The following was originally published June 29, 2015 at NerdWallet by Robert Schmansky, CFP®
In a recent episode of the HBO fantasy series “Game of Thrones,” the cute but deadly Arya Stark was tasked with assassinating a scam artist selling bogus “insurance” on the lives of merchants and sailors.
In the world we live in, many people are paying for coverages that do not have an insurance purpose, wasting dollars on a policy that either will not pay or does not fit their needs. And while our legal protections are greater than those in the World of the Seven Kingdoms, it is important to heed Arya’s mentor, “It is one thing to write such a [contract], though, and another to make good on it.”
In lieu of mortal vengeance, how can you make sure your insurance will pay when you need it, and that you are not spending on unnecessary coverage?
The first step is simply to have a basic understanding of insurance. Insurance is a contract between you and your insurer, in which your insurer agrees to cover the cost of unlikely but high-impact events that your assets currently cannot cover or that would devastate your finances.
That definition is different from how many think of insurance. Cracked windshields in the winter in Michigan or regular visits to the dentist are not necessarily high-impact expenses, nor are they unlikely to happen. Items that are routine and regular are best covered through savings.
Once you identify a risk, it’s crucial to make sure your insurance covers that specific risk.
For example, many people buy accidental death and dismemberment insurance in the belief that it’s life insurance, since it might pay out if they die in an accident. But your need for life insurance doesn’t depend on how you die — only on how much people count on you to provide for them while you’re alive. If you die of an illness instead of an accident, those people will be left without support.
Another reason people buy AD&D insurance is that it’s inexpensive. But it’s cheap for a reason: It’s not very likely to pay!
As risk changes over time, so do your insurance needs. Over-insurance is another waste to avoid. Take life insurance.
It’s commonly said that life insurance is sold, rather than bought — meaning that in most cases, it’s the insurance agent convincing the customer of the need for coverage, rather than the customer coming to the agent to buy a policy. Sales practices include discussing the standard rules of thumb for life insurance, and perhaps determining how much insurance you can afford rather than how much you need.
If you do not have children, you may have very little — if any — need for life insurance. Your children have no need for life insurance, even though many insurers sell policies on children. Singles and retirees with pensions often have no promises to others that they have not accumulated the money to pay for, and they probably don’t need life insurance.
Life insurance should protect your loved ones from the financial effects of your death. Mortgage insurance, which pays off your home if you die, exists mostly to protect the bank, not your family. It’s expensive compared with a term life insurance policy that can be used in a more versatile way to cover the same expense.
And speaking of the comparative cost of insurance coverage, recognize that paying more for your policy may not necessarily be a bad thing.
While rate shopping is important, even more so are choosing a strong insurance company and reviewing coverages and exclusions. You want your insurer to be profitable, to avoid taking financial risks, to cover the things you need covered and to pay out when you expect it to. Policies that are significantly cheaper than others are likely skimping on coverages or are riskier than you want.
Finally, don’t use insurance for investment purposes without understanding how it functions and fits into your plan.
Equity-indexed and variable life insurance and annuity policies are typically sold on a story of growth and income; like “Game of Thrones,” that’s just fantasy. Policyholders get hit with the expensive nature of these vehicles twice — once in lower growth, often due to expensive insurance, and again in lower payouts.
Review your policy coverages and ask questions of your insurance agent. Make sure any amounts and additional riders are appropriate. Ask competitors for a quote and an explanation of where they think you may be underinsured.
Finally, make sure your policies fit into an overall financial plan. Working with an independent financial advisor can provide a second opinion on any insurance plan, without the conflict inherent in any insurance policy sale.
By understanding your insurance needs and making sure you have coverages in place for them, there won’t be any need to send Arya Stark down to the waterfront.