31.OCT.08

Insurance- A vital part of your financial plan

You have created a budget, reduced your expenses, eliminated your credit card debt and, have started saving for retirement, so you are all set, right? While you have certainly come a long way, there is one more important aspect of your finances that you need to consider.

You have worked very hard to build a solid financial footing for you and your family, so it needs to be protected. Accidents and disasters can and do happen, and if you are not adequately insured it could leave you in financial ruin.{{more}} You need insurance to protect your life, your ability to earn income, and to keep a roof over your head.

Insurance is often the most overlooked aspect in the personal financial planning process. There is an old saying in the industry that when all the other expenses are paid, then whatever is left, if any, goes to insurance. The truth is that insurance should be the first one paid, simply because if one is having financial problems now, imagine what it would be like when disaster or tragedy strikes.

Unfortunately, insurance is still one of the least understood areas of personal financial planning. Therefore, in the spirit of Financial Literacy Month and the theme: “manage your money … live your dreams”, we will make the case for insurance as a fundamental part of any strategic financial plan. First, we will look very briefly at how insurance works and how it is employed to cover financial assets. We will also discuss how life insurance can be used to reach savings, investments and retirement goals. Finally, we will show that it is financially prudent to pay an affordable insurance premium today to insure against huge losses in the future.

Insurance premiums go into a pool

Insurance is an arrangement by which one party (the insurer) promises to pay another party (the insured) a sum of money if something happens, which causes the insured to suffer a financial loss. While it may seem complex, insurance is really quite simple: the payments, called premiums, of the many pay for the losses of a few. Your premiums go into a large pool, if you will, at your insurance company. The claims of the few are paid from that pool. Because there are more people contributing to the pool than there are making claims, there is always enough to pay the claims – even large single claims like when someone is permanently disabled as a result of a car collision, or many smaller claims like those resulting from a natural disaster.

Insurance as asset protection

Most of us already recognize the value of insurance in asset protection. Mortgage banks and credit companies mandate that the prospective homeowner acquire life insurance to guarantee future income in the event of untimely death and property insurance to guard against perils such as hurricane, flood and fire. Building contractors must use Contractor’s All-risk policies to insure against physical damage to works, plant and equipment and materials during the course of construction. And, of course, there is compulsory motor insurance which protects against the financial losses and liability that result from traffic accidents. There are very few financial assets that are not backed by insurance of some sort. In this case, insurance is the foundation of wealth creation and wealth preservation.

Life insurance as savings and investment vehicles

We have seen how insurance protects our major assets and investments-be it the dream home, a college education, or a business enterprise. Term life insurance covers the life of the insured for a fixed period of time. If the insured within that period of time, the sum assured is paid to the named beneficiary. Whole life insurance provides income protection, i.e. your earning potential, for your entire lifetime or up to a certain age in some instances. Unlike term insurance, part of the whole life premium goes into building up an accumulated cash value. This cash value can be borrowed or in some cases even withdrawn to help meet future long-term goals such as paying for a child’s college education, or retirement.

Popular life insurances like the whole life and endowment plans are a must have for any comprehensive personal financial plan. They are the right products to have when it’s important to have both protection and cash value accumulation. Additionally, some endowment plans pay 25% of the sum assured every five years and the total face value of the policy at the end of the endowment period. As cost effectiveness goes, they offer guaranteed premiums, i.e. they never increase; guaranteed death benefit and guaranteed cash value.

Other life insurances such as universal life, variable life and variable universal life are termed as interest-sensitive insurance. The universal life is a more flexible, investment -linked plan that allows for a designated amount of the premium to be invested in bonds, mortgages and low-risk securities funds at guaranteed interest rates. Variable life allows the policyholder to allocate a portion of the premium to separate account comprised of various investments funds within the company’s portfolio. With variable universal life, the policyholder can direct the investments themselves from a pool of options given in the policy. However, the risk is, where the investments perform well, the cash value grows faster and if they under perform premiums may have to be increased to keep the policy in force. These policies, with greater element of risks, allow for the cash values to grow much faster, thus accelerating savings, investments and retirement goals.

Insurance and retirement planning

The best way to plan for retirement is to start as early as possible. Without adequate long term planning, the retirement dream can become a nightmare. Financial risks, health issues, increased longevity, rising cost of living and uncertain retirement benefits obligations can cause living expenses to greatly exceed your retirement income.

Cash value life insurance is one of the ways to offset the risks of reduced income in your golden years. The guaranteed accumulated cash value in your whole life policy can now be used as supplementation for your Social Security benefit and your employer’s pension.

With practical financial planning, the cash values in your life insurance can be customized to help fund your retirement in the following ways. The cash value can be paid out every month like a pension. A lump sum payment can be used to buy an immediate annuity for pension income or for emergencies, vacation, education, long-term and health care or any other unforeseen expenses during retirement.

Insurance and financial prudence

What is essential about protection insurance, and most overlooked, is its direct and indirect cost saving features. Remember, your affordable premiums go into a pool which pays out relatively large claims to the unfortunate few. This pooling feature brings the cost of protection within the means of most people, especially those who cannot readily source funds to handle the huge financial losses resulting from accidents, poor health or natural disasters.

Since insurance covers unforeseen events, many people do not view payments on insurance today as saving for a rainy day or as receiving any significant cost savings. In fact, they believe that it is more prudent to manage their own money through their own savings and investments. This is not ideal, as many people are seldom able to reach their own savings goals. Investments have their place but they are prone to the fluctuation of the markets and are not guaranteed. The insurance contract, on the other hand, provides cash guarantees for just when you need it.

Few people are able to pay out of pocket for major medical care. With an affordable medical insurance plan, the buyer can be assured of access to quality healthcare especially in the event of an emergency or major illness. In a time of astronomical medical and health care costs, this can be the difference between financial ruin and the peace of mind that comes with knowing that you have access to quality healthcare.

Just in strict money terms, the actual average cost of retail air ambulance service to Miami, USA, is US$15,000. That is what someone without coverage will have to pay before they can access this service. So if you are ever in need of an air ambulance service, think of how much you will save in the future by paying a reasonably priced air ambulance premium today.

Term life insurance is the most affordable life insurance because the premium is designed to cover the cost of protection and, therefore, it has no cash value built in. However, term life is very useful for anyone who is cash-strapped like new some homeowners, or college students but absolutely must have life protection. Such persons are usually advised to upgrade their coverage to whole life as soon as their situation improves since term policies have no cash value and, particularly as the insured gets older, coverage becomes more and more expensive upon renewal.

With cash value insurance, owners have access to a ready cash reserve that they can either borrow or withdraw from to use as a down payment on real estate or take care of contingencies such as accidents, family crisis, and overseas travel. This is essentially a hassle-free loan at the time when you need it most. Additionally, in terms of cost-effectiveness, holders of multiple policies in the same company may qualify for discounts and bonuses which help to stretch their disposable incomes.

In the case of life insurance, the cost of protection increases as one gets older. Hence younger persons can buy larger amounts of insurance at lower rates. For whole life insurance, these premiums are guaranteed, i.e. they do not change at all throughout the life of the policy. Hence early starters can lock in a relatively inexpensive premium with a substantial amount of insurance cover that can be used for later on for education, mortgage protection and retirement.

If you want to save for retirement, send a child to college or buy your dream house, then insurance must be a central feature of your own personal financial plan. Cash value insurances are also savings and investments vehicles with guaranteed accumulated funds that grow to fit your day to day financial needs. Insurance protects our most cherished financial assets and brings peace of mind and a sense of well-being in the golden years.

A well-known fact in the industry is that insurance coverage is usually one of the first things that people will forego during financially tough times. There is plenty of evidence as to how quickly catastrophes like the loss of the breadwinner, a major illness or natural disasters can deplete financial resources where there is no insurance. With better public education about insurance, this kind of attitude is sure to change for the better with more and more people actively seeking out the essential insurance coverage. That is why the dedication of at least one month a year to financial literacy is so important.

This article was written by Floyd D. Charles, Sales and Marketing Manager, National Caribbean Insurance, as part of the activities commemorating Financial Literacy Month, October 2008, an initiative coordinated by the ECCB.

Financial Literacy Month October 2008 – Manage Your Money….Live Your Dreams.