Wednesday, February 23, 2022

Insure Yourself Into The Poorhouse!

Is it possible to have too much insurance?  Certainly!  Insurance companies will sell you poor bargains and insurance against long-shot outcomes.  It is up to you to decide what is worth insuring and what isn't.

NOTE:  This is a posting I started in 2018 and only finished today.  What a procrastinator!

A reader writes asking if short-term disability insurance is worthwhile.  And of course, it could be, if it cost $1 a year and provided $1,000,000 in coverage.  I suspect it doesn't though.  So the reader will have to answer that question for themselves.  Myself, I think that if you took that premium money and invested it in an after-tax account, it would quickly grow to an amount to cover "short-term disability" or what we used to call a "rainy-day fund" and if you didn't need the money (far more likely than being disabled, long-term or short-term) you could use it in retirement (when eventual disability is sort of a guaranteed thing).

But the question illustrates how a lot of Americans think.  Many of us live "paycheck to paycheck" in our lives so we can have a nice house and a fancy car, cable TV, the latest $1000 smartphone, designer coffee drinks twice a day, and restaurant meals four nights a week - plus lunches.  We live in fear of losing our jobs, because our carefully crafted house of cards will collapse around us if we miss even one paycheck.

And I know this, as I used to live this way, and it kind of sucked.  I had a good job - paying the vaunted six-figures (20 years ago, when that actually meant something) but I had little or no after-tax savings, a credit card debt that never seemed to go away, and a host of toys parked in my driveway or lawn.   I sort of figured, when I was very young, that if the shit hit the fan, maybe I would ask Mom and Dad for help - as my siblings did well into their 40's.  Later on, I figured I could borrow against my 401(k) or life insurance or cash out money from an IRA (and pay a hefty tax penalty) if something went horribly wrong. Those were horrible "what if" scenarios, as I would be cashing in assets protected from bankruptcy in order to protect assets not protected in bankruptcy, namely my house and cars and toys and junk.

Later on in life, I accumulated more after-tax wealth and worried less about "what if" scenarios and started to realize that eventually I would get sick and die - and in about the next 20-30 years or so.   And what I realized is that trying to insure against this wasn't insuring myself from harm, but insuring my assets - my house and toys - against loss of income or high medical bills.

My insurance agent tried to sell me long-term care insurance.   It would kick in if you needed to go to a nursing home, for example, if you had a stroke or something.  Seems like a good idea, but this sort of insurance is what nearly bankrupted GE, and I suspect that even if I bought the policy, the insurance company would probably have gone bust by the time I could file a claim on it.  That is to say, if I needed to file a claim on it.  Not everyone ends up needing long-term care. Just because grandma ended up in a nursing home or needing a home aide doesn't mean you will.  You just might keel over dead - as my neighbor did - and not be able to cash in on that swell deal!

In any event, the cost - about $500 for each of us, per month, for the rest of our lives - was just too much to pay.  And what I realized is that what I was insuring wasn't me, but my "stuff."  The agent explained it succinctly.  If I ended up needing long-term care, Medicaid would kick in, but only after I had exhausted my assets - my savings, my "stuff", my house, etc.   Although in the case of a married couple, usually the spouse gets to stay in the house - the government doesn't need to create more homeless people.

So you burn through your life's savings in the last few months or years of life, and then medicaid kicks in and pays for long-term care.  Where you are going, you don't need money.  So what's the big deal?  Sure, maybe a long-term care policy might put you in a nicer rest home, but chances are, a rest home isn't going to be much nicer and you'll be oblivious to the difference.   The long-term care policy protects your assets, not your ass.

And if you want to leave an inheritance to your children, I guess that is a swell idea.  On the other hand, let them earn their own damn money.  Or if you really want to leave money to them, try doing it while you are still alive. Use inter-vivos transfers to send them about $20,000 a year (consult your tax adviser for the exact amount this year) tax-free.  Deposit it right into their 401(k) or into an IRA (which may give them a tax deduction and tax credit) and they will have an inheritance to live on later in life.   Just a thought.  Leaving money to people when you are dead gets tricky.  Oftentimes your wishes aren't carried out the way you wanted them to be.

Insurance companies make money selling policies where the premiums pay them more than they pay out.  Seems like a simple proposition, but it is lost on most people.  You can't have an insurance policy where you take in $100 and pay out $1000.  You can, but you'll end up bankrupt before long, as GE is finding out with its long-term disability policies. Most mainstream insurance plans are pretty competitive, however.  Homeowners and car insurance, for example, is sold widely and there are many companies in the business.  So rates are pretty uniform across the board.  Some companies claim in their advertisements that they can save you hundreds of dollars over another company's premiums.  In most cases, however, this really isn't true, unless you are comparing apples to oranges - a "cradle to grave" coverage versus a stripped-down high-deductible coverage.

So there isn't a huge amount of profit to be made in typical insurance coverage.  However, you can make a shitload of money selling long-shot insurance policies, mostly to poor and middle-class people.  These are policies where the payoffs are trivial or non-existent, and the premiums are pretty hefty.  And these policies are sold on fear - fear of death, fear of car repairs, fear of debt, or whatever.  What sort of policies am I talking about?  Well here are a few examples:
1.  Burial Insurance - I wrote about this before, "Life insurance for over 50" which is a ripoff.  They want to sell the idea that you can "leave behind" a legacy for your children, for only pennies a day.  But the amount of the policy is trivial - $5,000 to $10,000 or so, and the premiums, while advertised as being tiny, end up costing a lot of money per year - enough that if you simply put that money in the bank, you'd likely end up with more cash in a few years than the policy could pay out.

This is insurance sold to people who didn't save up money in life - people who are not sophisticated and think you can get something-for-nothing.   "No medical exam required!" they say.  So you can have terminal cancer and get a policy, right?  Wrong.  You have to sign a paper saying you don't have some serious illness, and if you lie about this, that is grounds for them not to pay out.  And guess what?  They'll find grounds not to pay out. 
Many of these companies are fly-by-night.  They sell a lot of policies, declare bankruptcy and then start over - leaving the policy holders high and dry.
In terms of bang-for-the-buck, it just isn't worthwhile.  Insurance companies are no fools.  They aren't going to sell life insurance to dying people.  But they will sell overpriced trivial policies to old people who have  many years left - and likely will stop paying on the policy before they die, anyway.

2.  Junk Car Insurance - I wrote about this before.  You sign up for car insurance and they tack on "rental car" coverage and "towing and roadside assistance".  The "rental car" coverage provides you with a rental car if your own car is wrecked.  Yes, it only costs a few tens of dollars a year, but the likelihood is, you won't get into an accident but once every 11 years or so (on average).  Add up the money here and you can see the car insurance company is coming out way ahead.

On car discussion groups, I read about people who get into a wreck and then bitch that the insurance company didn't provide them with a "comparable car" (usually comparable to their BMW).   To them, it is an outrage they have to drive a Chevy Malibu for a week while their car is in the shop.   There are more important things in life, I think.  And wrecking your car should not be like an all-expenses paid spa vacation.   And if your own insurance is paying, odds are, you were at fault, and thus you should be contrite and take the fucking bus to work or get a ride with a friend (which you probably should be doing anyway, rather than travelling alone in a car).

The towing insurance falls along the same line.  They sell this on fear - fear you will break down on the road on a dark and windy night, and since your credit cards are all maxed out and you have no money in the bank, what will you do?  Of course, if you have AAA - which is usually cheaper than towing insurance, they will pay to tow your car.  The only time I have had a car towed in the last 30 years, I used AAA and it was no big deal.

Bear in mind that if you have a new car or a "certified pre-owned" car, you may have roadside assistance included.  That is the most profitable insurance of all - insurance that insures something that is already insured!  The beauty of towing and rental coverage is that most people don't even know they have it, and thus when they need a tow, they get out their wallet and pay and never think to bill the insurance company.  Or they use AAA or their car company's "free roadside assistance" and don't need the towing coverage.

Like I said, many companies - even GEICO - add this on to policies without asking.  GEICO at least itemizes this on their website, and a simple click of a mouse and remove it from your policy.

3.  Extended Warranties are really a form of insurance. Yes, they are a contract - so is insurance. You are betting your car is going to fall apart, and the warranty company is betting it won't - or they will be out of business (it happens) before they have to pay.  Again, these policies are sold on fear to people who don't have two nickels in the bank (because they buy junk insurance!) with the argument that "a new transmission could cost $10,000!  Paying $5,000 for this warranty is a bargain!" which might be true if your transmission fails under warranty, they pay out a claim (after you've followed the esoteric procedures and filled out all paperwork correctly) they are still in business by that time (many third party companies go belly up, by design, every few years).

But most cars don't fall apart, so you pay $5,000 for.... nothing.   It is pure profit to them and no benefit to you - or rarely one.  My own experience with this is illustrative.  I bought a boat from a guy who bought a third-party extended warranty.   It was "transferable" and I sent in the paperwork with the $100 transfer fee.  The output coupling on the engine broke, and I called the company, wrote to them, sent certified letters, etc., and they simply refused to respond.  My only option would have been to go to court and sue them for a $3,000 repair, which would have cost more in attorney's fees to prosecute.

Even if I could have gone to small claims court myself, collecting from the company - located in another State - would have been difficult and costly.   I just counted myself lucky that I didn't pay for this policy and kicked myself for even sending in the $100 transfer fee.  With factory-backed warranties you at least have a shot at getting repairs paid for.  But they aren't cheap, which is why the fly-by-night people offer lower prices and get suckers to sign up (these are the types of folks who call you on the phone with dire warnings that your warranty is about to expire).

4.  Loan Insurance - My credit union used to sell this.  They are supposed to be on your side, but they can't turn away a surefire income generator.  The gag is this - you borrow $10,000 for a used car loan, and the loan officer, at closing, says, "suppose you die before the loan is paid off?  What then?  For only a few dollars more a month, you can get loan insurance that pays off the loan!"

Again, they use fear to sell these kind of policies.  But what is the real danger?  That your car - a depreciating asset you no longer need (you are dead) will be repossessed and your credit rating destroyed?  Again, you are dead, so who cares?  And the odds of a young, healthy person dying in the 4-5 year term of a car loan are nearly nil.  For the price of loan insurance, you could buy a term policy with five times as much coverage, whose payoff would not decline over time.

And yes, I signed up for "loan insurance" when I was younger - in fact, twice.  I was an idiot.
The list goes on and on.  The bottom line is these types of junk insurance are sold based on fear - the fear that you will have an "unexpected expense" at some point in the future, and since you are living "paycheck to paycheck" you won't be able to handle such expenses.   But of course, one reason you are living "paycheck to paycheck" is that you are making bonehead financial decisions like buying junk insurance.

And I guess for a lot of people, this is the only way they think life can work.  They will never have money, because a dollar in their pocket is a dollar spent, and of course, they borrow a dollar more. Insuring against every trivial possibility is, in a way, a sort of perverse forced-savings plan.  If they didn't purchase this junk coverage, they would spend the premium money on more toys or take-out meals.  They would not put it aside for a rainy day fund. And statistics show this to be true - a staggering number of Americans have nothing set aside for a rainy day.

Does this mean you don't need any insurance? Of course it doesn't - and I hate it when people take things to extremes.  When you own something that you can't easily afford to replace, then you should insure it.  And you should insure open-ended liabilities.  Of course, one way to save on insurance is to own less things or own less expensive things.

Your house is an expensive item, so yes, homeowner's insurance is necessary.   But whether you need a low- or no-deductible plan is another question.  I try to use high deductibles to keep my premiums low.  I am not interested in insuring trivial things, like a broken window, but big things, like a house fire or a hurricane.   You'd be surprised how many people choose the former and then regale folks with how they got a "free window" out of the insurance company. Myself, I would just go to Home Depot, order a new window, install it myself, and pocket the difference between the cost of that coverage and the cost of the window.  Again, insurance companies are not going to pay out more than they take in, and if you file a lot of claims, expect your premiums to rise.

And that is one reason why higher deductible plans are so much less expensive.  They know you are not the type to waste their time with spurious and trivial claims. You just want catastrophic coverage, which is really all you should need.  Bear in mind your mortgage company may require a lower deductible, so check with them before making any changes.

Liability insurance is a biggie.  But again, since most Americans are broke and living "paycheck to paycheck" they have little in the way of real liability.  Once you have money and equity in your home, you have something to protect.  And again, insurance here is protecting your assets from attachment in a lawsuit.  Most plaintiffs are happy to go after your insurance company, who will quickly settle, than to try to take away your house and car.   This is one area where most folks don't think too hard.  They get minimal coverage, even though coverage is cheap.  An umbrella liability policy of $1M or more can be had for a few hundred a year.

With cars, it gets trickier.  Yes, if you have a new car costing tens of thousands of dollars, you may need collision and comprehensive coverage.  If you have a loan on said car, the bank will require you to have it - and require fairly low deductibles sometimes ($500 usually).   Sometimes the bank or loan company will accept a higher deductible ($1000) and this can lower premiums considerably.  But there does reach a time where you have to evaluate whether this coverage is still needed.

I have friends who have hoary old cars with over 250,000 miles on them.  These are cars from the 1990's and the "book value" on them is about $500 or so.   If you get into even a minor wreck with a car like that, the insurance company will write you a check for the book value, minus the deductible, which in this case would be.... zero dollars.   Even if the car books at $1000, all you can expect is $500 or so.  They are not going to spend $5000 repairing a $500 car.  So spending even $50 a year on such coverage is probably a waste of money.

Again, you have to do the math.  If you are young and have a shitty driving record, you may have no choice.   Collision insurance may cost you thousands a year - for a car worth only thousands.  What's the point?   You might as well just put that money in the bank towards your next car - the insurance company seems certain you are going to wreck the one you have.  In other cases, it gets tricky, and again you have to make a judgement call.   But as I noted in earlier postings, a lot of poor people will spend a lot of money insuring older cars for collision and comprehensive coverage, based on fear.   "What will happen to me if my car is wrecked?  Where will I go?  What will I do?"   So they spend more on insurance, over a period of years, than the car is worth in resale value.   It makes no friggin sense, but then again, that is why poor people are poor - they do shit that makes no friggin sense whatsoever.

Your life is something that might be worth insuring, again depending on your life circumstances.  If you are young and staring out and making a good salary and have a wife and kids who depend on that salary, a simple term-life policy might be a good idea.   If you are killed in a car wreck (as happened to a friend of mine, right after I persuaded him to buy a term policy!) it will pay out to your widow, which can help with expenses after you are gone.

But over time, the premiums will creep up - as they did with my term life policy.   Eventually, the odds of you dying reach 1:1 and the premiums reflect this.   By the time you are 50 or 60 years old, the premiums are very steep.  And by then, you (hopefully) have some assets so that your next of kin can get along without you.  At that point, it might make sense to drop the policy.

Whole life, I've gone into detail before.  As an investment vehicle, it pretty much sucks.  I ended up converting my policies to "paid up" status and others to use dividends to pay premiums, so they are self-funding.  The total premiums every month were killing me, financially, and I simply couldn't afford to keep paying.  I would have been better off, in retrospect, putting that money into a 401(k) or IRA account, but at least I put the money into something, as opposed into more toys and restaurant meals.

But other than those three - home, car, life, (and liability) - there really is no need for insurance, in my opinion (which may be wrong) other than, of course, health insurance - but that's a whole 'nuther can of worms.