PERSONAL FINANCE

Insurance Planning

"Educated risks are the key to success." - William Olsten

Insurance Planning is the act of identifying risk exposures and then transfering those risks that you can not or will not eliminate by avoiding, reducing, or assuming each of those risks.

For instance, avoiding risk is simply eliminating a risk by avoiding the cause of the risk. For example, if one chooses not to drive a car, he will have little auto liability exposure. This is an example of risk avoidance.

Risk reduction is simply reducing the potential risk of an event, such as driving more carefully or less frequently or keeping a fire extinguisher in the house to possibly limit possible damage should a fire occur.

Risk assumption is the conscious act of keeping or assuming a risk instead of transfering it. For instance, it will be almost impossible to insure against the risk of loss from a war, so this risk is usually assumed. One can also voluntarily assume a given risk even though one has exposure to a given risk and for which insurance is available. For instance, almost all individuals are subject to the risk of large health expenses, but many of these individuals do not own health insurance.

When an individual does not choose to avoid or reduce his or her risk exposure but does not want to assume the risk, insurance is usually used to transfer this risk. Examples of risks that are often transfered include those of illness or injury (with health insurance); loss of income for a family due to a death (life insurance) or disability; damage to personal assets (auto, homeowners, casualty, or title insurance); and/or personal and professional liability

Types of Insurance

• Auto Insurance
• Disability Insurance
• Homeowners Insurance
• Life Insurance

Auto insurance may consist of three distinct parts - Liability Insurance to limit your exposure for damages or injuries to others, Personal Injury Protection that covers medical expenses for the driver or owner regardless of who is at fault and Vehicle Protection Coverage that protects against loss or damage to the owner's automobile.

Liability coverage usually consists of Bodily Injury Liability Coverage and Property Damage Liability Coverage.

Bodily Injury Liability Coverage covers the driver for bodily injuries caused to others due to driver fault or negligence. This coverage will compensate that (or those) persons for their injuries, up to a limit of coverage specified in the policy. This coverage also extends to costs for legal defense if the driver is sued.
Property Damage Liability Coverage covers the owner for accidental property damage that the owner or the driver of the owner's car causes to another. If the driver is found to be at fault for an accident and legally responsible for damages to someone else's car, this coverage will pay for the repairs to that car, up to the specified policy limits. This coverage will also paid for legal defense expenses if necessary.

Personal Injury Protection includes Medical Payments Coverage and Unisured Motorists Coverage.

In addition to medical expenses associated with an accident, Medical Payments Coverage, mandatory in most states, may also include lost wages and rehabilitation expenses associated with an auto-related injury.
Unisured Motorists Coverage will reimburse the owner or driver for bodily injury expenses due to the negligence of an uninsured driver.
Some policies also include coverage for Underinsured Motorists which make up the difference between the coverage carried by the motorist at fault up to the limits of the owners policy.

Vehicle Protection Coverage includes Collision and Comprehensive. These provide coverage for damage to the owner's auto due upon collision with another object (Collision) or due to fire, hail, flood, theft, or impact with an animal (Comprehensive).

Even many individuals who have life insurance policies ignore their risk of becoming disabled and earning no or a small amount of income for an extended period of time. It is because of this risk that disability insurance exists.

Disability insurance is designed to pay a percentage (usually 50-70%) of the insured's income in the event he or she is unable to work due to disability. In addition to the amount of benefits paid, the cost of disability policies will vary significantly depending on the period of time before benefits begin (waiting period); period of time benefits will be paid (benefit period); and the conditions that must be met for the worker to be considered disabled under the policy (definition of disability.)

The most important factor for policyowners is the policy's definition of disability which determines whether the policyowner is eligible for benefits. A policy with a definition of disability known as Own Occupation will provide benefits if the injury prevents the owner from performing the duties required by his "own occupation". Other policies define disability as being unable to perform the duties of any occupation and are thus the most restrictive. As would be expected, the more restrictive the definition of disability, the less expensive will be the policy.

Homeowners insurance includes homeowners, renters, and condominium insurance. Homeowners insurance includes liability insurance to protect against injuries and damages to others on your property and; hazard insurance, financial losses from damages or theft to your property

An individual homeowners policy will include a combination of several mandatory coverages and may include certain optional coverages.

Coverage A covers just the policyholder's house.
Coverage B includes other structures, such as detached garages and sheds.
Coverage C extends coverage to personal property within the house and attached structures.
Coverage D covers loss of use, providing temporary housing needs if reqired.
Coverage E covers personal liability or damages resulting from injury or damage to others.
Coverage F covers medical payments to others who are injured on the policyowner's property.

There are other coverages specific to rental properties and condominiums.

Condominium Coverage is very similar to an ordinary homeowner's policy except it does not include coverage for the building exteriors.

Rental Coverage usually includes Coverage C that provides protection for personal property if they are damaged in a covered accident.
Coverage D, Loss of Use, provides protection if the owner is unable to live in the covered apartment or condominium and provides additional living expenses for the extra costs of the temporary vacancy.
Coverage E, Personal Liability, provides protection for accidental bodily injury or property damage.
Coverage F, Medical Payments to Others, provides for medical costs to others if they are injured while on your property.

Life insurance guarantees a certain amount of money to be paid to a beneficiary or beneficiaries in the event of death. This insurance may financially compensate for the loss of income from a wage-earning spouse, be used for post-death expenses (funeral expenses, for example), or for estate planning purposes. Life insurance may be "pure" or term insurance, with a specific amount of coverage payable upon death of the insured, or may be cash-value insurance, with both a death benefit and an investment account that grows tax-deferred. Types of cash value insurance include Whole Life, Universal Life, and Variable Life insurance. Whole Life Insuarnce provides permanent death protection for an individual's entire lifetime, regardless of how many years premiums are paid and is bundled with an increasing cash value. Universal Life (UL) allows a flexible premium (and therefore, cash value accumulation). Variable Life insurance is similar to UL except that policy cash values may be invested in common stock and other non-fixed income investments. With variable life policies the cash value and the death benefits will fluctuate. In addition, there are also Adjustable Life policies which allow the policyholder to change back and forth between whole

Term Life Insurance provides death benefit protection for a specified period of time. If death occurs during the specified period, the face amount of the policy is paid, with nothing paid should the insured survive the period. These policies generally have no cash or loan values. Because of this, they are often called "pure" protection. This type of insurance is often used when protection desired is for a limited amount of time, when the insured cannot afford the higher cost of a cash-value policy, or when the insured has long-term coverage needs but intends to "invest the difference" of the amount between the cost of a cash value and a term policy. In addition to purchasing individual term-life policies, many individuals receive term coverage through their place of employment, through Group Term Life Insurance. As in the case of an individual policy, there is no cash-value accumulation for Group Term. In the event an individual covered by a group term insurance policy leaves his or her employer, he or she is given 31 days to convert the group policy to an individual policy, before the coverage is terminated.

How Much Term Life Insurance do I need?

Depending on the families or individual, the proper amount of term life insurance to carry will vary greatly depending on much more than income alone. Although some advisors use general yardsticks such as '5-7 times your annual income' this quick approach is not appropriate for most. Such a simple rule-of-thumb does not account for differences in working spouses, other savings available, family medical histories, number of dependents, etc. In addition, the amount that an individual will carry will often vary during his or her lifetime. For instance, a young person with a relatively low income and few dependents who rents a house will usually carry less insurance protection then he might later in life if he has several children a significant mortgage and a large income that his family is dependent upon. That same individual may require less coverage during later years however, such as if he had acquired significant liquid assets and had limited debt or mortgages.

In this area, as in all financial areas, its important to find a trustworthy, preferably independent (not associated with a particular insurance company), who will objectively look at the your risk exposure in the various financial areas in your life (e.g. life, disability, auto, homeowners, business, professional liability, etc.) and ensure that you are adequately protected against these risks.

David Alan Pace, CFP, CFA, EA, Pace Financial Services

This document is for information purposes only. No part of this report may be reproduced in any manner without the written permission of Pace Financial Services. The views and opinions expressed in this report are not intended to serve as specific investment or financial planning advice or recommendations, and individuals should discuss their specific financial goals and available options with a professional advisor.