How much insurance do you have?
Opinion & Analysis
OPINION: There's nothing I like better than being able to tell clients that they can cancel their life insurance. It's a "made it" kind of moment - if people do not need life insurance, the mortgage is gone and/or there are no longer any dependants. That's a milestone of success to be celebrated with pleasure.
Insurance is one of the costs that we pay for, but never want to see a payback. After all, if there is a claim on your life insurance, you are dead (which seems to me to be a fairly extreme way of getting ahead financially). Similarly, if you claim on your contents insurance, they have been stolen; if you claim on your health insurance, you are sick etc.
Unfortunately, insurance is one of those things that you cannot simply go out and buy when you need it - you have to anticipate. Nor should you try to profit from insurance - the company has the numbers on its side. The best you can do is work out the risks you can and cannot afford to take.
Insurance is really paying someone else to take on those risks and you have to pay someone for that (you pay an annual premium). However, the odds are always stacked against you: insurance companies have actuaries who work out the risk and then add a profit margin. Better still (for the insurance company) they have the use of your money while they wait to make a pay-out. Over time and over a large number of people, only the company profits from insurance - therefore, the sooner you can cancel your insurance (whether life, income replacement, health etc.) the better.
However, by international standards, New Zealanders are under-insured - every time there is some kind of natural disaster, there is someone on TV crying into the lens of a camera saying that their house/contents/car is not insured. Although paying those insurance premiums and letting insurance companies make money is a pain, getting rid of insurance too quickly may be an even bigger pain.
Virtually everyone should have their house, contents and car(s) insured - we can take that as a given. (Certainly, there are some people who do not insure them, but most of us know that in the vast majority of cases, this is just plain stupid).
It is when we move on to consider less tangible insurance items (health, income and lives) that things become a bit more tricky - it is harder to imagine the loss of these things and even more difficult to calculate the consequences.
There are three questions that you need to ask yourself about these kinds of insurance: the first is the obvious one: do we need a particular insurance? This, in turn leads to another series of questions: what if I get ill? What if I can't work? What if I die? If the consequence of one of these events is dire for you or your family, you should probably insure. Most people with mortgages and dependants should have life insurance and probably insure against illness or injury as well.
The second question is how much insurance should you have? Remember that by insuring you are not trying to profit from a disaster, but to cover your position so that you can carry on reasonably well. The amount should, therefore, be set for this - not a wonderful windfall (the premiums will be too expensive) but to keep yourself financially above water. For example, I think the amount of life insurance should be set to pay off the mortgage and to give the equivalent of two or three years' living costs to the survivor.
The third question is which company to use and, specifically, what policy? This is where good advice comes in: the devil of insurance is in the detail and the cheapest policy is not necessarily the best - it is likely to be cheap for a reason with exclusions and other clauses that become important when you want to claim. Insurance providers and individual policies differ a great deal and without a major thrash through the fine print of several policies, you are unlikely to be able to differentiate them.
Whether you use an adviser or not, there are times when you should be insured. You should think of most insurances as temporary - only for the time you are exposed to a certain risk. When you are in a stronger financial position - when you have made it - you can cancel your insurance with relief.
- Martin Hawes is an Authorised Financial Adviser and his disclosure statement is available free of charge at www.martinhawes.com. This article is of a general nature and no substitute for personalised financial advice.