The importance of insurance in financial planning: independent financial advice
Posted by Don Martin on Thu, Jan 05, 2012 @ 10:53 PM
One of the most important parts of financial planning is to have adequate insurance. When someone is hit by a catastrophe then they may need to sell their investments to pay for the rebuilding of damaged assets. Selling investments during a market crash instead of holding on until a recovery is not a good idea as it could result in selling at a loss during a temporary dip. Also selling investments to fund the cost of recovering from a catastrophe could incur tax on the capital gains.
A basic rule of thumb is that if someone can’t afford to self-insure against a catastrophe then they need to insure against it. The temptation by consumers is to rationalize that a catastrophe won’t happen to them so they fantasize that they don’t need insurance. One should ask oneself how badly would one be hurt if they were uninsured when hit by a crisis rather than use a probability theory that the hypothetical value of the insurance payoff is less than the cost of the premiums.
An insured person may be able to use the insurance company to get leverage against vendors after a catastrophe by telling vendors that they must reduce prices and conform to insurance company standards in order to get paid.
When dealing with a catastrophe the insured may find that some insurance companies offer poor service at a time when the insured has lost a lot of energy and confidence. So the insured may find it difficult to get the energy and discipline to pursue their insurance claims. Then the insured would not get the full reimbursement due. So it is important to get an insurance contract with a company that offers reasonable service, rather than the cheapest insurance policy. The opportunity cost of taking time off work to deal with a recalcitrant insurance company could be a substantial portion of a year’s wages in the case of some painfully complicated catastrophes. Insurance companies may have narrow profit margins and may be tempted to make it difficult for a crisis victim to get their claim fully reimbursed.
When suffering from a catastrophe if the victim receives rapid, full insurance reimbursement with minimal conflict with the insurance company the victim may have a greater feeling of control over their life and a greater feeling of emotional recovery from their crisis.
This feeling of emotional recovery can lead to better investment decisions as an investor can regain his lost confidence and begin to feel comfortable with taking riskier higher return investments instead of hiding in the safety of low yielding cash. By contrast, an insured person who encounters a difficult experience getting reimbursed would be likely to not trust risky investments and thus may be tempted to hide in the safety of low yielding cash rather than take risk to earn a fair return on investments. So the implications of having a bad experience with an insurance claim go beyond the math of the cost of merely hiring a contractor to rebuild a burned down home or the cost of hiring a doctor to heal a hospital patient.
Investors should seek independent financial advice.