Which Financial Risks Should You Insure Against?

In many ways, personal finance is about managing risk. More particularly, financial planning must include plans for minimizing damage to your financial future caused by known but uncertain risks. These risks can affect your investments, your health, and your liabilities to others.

As an attorney who formerly worked in the insurance defense field, I observed first hand how insurance can and can’t work in limiting personal financial risk. My professional experience also has caused me to regularly consider whether and how to insure against our own financial risks. These are some of my thoughts on the subject.

1. Risk of Market Loss. If you are truly in the equity and bond markets and fully exposed to all of their ups and downs, there really is no way to insure against the risk of loss. Some will try by using certain guaranteed annuities and indexed annuities, but these products take you out of full participation in market gains. The best you can typically do is control risk with proper asset allocation and use of a retirement emergency fund.

2. Risk of Outliving Your Money. The risk that a retiree will run out of adequate retirement income is related to yet different from the risk of market loss. My personal view is that a retiree should do everything possible to eliminate this risk by making a plan for guaranteed retirement income, even if it means limiting exposure to equity markets. This general area of income risk also includes inflation. The inflation risk must be addressed by combinations of Social Security (which has a cost of living adjustment) and inflation protected securities, such as TIPS and I Bonds. This is like conventional insurance, only better.

3. Health Risk. This is a risk that must be insured against. At age 65, the proper use of Medicare will control much of the financial risk of poor health. The other aspect of this health risk- the cost of long term care – can be controlled by purchasing long-term care insurance.. Equally important for the baby boomer who is still working and saving towards retirement is disability insurance.

4. Casualty Loss Risk. The financial risks associated with casualty losses include: (a) adverse judgments arising from negligent behavior causing injury to others; and (b) casualty loss to an important asset, such as your home being destroyed by fire. The former risk is protected by means of automobile insurance and umbrella policies. The latter risk must be insured against by use of homeowners insurance. Both types of insurance policies must include appropriate coverage limits. Here are some tips for managing the cost of homeowners insurance.

5. Death Risk. You are going to die, so this is not really a financial risk except for how it might affect a surviving spouse. Generally, this is handled by having sufficient retirement assets to provide sustained income even after death. There are life insurance strategies to consider as well, if only to provide post-death liquidity to pay any taxes that might be owed.

My final thoughts: Insurance planning is a proactive step that we can all take to protect our financial future. Using some of our cash flow and assets to protect against known financial risks is logical and necessary. Ignore it at your peril.

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