#15 Creating Wealth: Insurance 101
Updated: Jun 21, 2021
Creating Wealth is an in-depth conversation between Bill Taber, an experienced financial advisor, and his millennial daughter about personal finance, investing, and financial planning.
Bill Taber is President of TABER Asset Management, a Registered Investment Advisor (RIA) and fiduciary firm located in Des Moines, Iowa since 1998. For decades, Bill has provided investment management services to clients, creating wealth, building wealth, growing income, and preserving capital for each and every client. TABER offers personalized asset management, wealth management, retirement planning, financial planning, and services such as 401(k) rollovers.
His daughter, Anastasia, lives and works near Washington D.C. She enjoys discussing finances and her cats’ latest antics with her dad.
Episode 15: Insurance 101 - What kind of insurance policies can you buy and why should you have them? Are there policies you should avoid, or insurance that is only needed at certain points in your life? Both Bill and Anastasia share anecdotes from their careers. Anastasia somewhat reluctantly shares why she is glad she had wedding ring insurance and discusses the Taber curse.
For questions and comments, you can email us at firstname.lastname@example.org.
Anastasia: Welcome to Creating Wealth, I’m Anastasia.
Bill: Hi, I’m Bill.
Disclaimer: The views expressed today are our own, solely for informational purposes, and it is not an offer to buy or sell, or a solicitation of an offer to buy or sell any security or instrument or to participate in any particular investment strategy. The views are subject to change and are not intended as a forecast or guarantee of future results.
Anastasia: What is the basic definition of insurance?
Bill: The textbook definition is that it's an economic device, whereby you substitute a small certain cost--the insurance premium that you pay--for a large, uncertain financial loss. Another way of saying it is that you buy this to cover the replacement of a large loss that has a small probability of actually happening. The purpose of insurance is also to transfer risk, because without insurance, there are certain losses that could bankrupt you.
Anastasia: Okay, so what are the different kinds of insurance that you can get? And why do you need them?
Bill: There are many different types of insurances. Homeowners is one of the most prevalent. An obvious example is insurance to replace your home if it's destroyed by fire. Like for example, could you afford to pay cash to replace the house that you just bought if it caught on fire?
Anastasia: Generally not. (Laughs) I would say no.
Bill: Well, that and there's many other risk exposures that are covered by homeowners insurance, so that's really important. If you're a renter, if you have an apartment, there's actual renter's insurance that covers your possessions. If the apartment building that you occupy has a fire, the owner of the apartment building has coverage for the building, but your contents are up to you. Another type of insurance is life insurance helps replace lost income due to a death. It's generally needed if you have dependents that are supported by your income. And so when young married couples start having children, it's important to have that if it takes two incomes to afford your house, insurance would replace the income if one of them died. Life insurance can also be used to provide cash to pay estate taxes when you die, to avoid having to sell a family business or to sell a family farm.
Anastasia: Okay, so life insurance. Are there periods of your life where you then don't really need it--if you no longer have any dependents? By dependent, do you mean children? Or do you mean a spouse that doesn't work?
Bill: Could be either. If you had a stay at home parent, that'd be a reason to have insurance. If you had a child that needed support beyond a certain age, that might be the reason to have it. If you were close to retiring or retired, and had your income needs covered, and had no dependents, then perhaps you wouldn't need it at that point.
Anastasia: Yeah, so it's really just life insurance replaces the lost income from a person not being there.
Anastasia: Okay, that makes sense. Can I interject what I experienced in my stint as a property manager in terms of renter's insurance?
Anastasia: So in the building I managed, one of the apartments on the 10th floor, he went away for Labor Day weekend and when he came back, all of his nice business clothes and shoes were completely soaked, because a sprinkler had broken inside his closet. It had started while he was gone. And then when he came back after three days, it was a mess. So he submitted a renter's insurance claim. They covered what he asked her what they appraised, and then we covered the deductible.
Anastasia: So renter's insurance is fantastic. It's also super cheap. I think I paid like $10 a month for a policy. I mean, it's just so completely worth it because random, random events like that can happen. So pay $120 a year and you don't have to spend $5,000 to replace your wardrobe.
Bill: Mhm. That's a good trade-off.
Bill: Small probability of a large loss.
Bill: That's a good example. Another type of insurance is health insurance. A single car accident could send you to the hospital with a six or seven figure bill to pay. In fact, medical bills are one of the top reasons that people are forced to declare bankruptcy today. Another type of insurance is auto insurance. Could you afford to replace your car if the value of it was totaled in an accident? The definition of totaled is where the cost to repair the car is actually greater than the car's market value. And there are other basic types of insurances as well that are probably beyond the scope of our short podcast today, but they include disability insurance, long term care insurance, umbrella liability coverage, and identity theft protection.
Anastasia: So how do you fit insurance within your budgeting plan?
Bill: You need to buy insurance for anything that you can't afford to replace, such as a house or wedding rings.
Anastasia: (Laughs) Do you mention that to get me to talk about that?
Only if you want to. (Laughs)
Anastasia: Okay, I'll talk about it. So (sighs), because life is what it is, the day before we did our justice of the peace ceremony, I couldn't find my engagement ring and looked for it everywhere. Could not find it. And that was a really great feeling to have on the day that you're getting "legaled." We're still planning to have a wedding next year, but we are doing this ceremony too, because we were emotionally ready for it. And not having an engagement ring (laughs)
Bill: Was a little bit of a damper, I bet.
Anastasia: You know you have to spend some time just forgetting about it, but it's hard because I don't know. (Laughs) It's a major thing that sucks to have happened on the day that you're...(sighs) So you know, I had no idea how the insurance process works. But we had gotten the ring insured. We ended up sending pictures to the insurance carrier and they had their in-house team appraise it. They actually came up with higher appraisal than the appraisal letter we provided them by the jeweler. And so they just asked us, "Do you want us to make it in-house, because we have people who will do that, or we'll just give you the money that we appraised it for, and you can use it to purchase a new ring." And so we went with the latter option. Our jeweler who had custom made the ring, he still had the mold and so he was able to make it again in, like, three weeks. I have the ring again, and it definitely covered the cost of the ring. So I'm kind of like, how do they afford doing this? Because they gave us this lump sum amount, and I don't know, are they planning to raise the cost of the policy? Like, what, how do they make their money on this?
Bill: Oh, that's possible. But the general concept of insurance is that they've collected enough in premiums from enough different people that they know on average they're going have a certain percentage number of claims against that, and that that money that they collected covers those claims plus a profit margin for their company. So it's just the concept of transferring the risk and pooling the risk, transferring it to someone else.
Anastasia: So basically, it's, you know, I don't know what happens if this were to please, no, happen again. (Laughs)
Bill: If it happened again, it's likely that you'd be paying far more for your coverage than you are currently.
Anastasia: (Laughs) Sure. The thing is, is I really need to break the Taber curse, because you lost your wedding ring. And yes, I'm calling you out. And my brother lost his wedding ring on the day of his wedding.
Bill: No, I at least waited about four weeks, which implies that it was intentional, but it really wasn't.
Anastasia: (Laughs) I just think that these fingers, they don't want rings on them. I don't know what to tell you.
Bill: They like to roam free.
Anastasia: They like the feeling of the breeze passing by. So yeah, that all worked out really well. And so that's my ring insurance story. It had a happy ending. So what kinds of insurance can you pass on?
Bill: While you may need these different types of insurance coverages, there are things that you can do to lower your premium costs, or actually improve your coverage. Talking about life insurance, whole life insurance, or cash value insurance as it is sometimes called is quite expensive. And so I always have always been an advocate of buying term insurance and investing the difference into investments. Term insurance is a whole lot cheaper. Instead of buying, say $100,000 cash value or whole life policy, which is fairly expensive, you can buy 10, 15, 20 times that amount in term insurance for perhaps even less money.
Anastasia: Can you explain a little bit more about how that works functionally?
Bill: Some people think, okay, I need to replace an income that's $100,000 a year. And so they receive a proposal saying here's the cost of $100,000 in whole life insurance that has a cash value to it. And here's the annual premium and the insurance is permanent, and will provide $100,000 at the death of the insured. Their thinking on it is "Income is 100,000. If I receive $100,000 in life insurance proceeds, then it'll cover that income." But what they fail to consider is the difference--and we've talked about this before--the difference between income and wealth is that they need a far greater amount of insurance coverage to provide a sustaining payment of $100,000 per year. So for example, based off of the 4% payout rule that we've been talking about, if they were to purchase $2.5 million in term insurance, and then have that invested so that it created a 4% income stream from it, that would create the $100,000 income, but it would be sustaining. It would be every year for the rest of their lives. What I'm saying is that to buy whole life insurance at that level at $2.5 million is extremely expensive.
Bill: Does that make sense?
Anastasia: Yeah, so term insurance it is.
Bill: Term insurance it is. Another type of insurance that you can avoid is credit mortgage insurance. It pays for your home mortgage in the event of your death. The general thought there is that buying term insurance instead is a whole lot cheaper. Credit mortgage insurance pays for the monthly cost of your mortgage in the event of your death and it is far more economical if you simply look at that last example we gave of replacing your entire income, of which, the expense of your house mortgage as part of that each month, and buying term insurance to cover that lost income and then use that to pay for the home mortgage.
Bill: Insurance companies that have credit mortgage insurance basically do the same thing, but they do it at a far, far higher cost.
Anastasia: Okay, that makes sense. I would rather have the whole income replaced, which would include other expenses like food and transportation, rather than just the mortgage.
Bill: Mhm, yeah. Car insurance is another example that you may or may not need car insurance. With a fully funded personal emergency fund, you can raise the deductibles to lower your premiums. You can consider dropping the collision coverage if you have an older car. So for example, that Toyota Prius that you're driving, once the market value of that falls, say below $5,000, certainly at the level at which it's worth only $2,000 - $3,000, the extra cost of having collision coverage on that is way too high. And you should consider dropping it because you have enough emergency funds basically, to--
Anastasia: Replace the whole car if I need to. If I total that thing, and I need to get it replaced, just make sure that I have like $5,000 in the bank?
Anastasia: Except that cars do cost way more than that. But, eh.
Bill: Yeah, the replacement is far more, but the actual value of what they're insuring is that they're getting far more in premiums for you than what they're willing to pay. Say the car's value is only $3,000 and you have a $7,000 loss, and so you decide to keep it and you wind up paying $4,000 out of your own pocket.
Anastasia: Yeah, that makes sense. They're not gonna give me the cost to replace the car. They're gonna give me the amount that they think the car was worth, which once it drops below $5,000. It's kind of like, eh.
Bill: Yep, exactly.
Anastasia: Okay. You always need liability insurance, though? You always need to be covered in case you hit someone and they sue you for medical expenses?
Bill: Yes, liability insurance is quite important. And if a person has a high net worth, financial net worth, it's important to have umbrella liability coverage of say, $2 million, $3 million, $5 million, whatever, to protect yourself in the event of a lawsuit. And that type of coverage is quite inexpensive as well.
Bill: Health insurance: Look into a health savings account that works with high deductible policies.
Bill: HSA or a flexible spending account, FSA, depending upon your employee/employer situation. Doing that helps lower your costs through taking advantage of breaks in the tax code.
Anastasia: Oo, we like that.
Bill: Yes, tax avoidance, not tax evasion. And increasing your deductibles and or coinsurance amounts to help bring your premium cost down. There are other types of insurance that you can avoid. For example, life insurance on dependent children. Some agents in the past have attempted to make an emotional sell to parents saying what would happen if your child died? You would need to have insurance on them.
Bill: But on the concept of insurance being available to provide for dependent children, the only reason that one would have life insurance on their children would be if they could not afford the burial expenses for that. Does that make sense?
Anastasia: Yes, burial expenses are kind of pricey, though, right?
Bill: Yeah, it depends.
Anastasia: This is literally a morbid topic.
Bill: You can very easily spend $10,000 on our funeral.
Bill: And if you're young parents, and you don't have the funds built up to cover that then that would be, I think, the only reason to have insurance on children. Another one is accidental death life insurance. What they say there is that they will pay you the insurance amount if you die in an accident. And my thought on that is why pay a premium to wager on how you will die. It just--it makes more sense just to basically buy term insurance and if you die, you die and it pays off. The fact that companies issue life insurance that only pays off when you die in an accident restricts the number of exposures or occurrences where they would have to pay and therefore it makes it more profitable for them.
Anastasia: Doesn't that mean that they would also kind of try to not pay because they would say, "Well, this wasn't an accident, really"?
Anastasia: It gives them more ways to say no--
Anastasia: --and turn down your claim. Yeah.
Bill: Which is why it's important to read through your policy to see what the exposures are that they cover and under what circumstances they might not cover. Like, for example, people sometimes think if their house is flooded out that their homeowners insurance will cover it. Homeowners policies have an exclusion for flooding, it's actually, you know, an additional exposure or additional risk that people need to pay for it to be able to get coverage for. Another type is cancer and hospital indemnity. Again, why buy coverage that basically says it's only going to pay off if you die because of cancer? Another one is pre-paid burial insurance. The only reason that I can see to buy burial insurance would be if it's required to cover a loved one that's needed to cover their nursing home expenses. And that gets into a whole different topic.
Anastasia: Okay. Have you ever worked with an insurance agent?
Bill: Ah, yes.
Anastasia: What are your thoughts on them? Because I have to.
Bill: I think many insurance agents are ethical. For me, it depends on whether they are a captive agent of a certain company, or if they are an independent agent. If they are captive to a certain company, you're only going to get certain types of recommendations and certain types of products. If they're independent, they generally work with a number of other companies. They can shop the market more for you. One thing that's important to understand is that most agents are just that--they are agents, which means that they work for the insurance company, not for you. They are paid when an insurance policy is purchased. And they are paid when it stays in effect. So if there's some way that you can deal with someone that's an independent, or someone that's a consultant that can give you unbiased advice about insurance policies, as opposed to product advice, or product information, I think that's preferable. What's been your experience?
Anastasia: Back when I moved to LA, and I was out of the nest, no longer in the college bubble, no longer living with my parents, starting my life as an adult, and also being like, "How do you do this? How do you do any of this? There's so much to know." One of my biggest stepping stones / moments of adulthood was buying car insurance. So I went and I gave all of the car insurance companies all of my information, so I could get quotes from them. I must have given them to, like, 10 different insurance companies. And I noticed that there was quite a spread between what they were offering me for essentially similar policies. Then I asked my coworkers and one of them knew an independent insurance agent. So I talked with him, and he got me set up with an insurance company that had the best rate for my zip code. And during this process, I found out that the reason why rates can vary so much, is because it's based on how many claims they get in that zip code. And that can just vary per company. They base their rates off of all of these different factors. And you as the consumer have to go and you have to find the best rate and also a reputable company that doesn't take any opportunity to deny your claim. Because I know that my brother, he had an experience with one of the major insurance companies where they paid for his claim, but then they jacked up his rate. So he was disgusted by that and went with, I think, a different insurance company?
Anastasia: But that's something that can happen. It's partly through experience and it's partly through just a ton of research. But you could also work with what you said--an independent insurance agent.
Bill: And one of the things that's helpful to know and many agents will tell you this is that you can actually save money on premiums if you purchase your homeowners insurance and your auto insurance through the same carrier.
Anastasia: Right. So do you have any insurance related anecdotes from your career?
Bill: My favorite one is a dentist that I worked with. We took a look at his life insurance and said, "Let me review what you have." And he brought in a grocery sack--
Anastasia: Oh, no.
Bill: --full of insurance policies. There were actually 28--
Anastasia: Oh, no.
Bill: --and dumped them out on my desk all at once and looked at this. And there were a lot of $10,000 and $20,000 face amounts for whole life insurance policies. And when I asked him, "Why so many?" He just said, "I just can't say no to the salesman."
Anastasia: (Laughs) He's the perfect target. Salesmen love him.
Bill: One of the policies that was in that pile paid double the face amount of the policy, but only if he died traveling to and from, by car, his annual American Legion Hall Meeting.
Anastasia: What? That is the most specific thing I've ever heard of.
Bill: So in essence, what the insurance can do was severely limit their risk and it made that policy very, very profitable for them to write.
Anastasia: And they're like, "We know we can get these suckers like this dentist."
Bill: As far as other anecdotes, they all kind of get lumped into something that we just talked about, and that's that I've seen a number of situations where families bought $100,000 of coverage on the breadwinner, thinking that $100,000 would cover their lost annual income, when the problem was that it only covered the income for one year. And as we use in that example, if they bought $2.5 million in term insurance and invested in a 4% income payout rate that would give them the $100,000 that they needed each year to replace that income. So that kind of gets to the problem that at least 80% of Americans don't understand the difference between a sustainable income and wealth.
Anastasia: That's a meaty topic.
Bill: Mhm. And one of the things I've noticed is that people sometimes will kind of will themselves to an earlier death if they don't have enough money to live. And so having insurance to know that that money is there to cover needs for your loved ones can be sustaining in a healthy manner as well as financially.
Anastasia: Life sustaining?
Anastasia: What do you mean by that though? Simply having an insurance policy around makes them...?
Bill: It gives them more peace of mind knowing that if they haven't been able to provide enough to sustain their family, if they were gone, that they know that that insurance would step in and do that for them. And that takes a certain amount of stress and worry out of a person's life, which leads to better health, which leads to one continuing to want to live.
Bill: Money and health are very closely related. Money is a very emotional topic and it's one that is very important, obviously, in life. The only one that is actually more important, I believe, is one's health. But the two of the two of them are interrelated. So that's the view of insurance from 10,000 feet. We could obviously spend a podcast on any number of those. Any other questions come to mind?
Anastasia: No, I would be interested to know if our audience had any follow up questions. So putting that plug in again!
Bill: Sure. Please submit all questions!
Anastasia: It's fun to talk about this because you actually studied insurance back in college.
Bill: I did! At the University of Iowa, which had an insurance professor by the name of Emmett Vaughn, who was considered one of the foremost insurance experts in the country at the time.
Anastasia: That's cool.
Bill: Written several books and went on to be the insurance commissioner of Iowa and also had a daughter in the same position. And he was extremely entertaining to listen to. He had anecdote after anecdote, so...
Anastasia: "This is what happens when you don't buy insurance, folks."
Bill: Well, he knew all the horror stories, so. And he also would consult with lawmakers and policymakers on setting laws in various states.
Anastasia: So we probably have a lot of laws that are directly resulting from him that affect our lives today?
Anastasia: Well, given your expertise, I'm sure we will revisit this topic in the future. But for now, that's all I had.
Bill: Great, thank you very much.
Anastasia: Thank you for listening to Creating Wealth! If you liked our podcast, please subscribe and consider recommending it to your friends or leaving us a review on your podcast app. We would love to discuss your questions. You can email them to us at email@example.com. You can also find full transcripts of every episode on taberasset.com. That’s Taber with an “e” not an “o.” Thank you for joining us on the path to financial abundance. We’ll see you next time!