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Uncertainties and unfortunate events are just around the corner. Rather than get blindsided by the circumstances, it’s wise to be proactive by getting an insurance plan.
What is insurance?
To put it simply, insurance is a risk management tool that protects you from financial loss. But what is it really for and how does insurance work? Not to mention the most pressing question—do you really need insurance?
Just the Nuggets
- The main purpose of getting insurance is to manage unprecedented risks that pose threats to financial stability.
- There are four parties in a typical insurance contract: the policy owner, the insured, the insurance company, and the beneficiaries.
- Insurance companies have the following layers of safeguards to make sure that their obligations are fulfilled: state insurance regulations and licensing, statutory reserve requirements, reinsurance, and financial guaranty funds.
- The average monthly premium of life insurance is $44—according to S&P Global.
- The average monthly premium of health insurance is $138.76 employee contribution and $459.70 paid by the employer—according to the US Bureau of Labor & Statistics.
- The average monthly premium of car insurance is $112—according to Business Insider.
- You only need insurance if you think you need to protect your income, your health, and your wealth.
The American Insurance Landscape So Far
Having an insurance plan is a basic foundation of the Financial Pyramid. But despite that, not everyone is keen on having insurance yet. There are several reasons for that, with affordability being the leading cause (others will be talked about later). To remove this obstacle somehow, the Obama administration has signed the Affordable Care Act (ACA) into law in March 2010. Its goal is to expand health insurance coverage to the poor through subsidies.
After most of ACA’s provisions took effect in 2014, you could see a significant decrease in the uninsured population. Although the uninsured population was cut to almost half since 2008, the fact remains that there are still millions of Americans who are vulnerable to financial loss.
How Insurance Works
The main purpose of getting insurance is to manage unprecedented risks that pose threats to financial stability. In case of accidents, disabilities, dreaded diseases, calamities, theft, lawsuits, and untimely death, you are guaranteed financial aid from an insurance company.
Insurance is like a Subscription Plan
If you regularly subscribe to Spotify or Netflix, then you’d understand better if you treat the premiums—regular payments made to an insurance company—like a subscription fee to an insurance contract. That means you can enjoy the benefits as long as you subscribe to the insurance plan.
There are four parties in a typical insurance contract:
- Policyowner – the person who pays the premiums for the contract
- Insured – the person or property to be protected from risks
- Insurance Company – the financial institution that will provide the guaranteed financial aid
- Beneficiaries – persons or institutions with insurable interest (such that if an unfortunate event happens to the insured, they will suffer financial loss) that receives the financial aid
The policy owner or the insured (usually the same person) agrees to pay premiums in exchange for coverage of benefits depending on the terms specified in the contract (also called a policy). These benefits are to be fulfilled by the insurance company should eligible claims—requests of financial aid by the policy owner when risks have happened—be made.
For example, one of the cheapest life insurance products is offered by Banner Life. With just a monthly premium of $50, a 35-year-old healthy woman can have a sum assured—guaranteed death benefit that beneficiaries will receive after the insured dies— of $1 million for a 20-year term. In this case, the subscription plan runs for 20 years with a monthly fee of $50. If God forbid, you become permanently disabled—or worse, dead—before the term expires, you or your beneficiaries will receive the guaranteed benefits stated in the policy.
Insurance is NOT a Savings Strategy
It is crucial to understand that insurance is different from savings.
Suppose you set aside $50 every month to your savings account. In three years, you have $1,800 saved up for whatever purpose you see fit to use. If you get sick, you have $1,800 to cover your medical bills.
But in traditional insurance, if you’re healthy and all is well, you won’t get back the $1,800 from the insurance company. Insurance is a risk management strategy. To put it another way, an insurance plan is a coverage of financial benefits you prefer not to claim, but having one keeps you prepared anyway.
Safeguards of Insurance Companies
What if a national disaster or calamity happens where simultaneous claims are processed? Where will you get the financial aid if the insurance company goes bankrupt?
Unlike bank deposits, insurance coverage is not FDIC- or NCUA-insured. But they do have rigid safeguards:
1. State Insurance Regulations and Licensing
Each state sets its insurance regulation laws to which companies must comply before being given the license to sell. To get a peek of how state insurance regulations are structured, you can read this brief. In a nutshell, state insurance regulations continuously review the compliance and capabilities of these insurance companies for the protection of the consumers.
Visit the National Association of Insurance Commissioners’ website to view information on your state’s insurance department.
2. Statutory Reserve Requirements
The monetary requirement may vary from state to state, but rest assured that licensed insurance companies are mandated to maintain and hold a minimum amount of liquid assets called a reserve. Typically, the rate is around 8% to 12% of the insurer’s revenues, according to Policy Genius.
Insurance companies, too, spread out the risks with the help of reinsurers—companies that insure the primary insurance companies. This is especially applicable for life insurance policies with benefits in millions. If, for example, the policy owner wants a sum assured of $5 million, a part of that will be shouldered by the insurer while the reinsurers will co-shoulder the obligation.
4. Financial Guaranty Funds
In the worst-case scenario of bankruptcy where insurers are incapable of fulfilling their promises, state insurance departments have a system of financial guaranty funds—payments to the debt of the insolvent insurance company— to protect the consumers. The National Organization of Life & Health Insurance Guaranty Associations (NOLHGA), for instance, has protected more than 2.6 million policy owners since the 1980s.
Since the 2008 financial crisis, no insurance company has declared bankruptcy. Although rare, the possibility is still within reach if history has taught anything. These safeguards are meant to protect the insured population against the worst scenarios.
Categories of Insurance
There are different types of insurance you can get depending on what you need protection for. Here are some of the typical categories.
- Life insurance to protect you and your loved ones from any unfortunate instance that will stop you from generating an income
- Health insurance to protect yourself from sudden medical and healthcare bills
- Car insurance to protect your vehicles against damages, theft, and car accidents
All states except New Hampshire and Virginia mandate all vehicle owners to get one.
- Education insurance to protect your kids from student loans in the future
Most of the time, people opt for a life insurance plan with a primary need for education to get both benefits.
- Umbrella insurance to protect you from malicious prosecution, invasion of privacy, wrongful entry, and other activities that are damaging to you and your rights
A detailed discussion on each of these types is covered in Types of Insurance and Why You Need to Get Them.
Role of Insurance in Different Life Stages
The best time to get insurance is when you already have a budget surplus—what’s left of your income after deducting all expenses. According to the basics of financial planning, protection is the first financial need you should check off your goal list. Although, insurance will always play a part at every stage of your life.
You’ll likely have a budget surplus when you already have your first-paying job, usually in your early 20s. For single and healthy working individuals who don’t have any breadwinner duties to their families, they can get health insurance with their employers.
The next financial need after protection is savings. After saving up a portion of your budget surplus to your emergency funds, you’ll more likely allocate the money next to buying your first house or any residential space when you move out of your parents’ house. You’ll most likely need a car to get you from one place to another. Thus, you’ll be needing property and car insurance.
Between the late 20s to 40s is the typical age for settling down and starting your own family. To avoid mind-blowing student loans in the future, it’s best to start getting education insurance for your kids as early as possible. You should also get life insurance to protect your loved ones financially, just in case.
As you approach your retirement age, you will already be focused on wealth accumulation through investments. One of the sustainable ways of investing is acquiring real estate properties. Owning them will also entail getting property insurances.
Overall, your working days are a long journey of preparing yourself for any risks that might come from every angle. It’s working towards building and continuously reinforcing your protection plan—the very foundation of financial freedom. When you retire, you’ll have peace of mind knowing that at any time you get sick, or get involved in an accident, or be a victim of a calamity, or worse die, you and your loved ones are prepared.
Estimated Insurance Premiums
The cost of insurance has a lot of factors—namely, age, gender, location, lifestyle, financial statements, family background, and medical history. But to give you an idea of how much money you need to prepare to start a protection plan, here is some data gathered from recent studies and surveys.
To give a clear estimate, the average monthly premium of life insurance is $44, according to S&P Global. But it varies depending on factors like age, gender, location, lifestyle, financial statements, medical history, family background, and more. The general trends in life insurance are:
- the younger, the cheaper premium
- the healthier, the cheaper premium and the smoother underwriting process—risk evaluation of the insured and the determination of premium rates for the intended coverage
- premiums by the insured males cost more than females
- the more riders—supplementary benefits in the policy other than the death benefit— attached, the higher the premium
If rough estimates are not enough for you, you can compare quotes through PolicyGenius.
After the passing of the ACA in 2010, health insurance has been made more affordable to low-income American earners. Also, the workforce community can even be subsidized further by their employers as part of their benefits.
In the March 2020 National Compensation Survey, the following average costs were estimated:
- an average monthly premium of $605.20 shouldered by the employer
- an average monthly premium of $138.76 employee contribution and $459.70 paid by the employer
If you’re getting health insurance on your own without an employer’s contribution, you can utilize the Health Insurance Marketplace Calculator 2020 by Kaiser Family Foundation (KFF).
Factors that will affect your car insurance premiums are location, age, gender, credit score, and driving history. On average, the estimated monthly premium is $112, according to an article from Business Insider.
You can compare quotes to get a more accurate idea of the premiums in your location through Savvy’s free tool.
Talk to a Licensed Broker
Licensed insurance brokers or agents are the bearers of insurance policies. They are equipped with insurance company tools, product materials, and competency to provide financial expertise and customer service. As such, before getting a policy, the broker or agent will do data gathering to find the best-fit product for your needs.
But if you don’t personally know of an insurance broker, a quick Google search of the largest insurance companies is a good start. Check their credibility by looking into their information in your state’s insurance department. Look into customer reviews on social sites or ask for referrals from close friends and family. Check their financial ratings from well-known agencies like S&P, Moody’s, and Fitch.
Visit the official websites of licensed insurance companies, as well as their official social media pages. Usually, they have an online assessment which provides online quotes. If you are interested in their coverage, they’ll connect you to a broker or agent to personally assist with your queries.
Tax Benefits on Insurance
Another advantage of getting insurance is tax benefits. This benefit is significant for people in the higher income tax brackets. These are the instances how insurance gets you exempted from tax deductions.
- If you have employer-sponsored insurance (ESI), then the contributions made by the employer are tax-exempted from the employee’s income.
- In an ESI, particularly health insurance, the employee’s contributions will also be tax-exempted if the premiums are paid through a health savings account or a flexible spending account—both are special personal savings accounts dedicated for healthcare costs.
- Self-employed individuals or business owners can deduct premiums in their tax reports. More information about the ins and outs can be read here.
- The lump-sum benefits of your insurance coverage are tax-exempted. So if your life insurance policy states that your beneficiaries will receive $1 million at the time of your death, the whole lump sum amount will be given to them.
- For whole life insurance plans, an investment-linked component is attached to it called the cash fund value. The interest growth of your investments in it is tax-deferred.
Reasons for the Uninsured
The notion of yourself, your loved ones, and your possessions being financially protected seems like an implied basic need. But why doesn’t everyone have an insurance plan? According to KFF, here are some of the reasons:
Sometimes these are the underlying messages when one says they can’t afford something.
- They don’t see it as an urgent priority.
- Their income stream is limited.
If it’s the former, then chances are, they don’t see the importance of getting an insurance plan yet. The truth is—you only need insurance if you think you need to protect your income, your health, and your wealth.
If it’s the latter, there are two options—opt for cheaper plans first or find ways to augment sources of income. For life insurance, there’s a difference between whole life and term insurance. Premiums of term insurance are cheaper.
Having insurance is a privilege because not everyone can have it even if they want to. These are some of the instances where an insurance company does not approve applications as a result of the underwriting process.
- Medical history of serious diagnosis (except for health insurance because of the ACA)
- Occupational risks
- Not enough source of income
- Poor driving history
Everyone needs to get insurance, especially health or life types, at least. However, whether insurance is neither a need nor a want for you depends on your circumstances. Nevertheless, make sure that you study how insurance works first and how much insurance you need before deciding if its importance appeals to you.
Reasons like the difficulty of signing up and not being able to find the right coverage that fits your needs fall under customer experience. After all, insurance is a sales process. If you choose a subpar insurance company and most importantly, an insurance broker or agent, then a bad customer experience will be an obstacle.
Do You Need Insurance?
These are the circumstances when you need insurance:
- You have dependents (e.g. breadwinner, parent, or spouse).
- You don’t have enough liquid funds ready for expensive emergency hospital bills.
- You don’t have five to ten times your annual income ready for you or your loved ones in case of sudden death or incapability of earning an income.
- You have room in your budget surplus to allocate for premiums without compromising your basic daily needs.
- You have a stable income to pay for your premiums.
- You own a vehicle, a business, or a real estate property.
- You have a large debt that hasn’t been fully paid yet (e.g. student and mortgage loans).
- Your occupation is prone to accidents.
Nevertheless, at some point, the need of getting an insurance plan will come knocking. It might not be today as of this moment, but in the future, circumstances will change. So will your financial goals and your priorities.
If some insurance terms are lost on you, take a look at the extensive glossary of the common insurance terms used in the industry. The list is updated over time by the NAIC Research and Actuarial Department.
Our References and Further Readings
HealthCare.gov. (n.d.). Affordable Care Act (ACA). Retrieved on 11-17-2020.
Jeff Kinney. (2020). Cheapest Life Insurance Companies of 2020. Retrieved on 11-17-2020.
National Association of Insurance Commissioners. (n.d.). State Insurance Regulation. Retrieved on 11-18-2020.
Nupur Gambhir & Amanda Shih. (2020). Can My Life Insurance Company Go Bankrupt?. Retrieved on 11-18-2020.
Liz Knueven. (2020). The Average Life Insurance Rate by Age, Sex, and Coverage Type. Retrieved on 11-18-2020.
Liz Knueven. (2020). The Average Cost of Car Insurance in the US. Retrieved on 11-18-2020.
Roadshow staff & Tim Stevens. (2020). The 10 Best Car Insurance Companies in the US for 2020. Retrieved on 11-18-2020.
Mayo Clinic Staff. (2019). Health Savings Accounts: Is an HSA Right for You?. Retrieved on 11-19-2020.
HealthCare.gov. (n.d.). Using a Flexible Spending Account (FSA). Retrieved on 11-19-2020.
The National Council Org. (2012). Timeline for Implementation of the Major Provisions in the Patient Protection and Affordable Care Act. Retrieved on 11-19-2020.