How to Add Alpha by Helping Clients with Their Insurance Needs

Insurance is one of the areas I spend time working with clients to save them money and add value to the financial planning process. My analysis often makes a compelling case to lower insurance premiums, saving the client money. Here’s how I frame things to clients to give actionable advice.

The five frameworks I use to evaluate insurance

  1. Insurance companies (even mutual companies) need to make a profit after covering costs, commissions, and claims. On average, the client is likely to lose money on most insurance. Thus, they should only buy insurance for what they can’t afford to lose.
  1. The purpose of insurance is to protect wealth – either human (life or disability) or investment capital (liability and health). This differs from the purpose of investing, which is to grow wealth.
  1. Some insurance becomes less important as clients get older (life and disability, to protect human capital) while others become more important (liability, to protect investment capital).
  1. Certain types of insurance provide better deals in the early years of a policy (disability) while others provide better deals in the later years (term life).
  1. Clients typically fall prey to the most powerful force in the universe – inertia. This leads them to keep paying for insurance they don’t need and not do routine price comparisons.

Explaining with two extremes

I don’t have collision or comprehensive insurance on my family’s cars. Granted, if I have a wreck, I’d regret that decision, but it wouldn’t change my lifestyle. In fact, if I had a $2,000 fender bender and did have a collision while holding a policy with a $1,000 deductible, I’m not sure I’d file a claim, as I’d likely see my insurance premiums go up. Auto insurance is often a deferred payment.

I have liability insurance on the cars and an umbrella liability policy on top of that. While the probability of a catastrophic event costing millions of dollars is low, the adverse consequences are high, as my family’s lifestyle would be dramatically changed.

Life and disability

The greater the amount of human capital, the more critical it is to protect those years of earnings. Over time, however, the amount of human capital depletes while, hopefully, investment capital grows, and one can self-insure. Though expensive, disability insurance is often more important than life insurance because one becoming disabled lowers or eliminates income while increasing health care expenses.

Both life and disability protect human capital, yet I analyze them very differently. Let’s look at an example of a couple, Bill and Sue, who are both 35 years old. Sue is a physician with high income and Bill is a stay-at-home dad. Sue bought a $3 million 30-year level term policy when she was 35 years old and a $10,000 monthly long-term disability policy. Bill bought a $1 million 30-year level term policy.