The Role of Insurance in Your Financial Plan

Your financial planning isn't complete until you assess and address your insurance needs. This article describes different types of insurance and suggests ways to make sure you are adequately covered.

The Role of Insurance in Your Financial Plan

Insurance is an important element of any sound financial plan. Different types of insurance protect you and your loved ones in different ways against the cost of accidents, illness, disability, and death.

What Are Your Insurance Needs?

The insurance decisions you make should be based on your family, age, and economic situation. There are many forms of insurance and, unfortunately, no one-size-fits-all policy. Life insurance, for example, is a virtual necessity if you have a spouse and children, but perhaps is less important for a single person. Disability insurance, which provides an income stream if you are unable to work, is important for everyone.

Following is a list of the forms of insurance most people require.

Auto Insurance

Auto insurance protects you from damage to the often considerable investment in a car and/or from liability for damage or injury caused by you or someone driving your vehicle. It can also help cover expenses you or anyone in your car may incur as a result of an accident with an uninsured motorist.

Auto liability coverage is necessary for anyone who owns a car. Many states require you to have liability insurance before a vehicle can be registered. However, state-required minimum coverage often does not provide adequate protection. Suggested minimums are $100,000 for medical expenses per injured person, $300,000 for the total per accident, and $50,000 for property damage. Collision, fire, and theft coverage is also advisable for a vehicle having more than minimal value. You can cut costs, however, by choosing a higher deductible -- the amount of loss that must be exceeded before you are compensated.

The cost of auto insurance varies greatly, depending on the company and agent offering it, your choice of coverage and deductible, where you live, the kind of vehicle, and the ages of drivers in the family. Substantial discounts are often available for safe drivers, nonsmokers, and those who commute to work via public transportation.

Homeowner's Insurance

Homeowner's insurance should allow you to rebuild and refurnish your home after a catastrophe and insulate you from lawsuits if someone is injured on your property. Coverage of at least 80% of your home's replacement value, minus the value of land and foundation, is necessary for you to be covered for the cost of repairs. There are several grades of policies, ranging from HO-1 to HO-8, with increasingly comprehensive coverage and cost. Unless you increase coverage, most homeowner's policies cover the contents of the house for 50% to 75% of the amount for which the house is insured. The liability coverage in many homeowner's policies is $300,000.

Liability Insurance

Often called umbrella liability coverage, this takes effect when the personal liability and lawsuit coverage in other policies is exhausted. The cost for $1 million worth of protection -- especially necessary for high-income individuals and those with considerable assets -- may be only a few hundred dollars a year.

Life Insurance

Life insurance, payable when you die, can provide a surviving spouse, children, and other dependents with the funds necessary to maintain their standards of living, can help repay debt, and can fund education tuition costs. The amount you need depends on your situation. If you make $100,000 a year, have a sizable mortgage, and have two kids headed to an expensive college, you could need $1 million in coverage.

Value-accumulating, but commission-heavy, whole life or universal insurance is often sold as a conservative savings vehicle.

Talk with an insurance agent who offers policies from companies whose financial strength is ranked high by rating agencies. And remember that you can shop around.

Disability Income Insurance

A long-term disability policy is activated, replacing a portion of your lost income, when you are unable to work for an extended period. Some, but certainly not all, employers cover their employees with some form of company-paid disability income insurance. Typically, such coverage is only partial and/or short-term in nature. Thus, many people seek to purchase an individual disability income insurance policy. If you're buying, try to get a noncancelable policy with benefits for life, or at least to age 65, and as much salary coverage as you can afford. However, keep in mind that the duration of coverage may be limited because of your occupation.

Insurers will usually cover up to 65% of your salary. Generally, you should have total coverage equal to two thirds of your current pretax income.

If your company provides disability insurance, check to see whether it's enough for your needs. Group disability insurance policies may be capped at six months and provide benefits that won't cover your expenses.

Health Insurance

Most people enjoy medical insurance as an employee benefit, often with their employers paying whole or part of the premiums. Many employers offer a choice between HMOs (health maintenance organizations) and traditional fee-for-service care. Rates for HMOs are usually cheaper but have more constraints. Privately purchased health insurance is much more expensive -- often by several hundred dollars a month -- depending on such things as deductibles, coverage choices, and location.

Long-Term Care Insurance

With an aging population and uncertainty about the future of Social Security, insurance to cover the high cost of nursing home or at-home health care is becoming more widespread. Medicare pays very little of the cost of long-term care in the United States. Medicaid will pay for the care, but only for patients whose assets are almost completely depleted.

With Congress always debating the future funding of these programs, financial planning for long-term care is more crucial than ever.

Medigap insurance can help pay medical expenses of the elderly not covered by Medicare. However, it doesn't cover custodial nursing home costs. In fact, about half of all nursing home residents pay for the care with personal savings.

Contact a qualified insurance professional or AARP for more information on long-term care insurance.

Summary

• Your insurance needs will vary based on your family, age, and economic situation.
• Anyone who owns a car should have auto liability insurance. Collision, fire, and theft coverage can protect your investment in a valuable car.
• Homeowner's insurance should provide coverage up to 80% of the cost of replacing your home, minus land and foundation. Homeowners should also have liability coverage, and those with considerable assets may want to purchase liability up to $1 million.
• Life insurance is important for those who have families to cover living and other expenses in the event of death.
• Long-term care insurance can be expensive and complex, but may be a necessity for older people as the long-term coverage of Medicare is often inadequate.

Checklist

• Calculate your life insurance income-replacement needs (the amount of money survivors would require in order to maintain long-term financial security).
• Make a list of each policy's expiration date. A few months before those dates, start shopping around for better deals.
• If your home's value has increased recently, determine its current replacement value and then make sure that your home insurance policy would provide enough money to rebuild.
• Shop around for long-term care insurance and disability insurance if you don't have them already.