There are different opinions as to the proper use of insurance. Here
is my view: Insurance should be used to buy protection from unlikely,
catastrophic events.

Good examples of risks that are suitable to insure include:

  • A house fire
  • A catastrophic injury or illness
  • A lawsuit due to an automobile accident
  • A death or disability of a breadwinner
  • A long term care stay in an assisted living facility or nursing home

There are other risks that are normally unsuitable to insure, because
they are neither unlikely nor catastrophic. Examples include:

  • Dental costs
  • The cost of eye care
  • The cost of prescription drugs
  • The costs of a funeral

It is more cost effective to pay for these items directly, rather than
paying premiums to an insurance company. An insurance company
must add their overhead and profit margin to your premium. Because
these events are almost certain, the premiums will normally exceed
the direct cost. Little or no risk is transferred to the insurance company.
Contrast that with the risk of catastrophic loss, such as the loss that
results from the death of a breadwinner. For perhaps $30 per month,
a young person can buy a $1 million life insurance policy that will
compensate the dependent beneficiaries to keep the household together
and replace the lost future income.

Because the likelihood of death to a young person is remote, the premiums are low, and because the event is a financial catastrophe, it can make sense to transfer the risk to an insurance company. We are willing to pay a
small known cost in order to avoid a remote yet catastrophic loss.
One last word on the purchase of insurance: When it comes to doing
business with career insurance agents, caveat emptor.

Many insurance agents live under the self- serving illusion that everyone
needs massive amounts of every kind of insurance available.
Be assured that we at Financial Plan, Inc. are objective when evaluating
your need for insurance, and that we are licensed and qualified to
distribute life, disability, and long term care insurance.

James Twining
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