This article is part of our 52 week journey through Bill’s latest book, The Graduate’s Guide to Life and Money. Each week, a full excerpt from his book will be presented from beginning to end. To get your copy of his book, visit www.TheGraduatesGuide.com.
So what are the wrong kinds of insurance? Let’s start by describing my approach on how to determine what makes one kind of insurance wrong. I have two criteria that I use to determine whether insurance is wrong or not. 1) It costs too much for what you are getting and 2) You don’t need it. That’s basically it. Certain types of insurance simply cost too much for what you are getting in return. Extended Warranties are a prime example. I know it may be a stretch to classify extended warranties as insurance, but basically you are buying a policy that will cover your losses in the event that something happens to your personal property. That pretty much describes property insurance.
So what is wrong with extended warranties? They offer peace of mind after all, don’t they? Yes, but how much is piece of mind seriously worth? Let’s take an example. You buy a washer for $500 and a dryer for $450. You just spent $950. You also paid taxes and possibly a delivery fee. For sake of argument let’s just say you spent $1,000 total. Now, you can purchase an extended warranty for your washer for $150, which covers you for three years and one for your dryer just $100 that also covers you for three years. So you just increased your total cost for your washer and dryer by 25%. Instead of spending $1,000, you just spent $1,250.
Of course if you also buy the warranty for your refrigerator and dishwasher, etc. you could practically bankrupt yourself. And, all you get out of it is three years. Based on the 25% premium they charge for all these warranties, the only way you could come out ahead is if more than one-fourth of your appliances break down in the first three years. If that happens, then God is trying to send you some kind of message.
Extra Life Insurance Through Your Employer
What is wrong with purchasing life insurance through your employer? Well, for most employers a portion of your life insurance comes free. If not, there is usually an amount equal to your salary that is very reasonably priced, and you may want to purchase it. However, when your employer offers you the chance to purchase additional life insurance, look closely at the cost. It is almost always cheaper to purchase a separate policy on your own, outside of work (unless you have a serious pre-existing condition and cannot purchase life insurance on your own). Plus, you cannot take the policy with you when you leave that job. Think about it. If you purchase a 10-year term life policy on your own, not only will you pay less than half of what you would have to pay through work, but also that policy stays with you even if you quit or lose your job.
Whole Life Insurance
I know we discussed this before, but do not buy life insurance that has an investment attached with it. Don’t do it. You would be better off burning dollar bills to stay warm in the winter. At least that way you are not paying commission to someone who either cannot do math very well or does not have your best interest in mind. Remember, if you buy term insurance (15-year or 20-year level would be good), you will save a lot… a whole lot… of money. If you seriously try to purchase up to 10 times your salary in whole life, you won’t have any money left over to eat. Now, you can use the money you saved to pay off your debt (see Chapter 10) and invest the money for your future (see Chapter 11). That way, when you reach the age when your term policy runs out, you will be self-insured. You will have enough in investments to cover all the things that usually need covered by insurance.
Unless you are in a situation where you are required to purchase mortgage insurance by your lender, do not purchase it. Think about it, all you are doing is buying insurance to protect the bank in case you are no longer able to pay them. Why should you pay for an insurance to protect them? They have money. Let them protect themselves. What you should be doing is putting money away into an emergency fund to cover you in case you lose your job. At some stage in life you should consider long-term disability insurance, which will protect your income.
Long-term Planning Insurance (under the age of 50)
At this point, you are way too young to purchase long-term care insurance (LTC). LTC will protect you and your assets in case you have to go into a nursing home or you need cared for by a nurse at home. At this stage in your life, you do not have many assets that need protected. You will pay so much in the way of premiums over the next 20 years that you are better off saving that cost and using it towards some of your more immediate needs. When you reach age 50, you can take another assessment of your situation to see if LTC makes sense then.
Accidental Death and Dismemberment Insurance (AD&D)
Seriously. Have you ever looked at these policies? “If you lose your left leg and your right eye then you are entitled to…” Who gets in these types of accidents anyway? The way these policies are designed by insurance companies is to use their actuaries to determine some seriously unlikely situations and then they cover you for these specific scenarios. Don’t buy it. What you should have is long-term disability insurance, and maybe a very good lawyer if one of these types of accidents happens at work or because of someone else’s negligence.
Cancer Insurance and Critical Illness Insurance
These policies are similar to the AD&D policies. There are very specific scenarios that are covered and very limited coverage at best. They only cover for specific illnesses, and only cover specific expenses for these illnesses. On top of that, they only offer up to certain maximum dollar coverage in most cases. And as with almost all insurances, any preexisting condition you may have is not covered. You can’t buy life insurance for a dead person, and you can’t buy critical illness insurance for a critically ill person. Your best bet is to have a good, comprehensive health insurance plan (usually through your employer if you are not self-employed).
Despite my ranting, I am not against the insurance industry. I simply understand that insurance agents are sales people, the same as stockbrokers are sales people and car dealers are sales people. In some cases, the individual sales person starts thinking more about their commissions than about the person they are trying to assist. Their goal is to get some of your money to feed their family. Your goal is to keep more of your money to feed yours. So keep in mind that some of the policies listed above are the ones that provide the best commissions for the sales people, and may be an incentive for them to sell these policies.
Bill Pratt is a former credit card executive turned student-advocate. He is the author of Extra Credit: The 7 Things Every College Student Needs to Know About Credit Debt & Ca$h and The Graduate’s Guide to Life and Money. Bill speaks at colleges to educate and entertain students about real-life issues in money, leadership, and success. His goal is to help students succeed personally and financially so they can improve the lives of those around them. You can learn more at www.ExtraCreditBook.com or www.TheGraduatesGuide.com.