Within the risk management section of your financial plan, we document how you will handle inevitable and unexpected risks. You can prepare for risks by stashing away funds to cover costs or outsourcing that risk to an insurance company by purchasing an appropriate policy. We see five common mistakes people make in their insurance coverage. By avoiding the five most common insurance mistakes, you will be one step ahead and better prepared for risks to your finances.
In a financial plan, we often work with clients with a combination of life, health, disability, umbrella, and long-term care policies. Each type of insurance covers a narrow sliver of your total risk. Your policies should stitch together to provide a blanket of coverage for you and your family.
Given the many types of insurance policies you may have, there are many possible mistakes we could find in analyzing your coverage. It is essential to point out the mistakes or the ways your insurance policies could be better serving you. We often suggest including an independent insurance broker in the conversation. Independent insurance brokers can shop around for you; they are not tied to one specific insurance company. Insurance is a trillion-dollar-plus industry; it isn’t easy to navigate on your own.
First mistake | Wrong policy
The most common mistake we see with insurance is having the wrong type of policy, specifically the wrong life insurance policy. There are four main types of life insurance policies. Each policy has various ways to customize your coverage through add-ons called riders.
- Term Insurance: A policy that will be in effect for a certain amount of time or until you reach a specific age. Term policies tend to be the most cost-effective.
- Whole Life Insurance: A policy that will be in effect for your whole life. You will pay level premiums. There is a savings component that could include a cash balance.
- Universal Life Insurance: A policy that will be in effect for your whole life. Your premiums could be flexible. There is a savings component that could include a cash balance.
- Variable Life Insurance: A policy that will be in effect for your entire life. There is an investment component that will vary based on your investment selection. Your premiums could be flexible.
When you have the wrong type of life insurance, it is like owning a convertible Corvette when the type of vehicle best suited to your family is a van. Yes, you will get from point A to point B in the Corvette but not comfortably and probably not without accommodations.
To correct the purchase of the wrong type of life insurance, we must analyze the options, such as the impact of converting that policy or applying for an entirely new one and canceling the old one. We can often find a solution that will more efficiently cover your life insurance needs. Usually, the solution involves a discussion of eliminating a policy because you have too much coverage, which leads us to the next mistake we often see.
Second mistake | Too much of a good thing
Too much life insurance is the second mistake you should avoid with your insurance coverage. The problem with having too much life insurance is that since life insurance isn’t free, your funds are not being used efficiently. Having too much life insurance is not the same as having too much in an investment account (a good problem to have); there are multiple layers of fees on life insurance policies. You could better allocate your money to your other goals which would be more impactful than maintaining too much life insurance.
Third mistake | Not enough broad protection
Umbrella insurance is a type of policy that covers you in the event you need extra liability insurance. Think you are facing a significant lawsuit that would completely drain your life savings. An umbrella policy would cover you for the liability in that lawsuit over and above what your standard policies like homeowners or auto insurance provide.
Umbrella policies are very affordable coverage. Having an umbrella policy is a good idea once you are a homeowner. You can keep an umbrella policy in place even into retirement. Usually, your risk that an umbrella policy offsets reduces in your 70s and 80s, and you can drop the policy at that time.
Fourth mistake | Forgetting the unique coverages
As I mentioned, you can customize your life insurance policy with optional add-ons called riders to suit your needs. Other types of insurance have optional riders too. You might have a rider on your homeowners’ policy to protect certain exceptionally high-value items. Don’t assume just because you have an insurance policy; it will cover every aspect of your risk. Discuss your situation, risks, and unique factors with your insurance broker to ensure you are appropriately covered by the right policy and riders.
For example, when we moved to the farm, we no longer needed a standard homeowner’s policy. Instead, we purchased a farm policy. Once more farm-related activities started happening on the farm, we had to add additional riders to cover new farm-related risks. We chose to discuss with our insurance broker what activities were happening, who was involved, and the frequency to ensure we had the right coverage in place.
Fifth mistake | Using a set it and forget it approach
Your life and risks change, and you must update your policies regularly! Many take a ‘set it and forget it’ approach to insurance. Once they have a policy in place, that box is checked, and they don’t revisit it for many years. Including your insurance coverages in your annual financial plan review process is best. If you are not reviewing your financial plan regularly, set a reminder to call your insurance broker and discuss your policies annually.
One of my newer clients had a homeowner’s policy for 20 years, never reviewed it, and just renewed it every year. Once we reviewed it and discussed their risks with a new insurance broker, they found a policy that more appropriately covered them. The bonus is that the new policy saved them several hundreds of dollars a year.
There are risks we can’t eliminate in life; that is precisely why insurance exists, to help mitigate some of the risks we all face. We all make mistakes along the way. Avoid the most common five mistakes people make with insurance. Your financial position will be more robust, and you will be one step ahead on your financial journey.
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