Today, we’re going to continue our series on insurance and essentially wrap it up to this point We’ve talked about various types of insurance.
We talked about what insurance is for from a basics perspective We’ve talked about medical insurance and how it really protects against bankruptcy We talked about homeowners and renters protecting your biggest asset We talked about auto insurance about how state minimums are not enough We talked about disability, about protecting your future income and wages.
Should you get disabled? We talked about life insurance in providing for those that are financially dependent upon you. And last week we talked about long term care insurance, which protects against the financial impacts of potentially entering a nursing home. Insurance in general is one of the two rails on the financial framework, and it’s important to have insurance.
but not to have too much insurance. It’s kind of like the Goldilocks and the three bears, not too hot, not too cold, but just right. Insurance is the same thing. We want to have the right insurance in place, but we don’t want to have the wrong insurances in place. And we want to have the right coverages in place, but we don’t want to have too little or too many coverages.
And so today I want to talk about what I’m going to overarchingly label as Scam insurance. Now the reality is these are not scams. There is such a thing as scam insurance out there. Things we’re going to talk about today is legitimate insurance. It does protect certain things, but for most people, they’re not really needed.
So, if you remember back in the basics of insurance, we talked about the primary purpose of insurance is to transfer risk. And you can go back and watch that video where we talked about. Risk mitigation, risk retention, risk avoidance, and risk transfer. But the idea of insurance is to transfer risk, meaning that if an event occurs.
Instead of you bearing the financial impacts of it, you transfer it to an insurance company. And you only want to do that for things that are large, large expenses, things that would have a debilitating or even a disastrous financial impact, like your house burning down, like a death, like a disability, things like that.
And so, these types of what I’m going to call scam insurances are kind of little things that take place in life where ideally you would have a solid emergency fund that would protect against these. But There are things that occur, but aren’t overwhelming, right? They’re just kind of at that annoying level if that makes sense.
So, some things that I might put under this umbrella would be things like extended warranties, small death policies, like two to 5, 000 cancer insurance, supplemental insurance. So, you’ve heard of like Aflac, they sell supplemental insurance. It’s kind of insurance that, you know, things don’t work out, right.
You have maybe a medical. Co pays, it might share against that. Loss of wages for a period, they might cover things like that. Just, you’re having a hard time type of insurance. Accidental death insurance. Accidental death is the idea that if you die due to an accident, they will cover an additional amount, you’ll get additional amount of death benefit.
If you die in an accident, generally it’s relatively cheap. You can get it through work. Sometimes if you get through work and it’s free. Fine. Go ahead and get it. But if it’s to pay for it, probably not a good idea. Other types of, you know, scam insurances would be things like in your auto policy, things with towing or roadside assistance or rental coverage.
You know, they’ll cover if you have those events take place. Pet insurance would be another one. Burial policies mortgage insurance, right? These types of things. You ever get a mortgage through a new home, you get a new home, you get a new mortgage, and then suddenly all these, you know, insurance things, protect your title, protect, you know, against not paying your house off, all kinds of various things that come, you know, flooding after that.
And so, these are things that you want generally to self-insure through. So why is that? For two reasons. Number one, only about 10 percent of the premiums that you pay go to covering the cost of the expenses that would be incurred. And the rest is just overhead, sales profit, and commissions.
To the companies. So just to illustrate this here I had a meeting last year, sometimes with a client and they have a couple of pets and one of the pets got sick. And, and we had a conversation about, you know, it was hefty bill from the vet, and they were asked about pet insurance and what I did was I said, well, let’s reverse this and think about it a little bit, let’s say you and I are going to go into the pet.
Health insurance business. Let’s say specifically we’re going to cover cats, right? Cats have nine lives. They live forever. And so, you know, we’ll talk about cats. So, let’s say we want to go into the cat insurance. The cat health insurance business. So, what would we do if we’re going into business? Well, the first thing we must do is we have to figure out what we’re going to cover and what we’re going to exclude.
So, we might cover surgeries, but we’re going to exclude cancer. We might include things like medicines, but we’re going to exclude You know, I don’t know. Again, I don’t know much about pets, right, but we go through the things we try to figure out what we would cover and what we won’t cover. And then what we’d have to do is we’d have to come up with some kind of actuarial amount of for every policy that we issued, how much cost would we expect to pay out?
Historically for insurances, that’s about 10%. So, whatever we’re, whatever we’re selling the policies for, we want to make that essentially 90 percent more than what we must cover. Why is that? Because once we figure out how much we’d have to pay out, that’s our, that’s our cost of doing business in the.
cat healthcare insurance business. Then what do we have to do? Well, we’re going to have a, we’re going to run a business. We’re going to have costs. We’re going to have buildings that we’re going to sit in. We’re going to have desks. We’re going to sit in. We’re going to have employees. We must pay them.
We must pay taxes on the wages that we make. So, we have all these costs associated. So, we’re going to take our baseline costs of insurance that we expect to pay on in every policy. And then we’re going to add more to that. The costs that we would have if doing business. Well, of course, then we must sell these insurance policies.
So how would we do that? Well, we would probably go to places that have direct means to customers that would be interested in buying insurance. Cat health insurance. So maybe for example, veterinarians or at animal stores, right? So, pet smarts or things like that. We would go to them, and we’d say, hey, we are, we are starting a new company, and we are selling cat health insurance.
And we’d like you to sell our policies. And they’d be saying, sure, that’s fine. We can gladly do that. How much are you going to pay us? So, we’re going to have to pay a commission to the people that are selling it. So, the vets or the salesmen or the businesses are going to sell these policies, we’re going to have to pay them a commission.
So now our costs of doing business are the amount of costs to pay out to cover the expenses that we would pay on a claim plus the cost of doing business. Plus, now we must. Commissions and we’re not running a charity here, so we want to run a Profitable business, which means we must charge more than that.
So, we have the costs of the policies, the claims we expect to pay out the overhead costs, the commissions we’re going to say to pay to the salespeople, which are generally about 50 percent of the policies. And then we’re going to make profit over it. So, when you buy one of these types of insurances, so for pet health insurance, about 90 percent of what the actual.
Costs of your paying goes to profit commissions and overhead, and only about 10 percent covers the actual costs of claims, which means statistically you would be better off self-insuring and not paying the 90% Of the cost to the insurance companies, you would just retain it. Ideally have an emergency fund.
And yes, it does stink when your cat must go to the vet or your dog must go to the vet or any of those other events occur that we talked about in the list of scam insurance, but you’re better off paying that out when they occur rather than paying for insurance that you’ll never recoup the benefit from.
Which brings me to the exceptions, right? So, everything, there’s an exception and there’s generally two exceptions. The first one is when, you know, for sure, you’ll get more out of the policy than you pay in. A good example of this is dental insurance. I remember I was talking to a client. Five, six years ago, younger client and they were asking about dental insurance, and I can’t remember exactly.
I think they paid like 2 a pay period or something like that for dental insurance. And so, we talked about, I said, well, the dental insurance is good. To buy if you’re going to use it. So, I said, let’s say for example, you and your husband and your kid all go to the dentist to get a cleaning every six months.
How much would that cost? Well, it’s 300 per person times three is nine times two is 18. So, you’re going to get 1, 800 of value out of this policy, but you’re only going to pay in, you know 26 pay periods times two What is that? 52. You’re going to pay in 52, but reap 1, 800 of benefits. That makes economic sense.
Assuming you’re going to go to the dentist and if you’re going to be one of these people that hate going to the dentist and never go, then it doesn’t make sense to have the insurance for those reasons, right? So. If you know for sure you’re going to get more out of a policy than you’re going to pay in, then that makes sense.
Now, insurance companies got smart with that and a lot of times there’s exclusion periods and benefit periods and limitations and stuff like that. Especially with dental, sometimes for major stuff explicitly. Alright, so the other reason is that where the exception to this is you, it might be a large financial risk.
That you can’t otherwise insure through. So, example of this would be something like if you had a medical condition that would preclude you from getting life insurance, but you have a mortgage. Well, there is generally what’s Referred to a lot of those mortgage insurance. It’s really a decreasing term policy but where you can get that through your lender or through a bank something like that where if you were to die, they would pay off the mortgage.
So, it’s kind of like life insurance, but it’s not really to go provide an income, like we talked about in the life insurance policy, it’s more of to just pay off the mortgage, but paying off the mortgage reduces your expenses, which effectively kind of raises the income or at least lowers the income a person needs.
So again, that would be another exception where there’s a. Legitimate large financial risk. The idea of, of a mortgage that you couldn’t otherwise insure through. All right. So that, that’s an example of that. So, your micro action for the week. Review any policies that would kind of fit in this. Again, I’m generally labeling it as scam buckets and question.
Do you really need them, or can you self-insure? Now the thing about these is they don’t cost a lot. They’re going to cost a dollar, 3, 10. And you think, ah, they don’t cost a lot. Yeah, but that stuff adds up. It’s money you’re paying out. It’s money you don’t have to pay down debt. It’s money you don’t have for savings.
And it’s less that you must invest. So over time, these things add up. All right. So, your micro action for the week is to review any policies that fit into this category and question them. Do you have a legitimate need for them, or can you self-insure them? Today, we talked about kind of the other insurances, the scam insurances, and we listed some examples.
We explained why you wouldn’t want to have them. the unique circumstances that you might. I hope this helps you on your financial journey. If you have any questions, please feel free to list them below. Additionally, you can send an email to Mike at true wealth dot show, Mike at true wealth dot show. And until next time, I hope you have a great day.
