Reviewed October 1993
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Risk is unavoidable. Every day we face events and circumstances that could potentially erase our prospects for achieving our personal and family goals. Fortunately, we can limit the financial effects of these risks by establishing and maintaining a sound insurance protection program.
We face insurable risks too numerous to mention, but we can condense these risks into a few categories. These categories allow us to focus on the broad range of risks we need to insure instead of concentrating on each particular catastrophe that could happen. For example, we all face the risk of cancer, but we do not need cancer insurance. Rather, we need adequate life insurance to cover the income our family will lose following our death, regardless of how we die.
We can place all family financial risks in one of five categories: death, illness or accident, legal liability, property loss and living too long. This guide will help you design an insurance plan that guarantees reaching family goals while staying in line with financial resources, family make-up and attitude toward risk.
Insure a family member only if the loss of that person's income or production (household maintenance, taking care of children) forces the family to live at a lower economic level than desired.
The more income or production a person contributes, the more insurance they should have. However, a family that has assets it can convert to cash will need less life insurance. For example, if you own a parcel of land or have large holdings of financial securities, you could turn those into income producers by converting them to a cash-paying annuity or some other financial security arrangement with periodic cash payments.
Proper life insurance planning incorporates such possibilities as well as the proceeds from Social Security payments, if the family is eligible for them. To help you decide your need for life insurance, visit your local MU Extension center for particular help through Life Insurance Planning, a computer software aid to your individual decision.
Once you establish the need for life insurance, the job of selecting an appropriate policy must start. Policies come in two basic forms: term and cash value.
Term (pure life insurance) includes no savings element (cash value) to which a portion of your premium dollar applies.
Cash value policies combine a savings element with insurance protection. In such policies the insurance company becomes essentially a bank as well as an insurer. You pay a higher premium (monthly, quarterly or annual) for a cash value policy because you not only pay for the insurance, you also deposit money into a savings plan. Using your life insurance as a method of saving money is actually quite costly, though, and it reduces your ability to reach financial goals.
If you buy term life insurance and wisely invest the difference in premiums, you can have insurance protection for less cost, and the monies saved and invested will earn interest above what you could earn through a life insurance "bank."
Illness or accident may involve two categories of financial loss: health care expenses and lost income.
Medical costs have risen so dramatically that a short hospital stay could spell financial disaster for most families without health insurance. Health insurance costs have risen along with medical costs, and families hard-pressed for financial resources often (and erroneously) let their health insurance lapse. Such a decision has placed many a family in a position to watch their possessions and dreams slip away as assets are sold in an attempt to pay for medical expenses.
Staying healthy keeps medical expenses low. Unfortunately, even the rigors of exercise or work cannot eliminate the possibility of a prolonged sickness or accident. In fact, one of the more vigorous, healthy occupations, farming, ranks second with regard to the greatest risk of accidental injury.
No standard health insurance contract exists; however, most include similar policy provisions. The most important provisions (benefits, deductibles, dependent coverage, coinsurance, exclusions, limitations, maximum benefits, pre-existing conditions and renewability) are covered in MU publication GH3425, Kinds of Health Insurance. Applying the information in these guides will assure adequate health insurance for your family. Do not consider health insurance an option; you must have some form of health insurance for financial security.
Disability income insurance provides partial replacement of a breadwinner's income should that breadwinner become disabled following an accident or sickness. Granted, Social Security and income from your spouse can replace some of these lost earnings; however, they may not replace all (or enough) of what has been lost. A systematic disability insurance plan is a necessity to meet such income reductions.
The Social Security system provides some disability insurance for the disabled person and that person's dependents (provided they qualify). However, Social Security benefits do not usually provide sufficient resources to meet a disability income need. To help you with the decision of disability income needs and to further your understanding of income protection policies, read MU publication GH3427, Staying Financially Able When Physically Disabled.
You are liable if, through negligence or foul play, you cause a loss of property or life. Liability cases fill our court system and have resulted in substantial financial stress for many of our nation's insurance companies. This stress does not compare, however, to that felt by defendants who are not adequately insured against the risk of financial loss through being found liable for some party's loss.
Many people do not carry liability insurance, but most have liability insurance as a part of their homeowner's or renter's insurance policies and their automobile policies. Homeowner or renter insurance policies contain general liability insurance. This provides coverage if you are liable for damages to another person resulting from a broad range of acts, excluding automobile accidents. Automobile insurance, on the other hand, only provides coverage if one is found liable as a result of an auto accident.
Both types of policies only provide insurance coverage up to a contractually stated maximum, which may or may not cover your assets. If so, purchase additional liability insurance, as an addition to existing policies or as an umbrella, general liability insurance policy, which applies to both the homeowner's and automobile policy held with that company. In any case, the increasing tendency for Americans to sue, whenever they feel wrongfully damaged, means that you must have liability insurance to have a financially secure future.
Possible liability for damages occurring on the farm or through operation of the farm exposes farmers to the risk of financial loss. These losses may not only result in the loss of all current assets but also may involve the loss of future income.
A farmer's liability may extend to negligent actions of the employees. Employees injured while working on the farm can also hold the farm owner/operator liable. MU publication G451 Liability of Farm Employers, discusses farm-employer risks and how farmer can insure against potential losses.
To insure against the loss or damage of personal property such as your car, home and furnishings, you need property insurance. Whether the property is stolen or damaged, the insurance company will reimburse (protect) you up to a specified contractual amount. The contract will declare what hazards you are insured against as well as the specific financial amount of the coverage you are purchasing.
Property insurance provides protection for your home and other structures on your lot. This excludes buildings rented to others or those used for commercial or manufacturing purposes; it also usually excludes farmhouses. Farm households should apply for separate farmowner's insurance. Insure newer properties for replacement cost and older properties for their actual cash (depreciated) value, or perhaps for market value.
Homeowner (farmowner) policies also cover personal property, including household contents and personal belongings. Policies usually cover personal property at a percentage (stated in the contract) of the coverage on the house structure. As an example, if you insure your home for $70,000 and your policy provides for coverage of personal belongings at a rate of 50 percent of the insurance on the house, you would have $35,000 in personal property coverage.
Most homeowner policies will not provide full replacement cost of the lost personal property. To have full replacement coverage, you must purchase a replacement value rider separately. (A rider is a document containing special provisions not provided for in the policy contract itself.) If you have special property such as a valuable collection of antiques, you may purchase a rider to tailor your insurance coverage to your needs, or you may purchase a separate personal property policy to cover such items.
Your insurance company will assume that the value of your personal property will depreciate (decline in value) with age. Therefore, without a replacement value provision you would receive less money than needed to restore your furnishings to their pre-loss level. Weigh the value of such protection against the substantial added cost of a replacement rider to make the wisest, most informed consumer choice.
Maintain an inventory of your personal property regardless of the particular insurance you have. You can obtain forms for this purpose from your insurance company, or you can design your own. Completing an inventory will help you judge your need for special riders and decide what is adequate insurance coverage. One reminder: do not keep your household inventory at home unless you have a fireproof box or vault for storage. Additionally, photographs of rooms are good documentation of your inventory should a loss occur. Store these with the inventory in a safe place such as a safe-deposit box.
Most of us gladly accept the "hazard" of living to a ripe old age. However, the longer you live, the greater the need for adequate financial resources for retirement income.
You should start planning for retirement between the ages of 25 and 55. By the time you reach 60 or 65, retirement is just around the corner and you can't change the choices you have made. Failing to make choices for retirement equals making the choice for a substantially lower level of living in your golden years (which will then become tarnished).
The major retirement income sources are:
Social Security
Designed as a supplement to an individual's personal retirement savings,
it was never, and will never be, a replacement for personal savings and investment
income during retirement. Your Social Security benefits will replace only a portion
of your pre-retirement income. The proportion replaced by Social Security benefits
decreases with higher incomes. A higher-income household will experience the
greatest percentage decrease in their level of living at retirement if all they
will have to live on is Social Security. Given this, a higher income household
has the greatest need for pension plans, taxsheltered retirement accounts and
general investments to sustain their level of living. However, all households
not wishing to lower their level of living have a need to supplement their Social
Security payments with other income.
Private pension plans
These provide additional retirement income for those individuals working
for private corporations or for government institutions providing such a plan.
The law does not require employers to have a pension plan. However, if they provide
such a plan, the Employee Retirement Income Security Act provides certain minimum
standards for such plans. These requirements stipulate such things as when you
are entitled to your pension rights, who must qualify for a pension, and how
the accumulation of benefits is calculated.
If you change jobs, your right to the proceeds of your previous private pension may or may not transfer with you. Vested private pension plans do transfer. You will have to work a specific number of years to become vested; the amount varies from employer to employer. When interviewing for a job, make sure you understand your prospective employer's pension plan. (However, the interviewer may misinterpret too much talk about your retirement at the initial job interview. Be careful.)
Your employer may offer you either a defined benefit plan or a defined contribution plan. A defined benefit plan tells you your specific retirement benefit and explains how the plan adjusts to changes in the economy. In other words, you know your retirement benefits from the start. It is the only type of plan federally insured by the Pension Benefit Guaranty Corporation. The defined contribution plan defines only what amount the employer will deposit to the pension plan. Future benefits remain unknown and depend on the investment skills of the firm managing the pension fund. The lack of employer commitment to specify future benefits has led to an increase in defined contribution pension plans.
The federal government does not insure this type of plan. When investigating private pension plans, ask the following questions:
Tax deferred retirement accounts
These have greatly increased the family's abilities to prepare for
retirement. You cannot avoid paying income taxes, but eligible income earners
can postpone it. Beyond delaying payment of taxes -- sometimes for many years -- this
postponement of taxes has several advantages:
There are four broad types of tax-deferred retirement accounts:
Both salary reduction plans are available to you only if your place of employment has set up such a plan for their employees. You determine an amount, for the payroll office to deduct from your check each pay period. The payroll office makes this deduction before they deduct taxes, insurance, etc. Your employer places this money in a mutual fund or insurance company account in your name where it accumulates. The employer decides which investment companies can offer plans to their employees. Generally, those plans set up through insurance companies provide greater flexibility than those sold through mutual funds. Employees of certain nonprofit institutions know these plans as 403-Bs, and employees of participating profit-making institutions know them as 401-Ks.
Other investments
These should complement the elements of your retirement plan outlined
above, not substitute for it. That is, because it is so much more effective to
accumulate retirement funds in a fund that defers taxes, you should make use
of tax deferral plans before speculating with other investments. Such returns
are hard to match by investments of after-tax dollars with periodic returns taxed
as they occur.
No matter what forms of saving and investment you choose, you always run the risk of depleting your financial resources before you die unless you buy a life annuity at the onset of retirement. There are two types of life annuities:
Annuities form an important part of a retirement income plan for many households. The products vary from company to company but will fit somewhere in the classification scheme outlined above. Consumers should buy the annuity that best suits their needs rather than buying a product that may, in fact, be of little use in protecting retirement income. Read the contract carefully and seek expert advice (from someone not wishing to sell you a product) before you sign the contract.
Families should use risk management as an integral step in securing their goals. In some cases, you can eliminate risks (e.g., not driving) or reduce them (e.g., quit smoking) as a strategy for their management. Unfortunately, you cannot totally eliminate some risks. That is why insurance markets exist for the transferal of the financial aspects of those risks to another party -- the insurance company.
Insurance companies abound in this country. Some specialize in life insurance, others specialize in property insurance and some offer all lines of insurance. By selecting the right companies, you can save substantial amounts in insurance premiums each year without sacrificing the protection you need.
In general, when searching for an insurance company, you should choose a financially strong company. You can find Best's Insurance Reports and Best's Life Reports in most public libraries. These publications contain information on the larger insurance companies. A rating scale is used, similar to a school grade scale, with ratings of A+, A, B+, B, C+ and C. We suggest you choose no company with a rating lower than A, as its financial strength may be questionable.
How quickly claims are settled is an important consideration. Consumer Reports does an annual survey of claim settlement experiences, and you can obtain information from the Missouri Division of Insurance regarding their financial strength and which firms have the greatest number of complaints registered against them. Remember when comparing companies' complaint experience to consider the number of contracts the company has in force. A small company with few complaints could actually have a higher percentage of complaints when compared to larger companies.
Finally, the net cost of insurance can vary widely between companies with similar characteristics. Shopping among several insurance companies can result in substantial savings that only you can effectively achieve. If the costs seem to be high for all companies, you can employ several strategies to help reduce costs.
GH3420, reviewed October 1993