The Planner's Perspective: Function Over Form
By Paul Morrone CFP®, CPA/PFS, MSA
Unfortunately, most people purchase insurance, but not the right type of insurance policy. Even more frustrating is that these same people are likely overpaying for the wrong type of coverage when simply optimizing benefits and using the correct products would have resulted in lower out-of-pocket premiums for the years or even decades that they had coverage in force. There are numerous examples of this across all lines of insurance, but we most commonly see incorrect policy design in property and casualty insurance and incorrect product selection when it comes to life insurance. In both cases, the policyholder is the one that loses out, and the insurance company is the one that wins.
Incorrect policy design occurs when a homeowner has gaps in coverage, inaccurate values for market or replacement value of the insured asset, insufficient liability coverage and fragmented policies with riders that are not working together in a cohesive manner. Furthermore, homeowners often take out policies with low deductibles (e.g. $500 or $1,000) when, in fact, it would be more prudent to use a $2,500, $5,000 or even $20,000 deductible depending upon known financial resources, value of the insured asset and risk tolerance. Making this simple modification to an existing policy could result in a substantially lower premium allowing those excess dollars to be used to purchase higher limits and optimized coverage, or even realized as an annual cash savings (everything else being equal).
The same holds true for life insurance policyholders that got conned into buying a $100,000 whole life policy or hybrid term/whole life policy, when in fact they really needed a $750,000 30-year term policy that could be had for the same or less cost. Fortunately, most life insurance policyowners do not realize they are woefully underinsured because statistically only a small portion of individuals pass prematurely, which is exactly why term policies provide the highest level of coverage at the lowest cost. Those that do, however, find that the $100,000 in coverage does little more than cover the costs of the funeral, legal fees and defray a small portion of the transitionary costs to adjust to life without a loved one. Small life policies do little to help with salary replacement, liability payoff (mortgage, car loans) or help fund future anticipated expenses (college).
Monitoring all insurance policies as your life changes is critically important to maintaining optimized coverage over time. This may mean increasing the amount of your coverage on your home and contents after a major home renovation or to compensate for an increase in market value of homes in your area. It may also mean reviewing policy riders to ensure that if you sustain a loss that your house will be repaired (or rebuilt) to adhere to current building code (rather than simply replacing what you had). From a life insurance perspective, it may mean increasing coverage because of the birth of a child, a job promotion or bigger mortgage. Conversely, you may be able to reduce coverage over time your financial assets have accumulated faster than expected.