Q&A - Answers to basic questions No. 1 to 6
1. Why should we deal with insurance?
We should deal with insurance because
- as individuals or families we are quite vulnerable financially. Pooling resources with others gives improved chances in coping with various risks -- this is the basic, protection, aspect of insurance.
- In many cases, insurance can be a sophisticated tool in managing the finances of families and businesses. In these functions, insurance is not simply a protective tool. Because of its legal and taxation treatment, it can be an enhancer of wealth creation, maintenance, and smart utilization as well.
The first step of dealing sensibly with insurance is to face the possible financial consequences of some gloomy - but realistic - scenarios of illnesses, injuries, and death. It takes guts to do this, but the potential benefits make it worthwhile.
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2. What are the dangers insurance can be useful against?
The whole institution of insurance wouldn't exist if the future were knowable. Since it is not, the only thing we know is that we will die, and probably not without suffering fewer or more times from various illnesses and injuries first. Death can be financially devastating to dependents, a family, or a business. Consequences of illness or injury can be even worse. Insurance can provide for these tough times. Also, insurance can help coping with another, increasingly frequent, danger: outliving our financial resources.
3. Why should we bother with financial planning at all?
The reason for the need for planning is not that with it we can exclude risks from our lives totally. However, we can exclude at least some risks, and having a picture of various scenarios can help to respond well to unfolding events. Many of the needed, optimal, responses require certain preconditions (e.g., having a will, a power of attorney, or a proper insurance policy, or setting up a savings program). We do not prearrange these things if we do not think about various alternative futures. Risky situations may unfold suddenly or very slowly; actually, so slowly that we tend not even to notice or properly evaluate them. Planning is basically about these long term processes and whole situations, ... seeing the trees and the forest as well. Numerical calculations are an important part of long term thinking, since without them it's almost impossible to understand the cumulative effects of even small differences in inflation, savings, investment returns, costs, taxes, and the like.
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4. Why is time frame so important in dealing with our financial future? What does it mean, anyway?
Planning can, and should, be done with different time horizons, that is by peeking into variously distant stages of the future. This is what is meant by using different time frames. Why is this so important? It is because what can be a best arrangement for a short range evaluation might be far from the best alternative if the evaluation is done according to the long term outcomes. You can discern easily what I'm talking about if you have heard the old tale about the goose laying golden eggs. Staying away from animal husbandry, we can refer to the issue of cost saving with buying term insurance, e.g., or the importance of contributing to saving plans early. What might seem to be the best today (buy the cheapest protection, spend all the money today) can easily turn out to be a poor option on the long run. Experts and calculations can help you in envisioning various future options, but reconciling the lessons from using various time frames is the conclusive part of planning no-one can do for you.
5. What is the advantage of dealing with these issues now? Why not postpone it?
Of course, there is a good chance that you can postpone dealing with insurance, in the sense that you probably will not die, get injured, or sick very soon. But you just don't know, that's the point. The essence of insurance is dealing with these unknowable things. Chances or probabilities play roles of various extent in all our decisions in life, whether we calculate them consciously or not. With insurance, this probability element becomes the focus of the decision, or at least this is the sensible way of approaching it. I wish good luck to anyone who really trusts fortune tellers and horoscopes, but we will never understand each other, I guess. We can get some guidance from statistics; even if we know that certain people can misunderstand, misinterpret or misrepresent some statistical facts. On this site, you can find a lot of data, and many links to web sites with even more data. Please do not look at them as if they were presented for the purpose of scare mongering, or as if you were an outsider. This data is about us.
Besides not paying attention to statistics, another mistake many people commit is that they allow urgent things to rule all their thoughts, at the expense of more important things that do not seem to be that urgent today. We frequently do it as individuals, groups, and whole societies as well. At the end we pay too much for not balancing the important with the urgent.
A few aspects to remember :
- premiums are significantly lower at younger ages, and if you "lock-in" earlier, you may end up with substantially lower sums of premiums paid altogether, on the long run
- your health can deteriorate, making obtaining insurance impossible or especially expensive later when you may want it
- if you use your insurance policy for investment purposes, the duration of the accumulation of your money is crucial. If you start saving just a few years later, you have to save much more, and for much longer, to achieve a desired level of capital than if you started the process earlier.
To numerically assess the impact of time, let's see the example of someone who wants to retire at age 65. If we assume a good 10% annual real rate of return on investments, and $200 saving every month, this person will accumulate $1.11 million if he / she starts at age 25, $0.68 million if he / she starts at age 30, and merely $0.413 million if the accumulation starts at age 35 only.
Even if he / she invests more money monthly, it will be very hard to catch up if the savings program is delayed. Let's say that this person starts at age 30 with a regular saving of $300 from then on, or at age 35, with $400 in every month in this latter case. Staying with the same 10% annual rate assumption, the amount available at age 65 will still lag behind what can be achieved with only $200 a month, but started at age 25. Here are the numbers:
$200 monthly, started at age 25, growing at 10% a year, leads to $1,110,069 at age 65
$300 monthly, started at age 30, growing at 10% a year, leads to $1,019,637 at age 65
$400 monthly, started at age 35, growing at 10% a year, leads to $ 825,137 at age 65
6. I run a home business / I am an entrepreneur. Why do I need insurance?
As an entrepreneur, you must be used to taking risks. While you accept uncertainties, you should also try to balance it with keeping control of your essential assets and activities.
You need insurance protection even more than employed people, who usually have at least some coverage, against certain risks, from their employer. With the damage or loss of your most important asset, your earning power, you or your family may suffer painful, unbearable and/or irreparable harms financially. Moreover, if you have close associates or key employees, their loss of health or life can be similarly devastating to you as well. You should consider at least these benefits of dealing with insurance:
- peace of mind from knowing that the income and lifestyle of yourself and your family is ensured from tax free insurance benefits even during sickness and disability, after an accident, or even after death
- keeping business assets within the family
- improved creditworthiness
- tax-sheltering investment gains
- continuance of business after death or illness
- improved chances for recovery in a medical crisis.
In the past, being self-employed was a disadvantage when someone tried to get various kinds of insurance protection. This situation has been changing, however. Today, almost everyone can easily buy not only life insurance, but also very competitive income protection plans (disability insurance), just like people in regular employment. Family extended health and dental care, and even business overhead protection is also available.
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