Who Really Needs Insurance?

Posted by on June 27, 2007 in insurance

(excuse the appearance, we are under construction)

Last week, I received a notice from my potential disability insurance company that I had not completed all the pre-requisites for obtaining disability insurance and my pre-approval had expired. I would once again have to apply for insurance. What happened was that my doctor did not complete the insurance company’s paperwork in time (it turns out that he has a notorious reputation among the insurance companies for being extremely tardy in his paperwork). Although I am a little perplexed by my doctor’s actions, I have decided not to reapply for disability insurance for the very simple reason that I am now eligible for these benefits under a group plan.

However, this did get me thinking about who really needs insurance and why we should obtain it. At the end of the day, insurance shifts the financial risk of certain events from yourself to the insurance company. Thus, in the event of death, it is the insurance company who will pay out the debts of your estate. In the event of critical illness (cancer, blindness etc.), the insurance company will pay you monies to treat the illness and maintain a certain lifestyle and, in the event of a disability, disability insurance replace your wages.

But’s here’s the catch when you really think about insurance; its not the risk of a certain event happening, its the risk of what happens after the event occurs. For example, I am not insuring against a disability; I am insuring against my lost income if I cannot work due to a disability. If I insured against a non-existent risk after an event has occurred, I am over-insured. For example, I have no dependents so what monetary risk is there in me passing away (assuming that my assets are more than my debts)?

Having said that, I will be obtaining life insurance even though I have no dependents given that it is cheaper to obtain insurance when I am younger and for tax reasons. Life insurance is a great vehicle to pay taxes in the event of death.

Everyone gets taxed when they die- either in the form of estate taxes, probate or the deemed disposition of the deceased’s assets on the date of death triggering capital gains (in plain English, the tax authorities rule that the deceased sold everything on the day of death and any gains on those assets are taxed accordingly). The taxes can be quite onerous and can take up to 40% off the value of your estate. It is not unusual for an estate to declare bankruptcy if there isn’t enough insurance to fund tax liabilities arising from death (yes, the tax authorities even get you after death).
I have every intention of contributing my maximum allowable contributions to my RSP; I also intent to have a large portfolio of stock outside my RSP. This means that I will have a large tax bill on death. I intend to leave a legacy to loved ones and to educational institutions to fund scholarship for worthy but needy applicants. I do not want an unreasonable portion of my estate being used to pay taxes before it gets to the beneficiaries. Thus, life insurance to me is to insure against the risk of not leaving enough for my beneficiaries and various educational institutions; the insurance proceeds can pay my taxes and my estate can be used for the purpose it was intended for.

If there is a morale to this post it is this- ask yourself what risks will occur after a traumatic event and have you insured yourself against this? Or, to look at is another way, is it really necessary to insure yourself against the risk arising from certain events? Your comments are always appreciated.

6 Comments on Who Really Needs Insurance?

By Mr. Cheap on June 27, 2007 at 10:34 am

I wonder if you invested all the insurance payments you plan to make into your investment portfolio that this might not more then make up for the taxation upon death (e.g. I’d rather get 60% of $100K then all of $50K). Its pretty tough to beat the insurance companies (they have MANY people crunching numbers all day to make sure they come out ahead).

By admin on June 27, 2007 at 1:03 pm

Thanks for the comment. Over the life of a policy, I am never going to contribute $250K (my proposed coverage upon death) or grow the portfolio great enough to equal $250K (given that monthly premiums would be under $50/month). The insurance proceeds are earmarked for taxes and, hopefully, the rest of my estate will be used to pay beneficiaries.

By Riscario Insider on June 27, 2007 at 10:21 pm

What a refreshing and insightful post. Thanks for planning to leave a legacy to help others. Generally people without dependents — especially young ones — aren’t so forward thinking. Who cares if there are taxes when I’m dead? You also understand that there’s more to life insurance than term 10.

Mr Cheap, insurance is *not* gambling where the house wins big. It’s a form of spreading risks based on statistics and probabilities. The way to “win” financially is to pay $50, die and have $250,000 paid out. That’ll hurt the insurer but require a big personal sacrifice :) The way to “lose” is by living well beyond life expectancy and continuing to pay the $50/month. I wouldn’t consider a longer life a loss ;)

If the profits were huge, wouldn’t companies be dashing into the market? Instead, major international insurers have left Canada because the returns are too low: Met Life, Prudential Insurance, Aetna, ING, etc. Although there are fewer companies, competition for market share remains fierce, which benefits consumers.

So TMW, tax planning is a key use for life insurance these days, which is what you’re doing. The result? Thicker wallets for your beneficiaries. Thanks for caring.

By Mr. Cheap on June 28, 2007 at 10:03 am

How shocking, an *actuary* who thinks buying insurance is a good idea!

By FourPillars on June 28, 2007 at 11:25 pm

Interesting post. I think that you’re right about insurance being cheap at your age so really it’s not a big expense. Of course if you are a lot older then it’s a different story.

By Veracity on September 4, 2008 at 3:07 am

Great Blog. I just started my own this year…check it out if you want http://veracityfinancial.wordpress.com/

It looks like you probably never bought the disability insurance. When you get a private individual policy they will only cover about 55-60% of your income. If you have a group policy in place then you can only supplement a little bit with an individual policy. But if you buy you indv policy first you can then have you whole group benefit as well.
As for being over insured…I don’t think that is actually possible. If you went to your auto agent and said…I have a car worth 20k but will you insure it for 80k? I will even pay the higher premiums. I am pretty sure that they would say no thanks. The value is not there. Just a thought.

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