Insurance isn't a fun topic to discuss. No one wants to think about dying prematurely, having an accident, going through a natural disaster, or suffering from a crippling injury or disease. Denial doesn't make these tragedies any less likely to occur, but it does make them potentially more devastating than they might otherwise be. Proper planning can make it a little easier to get through tough times.
Now, you may think that you've taken care of all your insurance needs and might therefore be inclined to skip the rest of this article. After all, you bit the bullet and went to an insurance agent, sat through a meeting in which your agent discussed every possible type of insurance anyone could ever possibly need, and picked a reasonable number of policies and types of coverage. Doesn't that mean that you're done worrying about insurance?
The answer, sadly, is no. The problem is that the purpose of insurance is to protect you against risks that you face, and because the risks you face change over time, your insurance needs change over time as well. Because many people are uncomfortable with insurance, they often retain policies and types of coverage that they no longer need, while failing to obtain new policies and types of coverage that they may need for the first time. Here are some guidelines for deciding whether your insurance is doing its job for you.
Life insurance
The primary purpose of life insurance is to replace money that a person would otherwise earn and provide additional funds for any needs that arise because of a person's death. For instance, if a person is married with a child, then one might consider obtaining life insurance that would be sufficient to replace the person's income, as well as pay for the extra expenses that would result from the surviving spouse's new situation as a single parent.
The challenge here is that every one of these variables is constantly changing. Your earnings may rise steadily through periodic raises and bonuses. Your needs for insurance as a single adult may be quite minimal, but they may increase substantially if you choose to start a family. On the other hand, once your children are grown and you have substantial assets accumulated through savings, you may have less need for insurance.
The key to keeping your life insurance up-to-date is to make sure that the total death benefit on any life insurance policies you have is sufficient to meet your needs at that time. If your insurance is insufficient, you may be able to obtain additional insurance, either from your existing insurance company or by obtaining a completely new policy. If you have more insurance than you need, then consider replacing a policy with one that has a smaller death benefit.
In addition, even if your current policy is sufficient, you may wish to consider checking the cost of a new policy with similar terms. Recent changes in actuarial assumptions about people's life expectancies have had a significant impact on insurance prices, especially for older policies. You may be able to save money by replacing your policy.
On the other hand, keep in mind that insurance agents often earn commissions on sales of new products. Don't accept a new policy unless you understand all of the reasons for doing so, and consider getting a second opinion from another insurance agent if you feel uncomfortable.
Also, while it may be smart to get rid of policies you don't need any longer, keep in mind that life insurance may have purposes other than simple asset replacement. Good financial planners use life insurance for a host of other reasons, and choosing to terminate a policy without considering all of its uses may leave an unintended gap in your financial plan.
Homeowners insurance
With hurricanes, mud slides, wildfires, earthquakes, and other natural disasters, insuring your home is essential for most people. When you first obtain your policy, it's relatively easy to figure out what it should look like; since you know what you spent to buy your home, you can be reasonably assured that your policy will insure you at least up to what you paid.
A significant problem, however, is that with the strong appreciation in real estate values over the past decade and the accompanying increase in the price of many commodities necessary for home construction, many insurance policies have not kept pace. If you do not take an active role in managing your insurance, your insurance company may leave your policy coverage unchanged, or make a small adjustment for general inflation. For example, if you paid $200,000 for your home 15 years ago, and it is worth $600,000 now, your homeowners policy may still have coverage limits that are a lot closer to $200,000 than $600,000. Indeed, many insurance companies have made changes to policies that eliminated unlimited payments for replacing your home, and have replaced them with provisions that put a cap on such payments, often 125% of the current policy limit. While this sounds sufficient, if the policy limit doesn't reflect current conditions, then you may be dangerously unprotected without even knowing it.
Fortunately, this problem is relatively easy to fix by looking at your policy and contacting your insurance company to make sure your coverage does what you need it to do. If you need changes, your insurance company may be able to accommodate your needs. If they can't or choose not to, you can always look elsewhere to get a policy that will work for you.
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Fool contributor Dan Caplinger welcomes your comments.
