What are the odds?
Insurance is a basic part of everybody’s financial planning - even those who don’t think they are planning. But why? What’s the point?
Insurance - in any form - is about “risk transference”. When you consider risks, what happens is you form a view about the personal impact of losing your assets (the risk), and then decide whether you can assume the entire cost yourself or whether you wish to pay a relatively small price (a known loss) instead, and transfer that risk to somebody else. That’s all insurance really is: taking a little hit so you can pass the big hit, if it happens, on to another party.
But usually we don’t really know the odds. What are the chances of the things we dread actually happening? We make subjective assessments - not objective ones. Apparently the chance of these things happening in your working life are:
- Your house being totally destroyed by fire is 5%
- Dying before you turn 60 is 13%
- Writing off your car in an accident is 20%
- Suffering a 6 month disability is 33%
The last one leaps out as being a really statistically “significant” risk doesn’t it? According to research conducted in NZ in the mid 1980’s, more than 5 out of every 6 “disabilities” were caused by illness, and not covered by ACC. Some 275,000 Kiwi’s were temporarily disabled each year - two thirds of them being out of action for a month or longer.
The chances of being disabled for six months was more than six times as likely as your house burning down. Nearly everyone has fire insurance but few insure their income.
It’s probably still about the same. So being selfish (which is always a good attitude to take in assessing personal risk), what’s the potential loss if it happened to you?
ACC is the ACCIDENT Compensation Commission, it is not the If You Get Sick Comensation Commission. Health Insurance will pay your medical bills but it won't reimburse you for lost income.
If you’re a 25 year old earning $25,000 pa on average through to age 65 - well there’s $1,000,000 at stake in personal earnings. A 40 year old averaging $45,000 pa through to age 65 has at risk $1,125,000 in future earnings.
They are pretty impressive sums – and pretty impressive losses in a worst case scenario too. These risks are transferable - or insurable - most of the time for most people though.
A Friend told me of a wise client who had told him:
“If my employer paid me $80,000 per year, with 10 days guaranteed sick leave and 4 weeks guaranteed annual leave, it is pretty good. If my employer instead offered me a salary of $78,000 per year, with the same leave provisions, and with a further guarantee that I’d receive 75% of my income through until age 65 in the event of a major disability - I’d take the lower wage. That is excellent value. Certainty comes at a price - but this one is reasonable.”
A further thought - those with the most risk are those who live up to every cent of their current income. If you cannot survive on less income than you have now, you really should consider tightening the household budget and taking a known loss. Because the odds are reasonable that at some stage in your working life a calamity will hit your earning ability - and your financial survival may already be fragile. Create as much certainty as you can.
It’s all about weighing the odds, and putting the “loss” into perspective. Calculate what is at risk, find out what the known cost is, and then make an objective decision. That’s playing the odds.
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