Here is the long-awaited continuation of the Financial Peace University overview series. As I was reviewing the course, the last half of the sessions were jam packed with useful information so I will be breaking them down into several posts.
This lessons will cover FPU lesson #6 entitled “Understanding Insurance.” Since insurance can be so convoluted and confusing it’s important to know what to look for. There are some highly actionable nuggets of information here so be prepared to pull out your insurance policies and see how you match up.
The types of insurance Dave covers are:
- Home owners/renters
- Long-term care
Auto and homeowners insurance
Saving money on car and homeowners insurance
Here are the main ways Dave Ramsey recommends saving money:
- Increase your deductible
It seems to be pretty common knowledge that one of the best ways to decrease your insurance premiums is to raise your deductable. You really should only consider doing this if you have an emergency fund. Your emergency fund should allow you to pay the increased deductible.
To determine how much to raise your deductible do a simple break even analysis. Take the amount the deductible will change and divide it by the amount that the premium decreases (you will need to call the insurance company to find this out). For example, if by increasing the deductible from $500 to $1,000 (a change of $500) your monthly premium goes down $25, divide $500 (the change in the deductible) by $25/mo (the change in the premium). This shows how many months it would take for you to compensate for the increase in deductible using the savings from the premium. Here is the calculation for this example (note: if you pay a quarterly or yearly premium, the result will be the number of quarters or years).
$500/$25 = 20 months (1 yr, 8 mo.)
In this example if you go for 20 months without an incident that would put you above you’re deductible and you would save money. You have to feel this out and determine what you’re comfortable with. In this example, there’s a pretty good chance you won’t have a major accident every 20 months so you’re probably better off raising your deductible.
- If you have an older car and have money to replace your car in case of an accident (emergency fund), you may want to drop collision coverage
Auto Liability Insurance
Ramsey recommends having 500,000 in liability insurance. When reading your insurance policy (e.g. 100,000/300,000) the first number is your liability coverage. LOOK UP OUR POLICY
Only use “Replacement cost” homeowners insurance
I thought this was one of the most useful tips and one which we don’t currently follow (I better find another insurance provider). Replacement cost insurance pays you what it would cost to replace your lost or damaged property rather than just paying you what it cost you to buy them originally. There’s a huge difference, particularly when it comes to your house. If you paid $100,000 for a home and it has appreciated to $200,000 and it burns down, the insurance company will only pay you $100,000 if you don’t have replacement cost insurance. Replacement cost would pay you the full $200,000. I can’t say from personal experience, but from what I hear, replacement cost is harder to find. Insurance companies these days don’t want to offer it because they have to pay out more.
If you have over 200k in assets, get an umbrella policy
Ramsy recommends an umbrella policy if you have over $200K in assets. An umbrella policy is essentially another level of liability insurance within your auto and homeowners coverage. Umbrella policies cover accidents that happen on your property (e.g. if someone slips on driveway) and can protect you against someone going after your assets. I personally don’t carry any right now but am probably at a point I should start considering it.
How to save money on health insurance
Ramsey had three main recommendations for saving money on health insurance.
- Raise your deductibles – Again, this seems like standard, solid advice if you have an adequate emergency fund to cover you.
- Increase your co-pay – I loved this piece of advice and wasn’t previously aware you could raise your co-pay. In fact, reviewing this series reminds me that I need to do this. I imagine you would still want to do some sort of break even analysis similar to the one above for raising auto insurance deductibles. If your premiums don’t go down very much as a result of increasing your co-pay, you may not want to do it. I imagine if you have several kids and make frequent trips to the doctor, this also may not be such a great deal.
- Increase your “stop-loss” – This was also a tip I wasn’t aware of. The stop-loss is the total amount you can pay out-of-pocket before the insurance covers everything else. It “stops” your total “loss.” For example, if your stop-loss is $3,000 you would only have to pay that amount out-of-pocket (including deductibles, co-pays, etc). Once you’ve paid $3,000 out-of-pocket, the insurance company would cover everything else. Ramsey didn’t give any specific recommendations for how much to increase a stop-loss. I’ll have to research this a little more and post more details. If anybody has recommendations, please leave them in the comments.
MSA – Medical Savings Account (now called a Health Savings Account or HSA)
The next generation MSA is called an HSA (Health Savings Account). Emily and I are currently looking into starting one and are very excited about it. Here’s why. An HSA essentially allows you to save funds to pay your deductible amount tax-free. The money your save in an HSA is contributed pre-tax and grows tax free. You’re not even taxed when you use it. The reason this is so great is that it allows you to increase your deductible significantly which lowers your premium significantly. You can take the amount you’re saving on lower premiums and start putting it into the HSA.
This is honestly a topic I currently don’t know much about but as I learn more I will certainly pass the information along. In the meantime for more information on HSAs, check out the Wikipedia entry on HSAs
Disability insurance replaces a percentage of your income (typically 50-75%, averaging 60%) in the event you become disabled and are unable to do your job. Disability insurance is one of the most under-insured areas. According to Ramsey If you’re 32 years old you’re twelve times more likely to become disabled by 65 than to die. Dave recommends “own occ” disability which stands for “Own Occupation.” “Own occ” means that you’re covered if you become disabled and are no longer able to do your job vs. covering only specific injuries. For example, if you’re a computer programmer and lose use of a hand, you are unable to complete you’re current job. Disability insurance would then kick in and cover you for the pre-defined time period. By the time coverage ends you’d have to have recovered from the injury or find employment that doesn’t require both hands.
Dave recommends getting long-term disability which should cover you for roughly 5 years. Dave also recommends a long “elimination period” because it’s cheaper. The elimination period is the time period it takes for the disability insurance to kick in from the date of proof of your disability. You should be able to cover your expenses in the meantime with your emergency fund. The elimination period is like a deductible in ways because the longer (higher) it is, the lower your premiums.
Emily and I didn’t have a disability policy until recently when my employer started offering a group plan. It was so darn expensive getting it independantly. Typically group disability policies are a great deal at about 1/4 the cost of individual policies. If your employer offers group disability GET IT. There’s really no need to shop around because the group policy will always be way cheaper.
Long term care insurance
Long term care insurance is typcially for elderly individuals and covers the expenses of nursing homes and other forms of long-term care. Ramsey recommends having a long term care policy if you’re 60 years or older and don’t have over $1 million in retirement investments.
He also mentions that care for parents is one of the largest expenses for adults. Statistically 60% of people over 65 eventually have some form of long term care – 20% will need 5 years or more of long-term care. Dave recommends addressing this issue with your parents to make sure they have a policy. I think it’s great advise but may be an awkward conversation to have. Emily and I have only brought up the topic casually one time with one of our parents. I need to get the guts up to really address the issue with them as both my parents are approaching 65.
There are two basic types of life insurance: term and cash-value (including whole life, universal life and variable universal life). Ramsey compares term life to renting and cash life to buying. In other words, with term you pay for coverage but no cash value is accumulated. With cash-value the money you pay (or a portion of it) goes into an account that accumulates and that you can use later according to very specific rules.
Get term life insurance and invest the difference
The standard advice about life insurance from most financial planners is to get term life insurance and invest the difference. While cash-value sounds more attractive, it’s much more expensive. And while cash-value policies can act like a savings account of sorts with money accumulating accumulating in them, you earn a very small return on those funds and are extremely restricted as to how and when you can use them. By getting term life insurance and investing the difference between what you would pay for cash-value, you end up paying less for the coverage you need while having full control over the money you’re investing from the savings.
Life insurance isn’t always necessary
One of the more interesting points Dave brings up is that, contrary to common perceptions, life insurance isn’t always a necessity. The idea of life insurance is to cover your funeral expenses and replace the “economic value” of the deceased person for those left behind. If you have savings adequate to meet those objectives, you don’t need life insurance. For familys that have a solid saving and investing plan, the need for life insurance decreases over time as their savings grows.
Don’t overlook life insurance for a stay-at-home spouse and children
Because the idea of life insurance is to replace the economic value of the deceased, stay-at-home spouses should be covered. Even if a stay-at-home mom doesn’t provide any income, she certainly provides economic value. To replace what she does would have a real cost in the form of day care, nannys, and even the cost of meal preparation and cleaning.
For children, you mainly need to cover the funeral expenses.
How much life insurance should I get?
Standard advice for the amount of coverage to buy is ten times your income. If you make $50,000 then you should get a $500,000 policy. Of course, you’ll have to make an estimation for family members that don’t produce an income.
What to avoid
Dave mentions a few more tips.
- Don’t get policies that cover college for kids.
- Smokers typcially pay double or more for life insurance.
- Avoid “credit” life and disability insurance that pays off the loan if you die. It’s 90-200x more expensive.
- Don’t buy credit card protection.
- Don’t buy cancer insurance. Your major medical should cover cancer.
- Don’t buy accidental death insurance.
- Don’t buy prepaid burial policies.
- Don’t do mortgage life insurance (decreasing term).
- Don’t get duplicate policies from more than one company. This causes disputes as to which company is responsible and may prevent you from getting your benefits at all.
This post is filled with actionable advice. Take some time today to check your policies and see if there are any ways to save money or optimize your coverage. Reviewing this lesson has caused me to identify several changes that I need to make.
Stay tuned for more FPU overviews.
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