: At some point (after the car note is paid
off), collision and comprehensive are not realistic. For example, there is no reason to pay a $300
premium to provide for potential reimbursement on a car worth only $500. On old
cars, drop the collision and comprehensive coverage.
Another tip: If you have damage to your car that is covered, be sure to ask for Sales Tax. For instance, if your car is “totaled”, and the value of your car is $2,000, the insurance company is going to offer you $2,000 to settle the claim (instead of attempting to repair your car). The idea of insurance is to “put you back in the same place you were before the accident”. If you have to buy a car, you’ll have to pay sales tax. You are entitled to not just $2,000; but, $2,000 plus the sales tax on a purchase. If the sales tax in your area is 8%, you’re entitled to an additional $160. But, you won’t get it unless you insist.
Another tip: If your car is totaled, ask for a reimbursement of the unused premium. Let’s say you paid a 6 month premium in January, and, your car is totaled in February. You’ve paid for insurance through June. (Clearly they are no longer insuring the car from February to June). The insurance company owes you for the unused insurance (February thru June). But they won’t volunteer the money. Again, you have to insist.
III. Health and Disability Insurance
High medical costs necessitate health insurance. These costs are driven by technology, better health care, longer life expectancy, the aging of the “baby boomers”, more comprehensive treatments, fraud, and administrative costs.
The baby boomers have stressed each part of the economy as they have pushed thru it. As they retire, they will stress both social security and the health care system. As one economist put it, the boomers are like a tennis ball pushing its way thru a garden hose.
To reduce your own personal health care costs (and raise
your quality of life), you could consider diet, exercise, not smoking, wearing
a seatbelt, having an airbag in your car, and having smoke detectors in your
home. As noted earlier, these are all
examples of Risk Reduction or Risk
Avoidance.
Health insurance is the spreading of risk for health related expenses. Health insurance reduces the variance of expenses for health care. (Health insurance does NOT reduce the overall spending on health care by the entire population. It merely reallocates the expenses.)
3. Group Insurance
vs. Individual Insurance
Group insurance is
generally provided by the employer. 85% of persons in the
Key points:
Value of Tax Free benefit = Amount of benefit / ( 1 – marginal tax bracket)
For example, a $300 premium paid by the employer is a $400 “benefit” to the employee. Why? The employee, if he/she had to pay for the insurance, would have to make $400 ($300 to pay the premium, and $100 to pay the taxes on the income).
If the company is large (usually over 25 employees), it is covered by federal law. HIPA and COBRA are federal laws that say the company must allow you to stay on their insurance plan (at YOUR EXPENSE… the company doesn’t have to provide you free insurance) for up to 18 months.
In
Medical Savings Accounts
New – Contributions are tax free.
Restrictions on who can open an account (“high deductible health insured”).
Can spend on medical expenses or accumulate for future expenses.
HMO’s – in network, copay. Copay is designed to add an economic cost to the consumer so that he/she will consume health services wisely.
PPO’s - in network, copay. Out of network, same as reimbursement plan
Reimbursement plans – 90/10; 80/20; 70/30, all after a deductible, for example $500
Dental and Vision – generally, routine dental and vision not covered. But, dental or vision as an illness ARE. Know your policy, and, ask questions of the HR (Human Resources) department.
To provide money if
you can no longer work. Key point: Definition of disabled.
1. definition of
disabled
Make sure the policy says “can’t work at existing profession”, not “can’t work”
For example, suppose a dentist loses his hand in an accident. He can no longer perform the every day functions of a dentist. Is he disabled? Can he now draw money from his disability policy? It all depends on the definition of disabled – he certainly “can’t work at his existing profession”. But, he could teach school, i.e. he could work. The definition of “disabled” is the key variable when shopping for disability insurance.
2. Disability
Insurance Trade offs.
3.Sources of
Disability Insurance