Tag: insurance

Why you (probably) don’t need life insurance: how to self-insure your family

I’m not categorically opposed to life (and most other kinds of) insurance, but if you follow good financial practices, you’re better off self-insuring.  Self-insurance is essentially the idea that you assume a risk instead of paying an insurance company for the service, either by not taking out the policy at all, or selecting a high-deductible. This requires financial discipline and planning to keep sufficient savings to pay for emergencies.

Here are my thoughts on why insurance doesn’t make sense in most cases. I’ll focus on life insurance, but it applies to many others.

When (term) life insurance makes sense:

I’ll begin with an example where life insurance makes the most sense:
The Smith family has a single income of $100K/year, two small children, and Mrs. Smith has limited means to replace the lost income if Mr. Smith dies. They have $5K in the bank. In this case, term life insurance is a very good idea, for reasons which I hope are obvious: if Mr. Smith dies, the quality of life for Mrs. Smith and kids will be significantly diminished.

Complicating factors:

If Mr. Smith has a well-paying job, it probably comes with some disability/death benefits. Mrs. Smith will also get his social security benefits. It will be a fraction of their former earnings, but a non-trivial portion of a typical families expenses are work-related. Mrs. Smith will also qualify for several government programs (WIC, school lunch, etc). Possibly they have relatives who might help. While life insurance payouts are not taxable, it may affect your ability to receive other benefits, so the calculation is not as simple as it may seem.

There are probably tens of millions of American families in this general situation. Yet only 44% of households have life insurance, and many don’t have enough. Why? Because if you only have $5K in the bank (most Americans have very little savings and millennials have a negative savings rate), you probably have bad financial habits, and limited means to have another monthly expense.

When (term) life insurance doesn’t make sense:

If you are single, there is no point in life insurance. Buying life insurance, in this case, is equivalent to your beneficiary (let’s say girlfriend or parents) playing the lottery on your life. While the odds are probably better than the government lottery (your chance of dying in the next year in your 20’s or 30’s are about 1/2000, whereas the chance of winning millions in a lottery are 1/185 million), it’s a lot less somber.

If you’re married and both spouses have similar earning capacity (even if both are not currently working), again, there is little point — your quality of life will not change dramatically if your partner dies.

If you are married with dependents, have very different earning capacity, but have sufficient savings to recover earning capacity, again life insurance is not needed. Unless you have six kids, you only need enough savings to rebuild your ability to support your family.

If you’re too poor to build sufficient savings to recover from the death of a spouse, you’re probably poor enough that a single income will not dramatically affect the quality of life, and can’t afford life insurance anyway.

If you have sufficient earnings to afford insurance but are too financially irresponsible to save for disaster, then you may need insurance, but you’re probably not reading this, and may not have the budget to pay for insurance.

Three bad assumptions financial advisors make

Financial advisors (especially non-fiduciary advisors trying to sell you something) will typically make three flawed assumptions:
1: a single, non-working parent should never need to work again
2: your quality of life after your partner dies should remain the same
3: your savings rate is fixed

Here is why these assumptions are wrong:
1 is flawed because most adults do have the ability to develop marketable skills.
2 is flawed because insurance is only intended to protect you against catastrophes, not pay for your boat and summer cottage. You only need enough cushion to recover from a budget crunch, not profit from your partner’s death
3 instead of trying to patch over bad money habits with insurance (and especially whole life insurance), advisors should help you save more and build additional income streams through your investments. Instead of overmedicating to cover up the symptoms of an unhealthy money habit, good financial advice should help you adopt good financial practices that would make the medicine with dangerous side effects (more on this below) unnecessary.

Self-Insure your Family Instead

Here is the financial strategy which I recommend (scenario based on demographic averages):

While you are single (age 16 to your mid 20’s):

Max out your savings rate at about 50%. This should give you a cushion of $100K going into your marriage — hopefully, both partners have something to contribute to your net worth.

Marriage – before kids:

In the first few years of marriage, you should maintain dual incomes and build your nest egg at least until you decide to have children. If you have kids around age 30, you should have a solid 8-10 years of savings — enough to build a portfolio of $300K.

Marriage – post-kids (when you need a backup plan):

Let’s say the mom decides to be a full-time parent. By your mid 30’s, if you have multiple kids, your savings rate will drop to 20-30%, but 20 years of savings and compound interest should give you a net worth of at least half a million. This, combined the social security and work benefits becomes your insurance policy. Buying additional life insurance is thus unnecessary because each spouse has enough cushion to preserve most of their quality of life and/or recover earning capacity.

Addendum: Whole life insurance (also applies to Infinite Banking)

Once upon a time, when a diversified, well-balanced, tax-smart, age-appropriate, and personalized investment portfolio was not available to most people, whole life insurance made a lot of sense. It still makes sense for people who
1: are compulsive spenders who can’t keep any savings or investments and
2: don’t have a tax-advantaged savings options available or
3: need to hide assets from someone

For everyone else, investing their money in the market makes a lot more sense. You can invest up to $55K per year in tax-advantaged or tax-deferred investments. A properly diversified portfolio will return about 12% (pre tax, pre-inflation).
Ask an insurance salesperson for the yield for whole life insurance. They’ve intentionally made the product so complicated (with lots of hidden fees) that they won’t be able to compare it to the yield of traditional investments.
What the insurance company is doing behind the scenes to make a profit on your money is locking it in various ultra-safe (aka low yield) bonds and giving you a fraction of the return. Those bonds return a maximum of about 5%, and you get a portion of that. You’d do much better separating your insurance and investment needs, especially since a young professional should have a high-risk stock-based portfolio.

If an advisor scares you with the uncertainty of stock markets,  remember that there is No Free Lunch.  Guaranteed returns mean low returns.  Less risk means less profits.  Take your risks while you are young and retire rich.  See my post for simple, low-cost investment options.

Genetic discrimination saves lives

Thanks to recent technological innovations, companies like 23andme are now able to offer comprehensive genetic profiles that can reveal predispositions towards certain health problems, and allow patients to take proactive measures to prevent them. Unfortunately, this potentially lifesaving diagnosis will not be available to most individuals because of so-called “genetic privacy” laws, such as the Genetic Information Nondiscrimination Act, passed by the House earlier this year. One common argument used to justify such laws, is that genetic profiling will lead to a “second-class” of people who cannot obtain insurance or employment. Like most “ethical dilemmas” attributed to technology, this “Gattaca argument” demonstrates a lack of understanding of individual rights and basic economic principles. An analogy is useful to understand its flaws:

Suppose that you wanted to buy a used car. You have a choice of two dealerships: One dealership will provide the full specifications of the car, offer a test drive, let you look under the hood, provide a complete history from a trustworthy third-party, let you take it to your own mechanic, and even let you take the car back after a few days if you don’t like it. The other dealership tells you the year and model of the car and allows you to look at it, and that is it. Take it or leave it. Which dealership would you prefer?

Suppose that used car dealerships lobbied for a law that limited your information about their cars. (Such laws are common for doctors, lawyers, and drug companies, who face numerous restrictions on their freedom to advertise.) Who benefits from such a policy? First, due to the increased risk of purchasing a lemon, the value of used cars will fall dramatically. Owners of reliable cars will now prefer to keep their cars longer, while owners of lemons will prefer to sell. Less people will be able to afford a decent used car, and more will be stuck with cars they don’t want. There will be less incentive for car owners to maintain their cars, since their resale value will fall, as will the quality of used cars on the market. The auto dealers margins will go up, but their sales will shrink. New dealers will find it more difficult to enter the market because reputation will become more important than the prices and quality of individual cars. Much more effort will be spent on both advertising and researching reputable dealers. The overall effect will be to raise costs for everyone, discourage responsible ownership, increase fraud and deception, and benefit incumbent dealers at the expense of newer competitors.

Consider the consequences of such an egalitarian policy if it applied to health insurance. If the government completely outlawed discrimination based on all risk factors, insurance companies have to offer all customers a single rate. Healthy young women would be quoted the same rate as overweight, elderly men. What would be the result? It does not take an economist to predict that rates would immediately rise, as healthy people, refusing to pay for their neighbor’s health risks, stopped using insurance altogether. As the young and healthy jump ship, insurance companies would have to increase rates, accelerating the trend. Without further government interference, the health insurance business would disappear completely, shortly after millionaires on their deathbeds became the only people able to afford policies.

While such drastic restrictions on the ability of insurers to discriminate seem unlikely, the same principles apply to less restrictive measures, as well as “universal” insurance schemes. In response to the higher insurance premiums that these laws create, the public lobbies legislatures for price controls on health insurance and subsidies for the uninsured. Insurers and taxpayers respond to the growing costs of health welfare laws by pushing legislation that makes unhealthy behaviors and products (such as smoking and fatty foods) illegal. The more the government restricts discrimination based on health risks, the more pressure it faces to regulate and provide subsidies for health providers and forbid “unhealthy” behaviors by the public. Each additional restriction of insurers requires a corresponding subsidy or restriction of consumers, controls breeding more controls, until the entire healthcare industry is nationalized and freedom sacrificed for the “common good.”

Industries that do not face the odious regulatory burden of the healthcare industry have strong incentives to compete on the quality of their product. As their margins have shrunk, the total size of the market has grown. In competitive markets for used cars, some dealerships give cars expert inspections, refuse to buy lemons, and advertise their pricing up front.

If discrimination based on comprehensive genetic screening is legal, we can expect health providers to tailor plans according to our individual risk factors. That might be to the disadvantage of a minority of high-risk individuals, but greater information about risk factors will lower uncertainty, and thus lower rates overall. Furthermore, insurers will offer incentives to people who take proactive steps to discover health risks and take steps to alleviate them. Expensive procedures such as frequent biopsies or preemptive removal of organs might be fully covered for individuals whose genetic profiles uncover a high cancer risk.

If individuals are concerned with keeping the results of their genetic screenings private, they should ensure that screeners like 23andme are contractually obligated to keep their test results private, and prosecute them for the full damages resulting from an intentional or accidental disclosure. While the supposed purpose of genetic anti-discrimination laws is to “protect genetic privacy,” the actual effect is to remove the ability of insurers to provide financial incentives for people to get screened for potentially fatal genetic risk factors. This will only lead to unnecessary deaths from treatable genetic disorders and higher health insurance costs.