Insurance Basics

You don't often hear somebody say that they want insurance. “Boy, I wish I could double up on my homeowner's insurance,” is a phrase that certainly would cause you to look twice at the person speaking. Insurance, unfortunately, is something we buy because we need it—not because we want it.

We need insurance to protect ourselves from the environment, from others, and from ourselves. Insurance is a way to reduce risk by sharing financial losses within a group of people. There are many types of risks, both financial and nonfinancial. These risks include the following:

• Disability or death
• Property loss
• Personal liability
• Risk from failure of others, such as a breach of contract
• Speculative risks, such as the stock market

When considering these risks, you must decide if the protection you receive is worth the cost of the insurance you buy.

Many types of insurance are required. If you have a mortgage, your lender requires you to have homeowner's insurance. Most states require auto insurance.

In addition to these required insurances, you must decide what type of coverage you need for your family, and what you're able to spend on them. Riders, options, and basic insurance all come at a cost so you need to review the price and the coverage as part of your total financial picture.

You may need to provide your own insurance for some risks by putting aside funds on your own. You might want to set aside money for dental bills or a nursing home stay, for instance.

Let's look at some of the kinds of insurance that are important to you and your family.

Disability Insurance

Disability insurance kicks in if you're unable to work for an extended period of time due to illness or injury. This type of insurance is imperative if your family depends on your income to keep a house, maintain its current standard of living, and so forth.

Don't depend on health insurance in the event that you're out of work due to being disabled. Your health insurance will cover (hopefully) your medical bills, but it won't cover the loss of your salary.

Most disability insurance policies don't cover the full amount of a salary, but kick in about 60 percent. Hopefully, you'll have an emergency fund to supplement the gap between your income and the insurance. There are various types of disability insurance, and some factors you should be sure to consider when comparing them.

An own-occupation policy pays benefits if you're unable to perform your normal work. Other policies will only kick in if you're unable to do the job for which you're reasonably trained. Many infirmities permit you to work, but not at the type of job you held prior to your infirmity.

Own-occupation policies are the most expensive type of disability insurance, because it's more likely that the insurance company will have to pay you. It may not be worth the extra cost unless you're earning big bucks in a specialized job and would need to take a pay cut if you were forced to change jobs.

When looking at disability insurance plans, keep the following information in mind.

• Guaranteed renewable. This means that your policy can't be cancelled if you get sick. If your policy requires you to have a physical every so often, you risk losing your coverage just when you need it.

• Waiting period. This is the period of time between when you get disabled and when the plan starts paying. The longer the waiting period, the less the policy should cost. The minimum on most policies is thirty days, and the maximum can be up to two years. A good compromise would be 90 days to 6 months.

• Cost-of-living adjustments. This feature automatically boosts your benefits, either by a specified amount or depending on the rate of inflation.

• Future insurability. This feature allows you to buy additional coverage down the road. It's good if you have a job in which you expect to be earning much more in several years than you are presently.

There is a greater probability of being disabled than of dying by the time you're 65. Disability insurance is coverage that is often overlooked but very, very important.

Homeowner's Insurance

Your home probably is the biggest investment you'll ever make, and you need an adequate homeowner's insurance policy to protect it and what's in it.

You'll be required to have homeowner's insurance before you get a mortgage. The trick is to get a policy that offers the best protection for your home and its contents.

It's worth taking a look at your current policy to see exactly what it covers. Most homeowner's policies have personal property coverage, as well as liability coverage. Thus, if your house burns down, all your furniture will be replaced under the personal property coverage. Make certain you have enough to cover what you own.

It's important to realize that most standard insurance policies don't cover special property. To insure items such as sterling silver, jewelry, and artwork, you'll need to get an insurance rider at an additional cost.

In addition to protecting your house and property, homeowner's coverage also provides liability coverage in case somebody falls down your front steps and breaks an ankle.

Auto Insurance

If you own and drive a car, you need insurance to protect yourself from injury in the event of an accident. Auto insurance is expensive, and nearly every state requires drivers to have it. Even if it's not required, however, you can't afford to go without it.

Auto insurance includes different types of coverage, but the one that nearly all states require is liability. Liability covers bodily injury and property damage for you and others, if you're at fault in an accident. Most states require that you carry a minimum amount of bodily injury coverage—usually $25,000 per person, and $50,000 per accident.

Personal Catastrophic Casualty Policy (PCAT)

Your auto and homeowner's policies provide liability coverage up to a certain amount. What happens, however, if someone sues you for more than the limitations of your policy?

We live in an extremely litigious society. If you have a pool, a trampoline in your yard, or a dog with a nasty temper, you may need liability coverage that is more than that provided on your homeowner's and auto ­policies.

A PCAT policy comes in $1 million increments. If you've got sizeable assets, it's good to think about getting one. A PCAT policy supplements other policies that you have and is not overly expensive (usually about $150 a year). Such a policy should cover damages from accidents at your home and automobile accidents.

Life Insurance

Nobody likes to think about needing life insurance. If you're a source of income for your family, however, it really is necessary. If you're single, you probably don't need much life insurance. If you're married or in a relationship, but don't have children, you should have life insurance if your spouse or partner would have to make a drastic change in financial lifestyle if you were no longer around. If you have kids, you need life insurance.

Life insurance should be purchased according to income replacement need and should be five to eight times the amount of your current salary. There are two types of life insurance policies: term and cash value.

• Term life insurance. This type of policy pays a predetermined amount of money to your beneficiaries if you die during the term in which you're insured. All you have to do, of course, is keep paying your annual premium. The trick is that the premium increases as you get older, and may eventually become prohibitive. Term insurance is invaluable for your family if you die prematurely. It can be a source of college money, cover the cost of a mortgage, and generally provide financial security. This type of policy is intended to be used for a limited time period and is generally for younger persons. Most people can't afford to keep the coverage as they get older because the cost increases so much.

• Cash value life insurance. If the cost of your term life insurance policy has been creeping up, it might be time to consider trading it in for a cash value policy. Under a cash value life insurance plan, part of the premium is used to provide death benefits, and the rest is used to earn interest. It's both a protection plan and a savings plan that can actually provide some income in your later years. There currently are two types of cash value insurance. One invests your money in an assortment of mutual funds, while the other invests it in something similar to a certificate of deposit, with a fixed interest rate. Ask your insurance agent for more details about cash value life insurance policies.

Excerpted from The Complete Idiot's Guide to Personal Finance in Your 40s and 50s © 2002 by Sarah Young Fisher and Susan Shelly. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.

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