Insurance Planning

[moda0306]

I want to get a general idea of what people think about insurance planning in this forum, with special attention on Disability and Life Insurance planning.

Our accounting firm runs a tightly-connected financial advisory practice, which focuses on a "protection first" financial planning strategy.  So one of the first conversations we're having with people is whether they have their insurances and legal documents tightened up.

One of the more controversial (to our clients... not to me) concepts we encourage is "full indemnity" on items clients cant afford to lose.  Of course, what someone "can't afford" to lose is probably a sliding scale rather than a hard/fast line, but that's the general concept.  For most people that are NOT independently wealthy (most people simply don't have a net worth that is significant multitudes of their living expenses), this leads to a couple interesting protection conversations:

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Long-term disability protection:

Almost all clients under a certain age we recommend apply to get long-term disability protection, simply because it's obvious they can't afford losing their income (or even 40% of it, if they have a group plan).

We get a lot of "it seems expensive" or "I'd figure it out," or "we could liquidate our (meager) investments." 

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"Human Life Value" in Life Insurance

Keeping with the concept of full indemnity on large, catastrophic losses, we suggest protecting a spouse's income no different than you'd insure a factory of equal Fair Market Value.  This is almost always a term insurance conversation, but for an amount FAR higher than a client would intuitively have thought.

If we run an analysis that shows the "likely" scenario of the client's income, lifestyle, and Net Worth out into the future, and there is inadequate coverage to mend the gap for the remaining spouse & family if one died today, we recommend filling that gap.

This often leaves 20-somethings with 25x their income in life insurance.... 50-somethings with kids out of the house who think they don't need their existing life insurance any more, our analysis shows them needing more (often-times).

This is based on the general idea of "full protection" or "full indemnity" when it comes to insuring something that is sure to bring a huge financial impact.  We show clients a "quadrant" of scenarios involving two vectors... 1) You live vs You die, and 2) You insure vs you don't insure.  Usually to us, the decision seems clear, but to them, the decision is a struggle since they didn't come in thinking they "needed" that much, or any, life insurance.

To address the logic in a more emotional manner, is the concept that if your lifestyle is valuable enough to you to be worth working for today, and be worth saving/investing for tomorrow, it should be worth protecting as well.  If it is NOT worth protecting, we should ask our clients whether it is maybe worth reducing our lifestyle to generate an earlier retirement, and basing our protection plan around that.

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What do folks here think of this?  To me, it seems totally obvious at this point to totally indemnify large losses.  It's automatic for me at this point.  However, it's unintuitive to a lot of people, and was for me for a while.

What do folks hear think of these protection philosophies?  Do you "believe in" life/disability coverage?  Why or why not?  Does "full indemnity" seem important?

[hoost]

On the disability insurance, if you're paying post tax, aren't the benefits received post tax?  So if you have a plan that provides 60% of gross income, if you compare that to your post-tax income, it's probably pretty close.  Personally I have opted for 70% and the cost of living buy-up, but maybe I'm missing something.

On life insurance, 25x income seems high.  If you look post tax, and look at fixed expenses, and the idea that you may be getting capital gains rates vs. ordinary income, is the number really that high?  I haven't done an in-depth analysis here since I have no kids and no debt and my wife works and we have a very high savings rate, so the impact of either of our death on the other's lifestyle would not be that big.  It seems like it might be a bit individualized and is worth a discussion with each client on what scenarios they're willing to pay to insure against.

[barrett]

25 X income strikes me as really high because it violates my rule of not being worth more dead than I am alive (don't want to give anyone incentive to expedite my decline). My wife and I have rather low life insurance policies (250K each). Our main financial concern is - perverse as it may seem - that we might both have a long retirement to fund. At this level of coverage, if one of us kicks there will be enough money for the survivor.

In our line of work we are not eligible to buy disability insurance... or so we have been told from our State Farm guy.

We do have a daughter starting college in 2016 but have funds set aside for that. 

Honestly, getting life insurance was not a feel good experience for me, but the premiums are low enough so that it was a no brainer.

[moda0306]

I can't calculate it all out right here, but here is a hypothetical run from our system:


Both scenarios

- Husband makes $60,000
- Wife makes $40k
- lifestyle expenses of $80k (saving $20k if dad lives)
- income grows at 2% real
- investments grow at 3% real
- lifestyle expenses grows at 1% real
- 35 years of work with 30 year retirement
- no social security calculation

Premature death: today

- Death benefit of $1.6 million (25x income)
- $25k final expenses and time off.
- Lifestyle expenses don't drop until year 20 (assuming kid just born). Then it falls to 80% of their former level to adjust for only one spouse, but acknowledging cohabitational efficiencies. 
- Mom keeps working like nothing happened.
- No tax adjustments, SS survivor benefits, or SS retirement benefit adjustment (since no SS)
- No FMV placed on all the tangible work dad puts into the house & parenting.
- No calculation for increased health insurance costs for family.

Mom ends up with a little money left at the end of the line if dad lives.  She goes negative in the 2nd to last year if dad dies.

What do you guys think?  You could probably build something similar in excel.

[moda0306]

Regarding disability:

Group 60% benefits are usually taxable. But even when they aren't, we still usually recommend supplementing with an individual disability contract up to full protection.

A couple of the reasons:

- If dad is laid up, what kind of extra expenses are we having?
- eventually, employer terminates you and you lose employer match and have to usually pay much more for health insurance (we'll see with Obamacare on that last one).

[MachineGhost]

What do folks here think of this?  To me, it seems totally obvious at this point to totally indemnify large losses.  It's automatic for me at this point.  However, it's unintuitive to a lot of people, and was for me for a while.

What do folks hear think of these protection philosophies?  Do you "believe in" life/disability coverage?  Why or why not?  Does "full indemnity" seem important?

You have my sympathies.  No where will you deal with the irrationality of human being's neuroscience more than in financial planning and emasculation/death.

I think what makes sense depends on the client's sources of income, do they breed or not, are they caretakers for elderly or disabled, etc..  Wage earners need full indeminity coverage as they're completely at the mercy of others.  Enterpreneurs need to build up "start again" fund since they're self-starters.  To the extent people rely more on pensions and government transfer payments, less and less indeminity is needed.

I suspect your real problem is you're not selling it properly.  A quadrant or spreadsheet is geekbabble and not connected to the real world of floating emotionalism.  You likely need to assume the client is an idiot who simply won't do as you want them to do, and market your paternalistic doom porn accordingly.  After all, that is why they're using an accounting firm with all the risks that involves, instead of doing it themselves (i.e. they didn't think things thoroughly and/or are inner wimps about self-responsibility).  But a bigger reality is also likely that client's simply do not have the cash flow, whether real or imagined, to do what you want them to do.

So its a marketing problem, not a philosophical.

[moda0306]

What do folks here think of this?  To me, it seems totally obvious at this point to totally indemnify large losses.  It's automatic for me at this point.  However, it's unintuitive to a lot of people, and was for me for a while.

What do folks hear think of these protection philosophies?  Do you "believe in" life/disability coverage?  Why or why not?  Does "full indemnity" seem important?

You have my sympathies.  No where will you deal with the irrationality of human being's neuroscience more than in financial planning and emasculation/death.

I think what makes sense depends on the client's sources of income, do they breed or not, are they caretakers for elderly or disabled, etc..  Wage earners need full indeminity coverage as they're completely at the mercy of others.  Enterpreneurs need to build up "start again" fund since they're self-starters.  To the extent people rely more on pensions and government transfer payments, less and less indeminity is needed.

I suspect your real problem is you're not selling it properly.  A quadrant or spreadsheet is geekbabble and not connected to the real world of floating emotionalism.  You likely need to assume the client is an idiot who simply won't do as you want them to do, and market your paternalistic doom porn accordingly.  After all, that is why they're using an accounting firm with all the risks that involves, instead of doing it themselves (i.e. they didn't think things thoroughly and/or are inner wimps about self-responsibility).  But a bigger reality is also likely that client's simply do not have the cash flow, whether real or imagined, to do what you want them to do.

So its a marketing problem, not a philosophical.

How would you suggest to market to those people?  Stories about sad widows raising children?  Statistics?  Make it an automatic and be nonchalant about it?

It's part of the conversations I'm having, but I'm not doing that much work in this area.

[Kshartle]

What do folks here think of this?  To me, it seems totally obvious at this point to totally indemnify large losses.  It's automatic for me at this point.  However, it's unintuitive to a lot of people, and was for me for a while.

What do folks hear think of these protection philosophies?  Do you "believe in" life/disability coverage?  Why or why not?  Does "full indemnity" seem important?

You have my sympathies.  No where will you deal with the irrationality of human being's neuroscience more than in financial planning and emasculation/death.

I think what makes sense depends on the client's sources of income, do they breed or not, are they caretakers for elderly or disabled, etc..  Wage earners need full indeminity coverage as they're completely at the mercy of others.  Enterpreneurs need to build up "start again" fund since they're self-starters.  To the extent people rely more on pensions and government transfer payments, less and less indeminity is needed.

I suspect your real problem is you're not selling it properly.  A quadrant or spreadsheet is geekbabble and not connected to the real world of floating emotionalism.  You likely need to assume the client is an idiot who simply won't do as you want them to do, and market your paternalistic doom porn accordingly.  After all, that is why they're using an accounting firm with all the risks that involves, instead of doing it themselves (i.e. they didn't think things thoroughly and/or are inner wimps about self-responsibility).  But a bigger reality is also likely that client's simply do not have the cash flow, whether real or imagined, to do what you want them to do.

So its a marketing problem, not a philosophical.

How would you suggest to market to those people?  Stories about sad widows raising children?  Statistics?  Make it an automatic and be nonchalant about it?

It's part of the conversations I'm having, but I'm not doing that much work in this area.

Field trip to the cemetary

[moda0306]

We have life insurance on me (about 10x income, 20 year term ending when my son turns 20).  We don't have any on her.  We also don't have much disability insurance, just a bit on me through work. 

I figure toward the end of that 20 year term, I'll probably be worth more dead than alive, and my wife will have to do what must be done:

Desert,

I had a couple who were both 50, dad made most of the money, had about $500k saved up, house was paid off, and kids were in college.  They were on track to a stable retirement, assuming SS checks were coming in.  I forgot what he made but it was in the higher double digits.

If I "killed dad off tomorrow," between the loss of his income, and the lower of the two SS checks, and adjust lifestyle down by 25%, Mom would have had to still adjust her lifestyle down by about $10,000 per year.

I can't remember the details, but time-and-again I've been surprised at how a loss of one SS check tips the balance considerably for a lot of people.

[Kshartle]

Mom would have had to still adjust her lifestyle down by about $10,000 per year.

I can't remember the details, but time-and-again I've been surprised at how a loss of one SS check tips the balance considerably for a lot of people.

I presume his additional expense was significantly more than 10k per year though so........

[moda0306]

Mom would have had to still adjust her lifestyle down by about $10,000 per year.

I can't remember the details, but time-and-again I've been surprised at how a loss of one SS check tips the balance considerably for a lot of people.

I presume his additional expense was significantly more than 10k per year though so........

To get the insurance??  Not even close... To cover the gap for the next 10 years of his income (I think it took $300k of DB) (I actually forgot they both made about the same... around $50k each), it would be less than $1,000 annually.  Even 20-year term would cost only around $100 per month.

This was at pretty mediocre health rates.  Not great.  Not awful.

However, you'd need to do her, too.  So if you did like 15 years on both of them, it probably would come to less than $1,800, to protect a loss of $10,000 for both spouses.  That would get them to 65 with far more in assets, and only the smaller SS check to lose.

[moda0306]

I can't calculate it all out right here, but here is a hypothetical run from our system:


Both scenarios

- Husband makes $60,000
- Wife makes $40k
- lifestyle expenses of $80k (saving $20k if dad lives)
- income grows at 2% real
- investments grow at 3% real
- lifestyle expenses grows at 1% real
- 35 years of work with 30 year retirement
- no social security calculation

Premature death: today

- Death benefit of $1.6 million (25x income)
- $25k final expenses and time off.
- Lifestyle expenses don't drop until year 20 (assuming kid just born). Then it falls to 80% of their former level to adjust for only one spouse, but acknowledging cohabitational efficiencies. 
- Mom keeps working like nothing happened.
- No tax adjustments, SS survivor benefits, or SS retirement benefit adjustment (since no SS)
- No FMV placed on all the tangible work dad puts into the house & parenting.
- No calculation for increased health insurance costs for family.

Mom ends up with a little money left at the end of the line if dad lives.  She goes negative in the 2nd to last year if dad dies.

What do you guys think?  You could probably build something similar in excel.

Moda, I assume that's term life insurance.  How old are they when the term ends?

It was just a mock death benefit if they died today.  They could fulfill that with 10/20/30/YRT... whatever they wanted.  I usually don't see 10 recommended for youngin's.  Usually 30 or YRT.  YRT is an annually increasing term that starts lower than 20/30 (if you're youngish) and goes up over time.  Usually it makes the most sense for young people, less-so for older folks.

$1.6 Million of 30-year term on a 30-year old male would be about $150/mo if memory serves.

Sorry if it was misleading that I didn't include the 30-year premium in the "Dad lives" vs "Dad dies" scenario as a drain on lifestyle.  That's totally legit, and in fact what we show.

[Kshartle]

Mom would have had to still adjust her lifestyle down by about $10,000 per year.

I can't remember the details, but time-and-again I've been surprised at how a loss of one SS check tips the balance considerably for a lot of people.

I presume his additional expense was significantly more than 10k per year though so........

To get the insurance??  Not even close... To cover the gap for the next 10 years of his income (I think it took $300k of DB) (I actually forgot they both made about the same... around $50k each), it would be less than $1,000 annually.  Even 20-year term would cost only around $100 per month.

This was at pretty mediocre health rates.  Not great.  Not awful.

However, you'd need to do her, too.  So if you did like 15 years on both of them, it probably would come to less than $1,800, to protect a loss of $10,000 for both spouses.  That would get them to 65 with far more in assets, and only the smaller SS check to lose.

No....You're saying with his death her income would reduce by 10k.

My point was, shouldn't the expenses decrease by more with his departure?

So, even though she will miss him, she won't be worse off financially without him.

That's what I think is missed in these scenarios. The survivng wife has fewer expenses and therefore the loss of the small SS check and sometimes the smaller income does not financially impact the survivor.

[moda0306]

K,

In my "30 Year old father" scenario, expense DID decrease @ year 20, after the kids are out of the house.  The "rule of thumb" is that a surviving spouse will need 75%-80% to live the same lifestyle.

They don't decrease before then because, as you can imagine, even though Dad isn't driving or going on hunting trips any more, Mom's life just got significantly more bothersome.  Expenses simply DO NOT go down when a spouse dies and kids are to be raised.  Maybe I was a bit hasty to say "Mom still works" and "the tangible benefits of Dad doing fathering/household duties aren't priced in," since I tend to think those are the main contributors to expenses not going down for the family.

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In my other "50 Year Old Empty Nester" example, I actually used a 75% lifestyle continuation expense.  So the $10,000 adjustment would need to happen assuming you've ALREADY reduced your lifestyle expenses to 75% of what they were overall with Dad in the picture.  So this is $10,000 that Mom has to figure out of her solo budget.

[Kshartle]

K,

In my "30 Year old father" scenario, expense DID decrease @ year 20, after the kids are out of the house.  The "rule of thumb" is that a surviving spouse will need 75%-80% to live the same lifestyle.

They don't decrease before then because, as you can imagine, even though Dad isn't driving or going on hunting trips any more, Mom's life just got significantly more bothersome.  Expenses simply DO NOT go down when a spouse dies and kids are to be raised.  Maybe I was a bit hasty to say "Mom still works" and "the tangible benefits of Dad doing fathering/household duties aren't priced in," since I tend to think those are the main contributors to expenses not going down for the family.

----------

In my other "50 Year Old Empty Nester" example, I actually used a 75% lifestyle continuation expense.  So the $10,000 adjustment would need to happen assuming you've ALREADY reduced your lifestyle expenses to 75% of what they were overall with Dad in the picture.  So this is $10,000 that Mom has to figure out of her solo budget.

I was referring to the 50 year old Empty nester syndrome. I read it too hastily and assumend retirement and they were only losing 10k SS (the lessar). My bad, didn't see the 25% reduction, too hasty.

What inflation rate do you tag on SS for your calculations? Do you assume it will just keep up with CPI or the actual cost of the stuff people consume in retirement (food, fuel, clothes, travel, medical)? Seems like that stuff is going up much faster than the CPI.

[moda0306]

K,

In my "30 Year old father" scenario, expense DID decrease @ year 20, after the kids are out of the house.  The "rule of thumb" is that a surviving spouse will need 75%-80% to live the same lifestyle.

They don't decrease before then because, as you can imagine, even though Dad isn't driving or going on hunting trips any more, Mom's life just got significantly more bothersome.  Expenses simply DO NOT go down when a spouse dies and kids are to be raised.  Maybe I was a bit hasty to say "Mom still works" and "the tangible benefits of Dad doing fathering/household duties aren't priced in," since I tend to think those are the main contributors to expenses not going down for the family.

----------

In my other "50 Year Old Empty Nester" example, I actually used a 75% lifestyle continuation expense.  So the $10,000 adjustment would need to happen assuming you've ALREADY reduced your lifestyle expenses to 75% of what they were overall with Dad in the picture.  So this is $10,000 that Mom has to figure out of her solo budget.

I was referring to the 50 year old Empty nester syndrome. I read it too hastily and assumend retirement and they were only losing 10k SS (the lessar). My bad, didn't see the 25% reduction, too hasty.

What inflation rate do you tag on SS for your calculations? Do you assume it will just keep up with CPI or the actual cost of the stuff people consume in retirement (food, fuel, clothes, travel, medical)? Seems like that stuff is going up much faster than the CPI.

I just have it growing at 3%, right along with their lifestyle expenses (assuming it's CPI).  When I'm "stress-testing" retirements, I usually show SS lagging inflation, but when we're making life insurance suggestions, we want clients to understand that "while we think SS isn't going to match 'real inflation' for a senior, we don't want to be appearing to 'cook the books' to over-sell."

I have seen enough numbers run (and heard enough stories) to where my eyes roll pretty hard when I hear the phrase "worth more dead than alive." 

[barrett]

Damn you, Moda! I thought I had this all figured out because my numbers "felt" right but now you have me thinking that I should really run some scenarios.

[moda0306]

Damn you, Moda! I thought I had this all figured out because my numbers "felt" right but now you have me thinking that I should really run some scenarios.

If you woulda told me young parents "should" get 25x their income in life insurance a few years ago I woulda laughed in your face. Our steroided financial calculat helps a ton.

A lot of it has to do with at the very least making sure we're factoring in CPI increases, if not an expansion of lifestyle that would otherwise be provided, and, for people nearing retirement, taking a REAL look at social security in the effects of a premature death.

Also, it can't be understated all the cohabitational benefits and "team work" benefits of having a spouse, even if not raising children.

[moda0306]

It was just a mock death benefit if they died today.  They could fulfill that with 10/20/30/YRT... whatever they wanted.  I usually don't see 10 recommended for youngin's.  Usually 30 or YRT.  YRT is an annually increasing term that starts lower than 20/30 (if you're youngish) and goes up over time.  Usually it makes the most sense for young people, less-so for older folks.

$1.6 Million of 30-year term on a 30-year old male would be about $150/mo if memory serves.

Sorry if it was misleading that I didn't include the 30-year premium in the "Dad lives" vs "Dad dies" scenario as a drain on lifestyle.  That's totally legit, and in fact what we show.

OK, I understand now.  The YRT policies aren't too attractive to me.  The rate profile of a YRT is unpredictable, a bit like an ARM for real estate in some respects.  The $1.6M for $150 a month sounds just a tad expensive for a 30 year old, but it's not far off.  By the way, I found the TIAA-CREF insurance rates to be the best around, at least 6 years ago. 

I can't remember ... do you advise clients yourself, or are you more of a "back office" sort.

Kind of both. I reenforce the philosophy, but I'm in back doing other work, too.

[moda0306]

Regarding YRT Insurance policies.

The insurance company DOES have the ABILITY to raise premiums if they get approval from the state insurance commissioners.

However, most of the best carriers have not done so since the 1800's, and for younger folks applying for coverage, it often makes a huge amount of sense.

I've seen policies that YRT premiums for 30 years are cumulatively less than 30-year lvl premiums for 30 years, but start out less than half the price.  The younger you are, the more likely YRT will have attractive breakevens with level counterparts.

[MachineGhost]

That's what I think is missed in these scenarios. The survivng wife has fewer expenses and therefore the loss of the small SS check and sometimes the smaller income does not financially impact the survivor.

And you need to account for the fact that the wife can take Survivor's Benefits off the SS of the husband.  Most times its larger than the wife's own benefit since women are chronically undercompensated.

And if there's kids or disabled as well, there's a maximum 150% total family payout off the dead husband's SS.  SS really does live up to its name.