You’ll never have the “right” amount of insurance, and that’s because we’re dealing with uncertainty.
Working out how much insurance you need is hard.
You can only tell whether you need insurance with the benefit of hindsight – or a crystal ball.
For most people, the most likely – and best case – scenario is that you’ll pay more in premiums than you claim. (With some insurances, like life insurance, the hope is that you pay a lot in premiums and you never make a claim!)
Even if you need insurance, it’s virtually impossible to know how much you’ll need.
Consider life insurance. When it comes to the personal insurances, it’s the easiest to conceptualise. In short: if you die, your beneficiaries receive a lump sum payment.
(Other insurances are a little more complex and involve shades of grey. For example, with trauma insurance you get a lump sum if you’re diagnosed with a defined illness under the policy. Total and permanent disability (TPD) and income protection insurance are also paid out in vaguely narrow, sometimes ambiguous situations. For the purpose of illustrating my point, I’ll keep it simple and focus on life insurance.)
Although I sometimes “advise” people in relation to whether they need life insurance and the level of cover they need, in a lot of ways I don’t feel like I provide advice. All I do is ask questions, and elicit the answer from them.
I ask questions about the sort of position they want their loved ones to be in, if they were to pass away.
Let’s take a couple with young children, for instance. I ask things like: If you pass away –
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- What sort of accommodation arrangements do you want your surviving loved ones to have? (For example, do you expect them to keep living in your current home or something equivalent, or would you expect them to live an a more or less expensive property? If they were to downsize, what time frame do you expect to leave for them to make this change?)
- What sort of time frame (or buffer) do you think you’d want to give your surviving partner to deal with the fallout and adjust to a “new normal” before having to go back to work?
- Do you want to supplement your surviving partner’s income for a period of time? By how much? For how long? For instance, until the children go to primary school, or until the youngest turns 18? Or do you want to supplement their income until, say, age 65?
- Do you want to make specific provision for private education, or university education, for your children?
- Do you want to leave a portion for your children for when they reach a certain age?
And so on.
This is the best we can do in terms of working out a suitable level of cover. I can ask any number of questions, and come to a very specific figure. But the figure is never going to be a perfect figure.
Because we can’t predict the future.
In the same way that we never know whether we’ll pass away unexpectedly, we don’t know what will happen to our loved ones after we pass away. Or even the nature of our passing.
- In some cases, for example, life insurance policies allow for an early payout if you’re diagnosed with a terminal illness. This can make life a little easier in your final days. But it also means you’ll be spending funds that you might have earmarked for other purposes.
- You can’t predict the twists and turns of your partners’ career, and what their income – and therefore their financial needs – will be many years’ down the track.
- You also don’t know whether they’ll enter into another relationship, and what the financial situation of their future partner may be.
And this is the “easiest” form of personal insurance!
Consider other personal insurances, such as trauma insurance, which pay out if you’re diagnosed with a defined illness. There’s a world of difference between being diagnosed with a heart attack and having a swift recovery, versus being diagnosed with cancer and having to pay for treatment than isn’t funded by PHARMAC. In this sort of situation, we’re trying to make the best balance of all of the possible scenarios.
Insurance is hard.
This is because it’s a tool for managing the inherent uncertainty of life.
Even if you’re certain you need a specific type of insurance, there will always be uncertainty about whether you’re selecting the “right” amount of cover.
To be clear: I don’t want you to think “it’s too hard” or “it’s futile” and think it’s not worth it. For many people, insurance is a vital tool for managing risk. Just because you don’t know the exact amount you or your partner will need, shouldn’t stop you thinking through the various scenarios that might necessitate insurance, and working out what you think you need.
Like most decisions in life, it’s a decision made in the face of uncertainty.
It’s yet another reason why I recommend getting advice from a professional when arranging insurance. A good adviser may not be able to give you certainty, but they can give you confidence in the face of uncertainty.