February 17, 2018
It’s time to open this particular can of worms – Insurance!
The topic of insurance tends to divide people. And it usually brings up some emotional debate.
Some think insurances are mostly just a waste of money.
While others think buying insurance is a must, and just part of being a responsible adult.
It’s likely this article will ruffle a few feathers. And many folks won’t agree with me. But that’s ok. I’ll just offer my take on it and readers can decide for themselves.
Since I started this blog, I consider it my job to point out where we’ve saved substantial amounts of money in our life. Also, I aim to highlight a few topics or lifestyle choices, that are often not thought about or questioned.
Today, that topic is Insurance.
Firstly, let’s nail down what insurance is.
To me, it’s a policy you pay, to cover for unexpected circumstances, or if something goes wrong. That sounds pretty sensible, doesn’t it?
But it’s not that simple.
The companies providing this insurance have teams of experts (called actuaries), who compile mountains of stats and estimate how much they will have to pay out in claims.
Then, they set your premium higher than this, so that after they pay their employees and all their other costs, they still make a nice profit.
You’re an insurance company. The money comes in. You then get to hold onto this cash, earn interest or invest it, and you don’t have to pay out any claims until later, when the customer needs it, or possibly never.
And not only that, on average, you pay out less than you receive, while you’ve been earning interest or investment returns, all that time!
Sounds like a great business. Maybe not such a great product.
As a side note: Warren Buffett’s investment business has been built on the back of the huge amounts of insurance premiums they collect – which Buffett uses to buy other businesses, multiplying that money over time, and then paying out some of it later in claims.
So the bottom line is, the odds are heavily stacked against us. It’s like a casino. We can win. But mostly, we will lose.
And like the casino, if we keep playing this game long enough, we’re very likely to end up with less money than when we started.
Now it doesn’t sound so sensible, does it?
So why do we do it?
The answer is two-fold. Firstly, because of fear. And secondly, lack of savings.
Some folks pull their hair out at the thought of having no insurance.
After all, if something goes wrong, what the hell do we do? We’re screwed!
This fear factor is what keeps the insurance cogs turning. And why most people will still opt to have insurance, even if they know, statistically, it’s a losing bet!
It’s important to understand the reason why we have this fear. And I believe it comes down to not having enough savings.
After all, if you had $5 million, would you insure your car? Your house? Anything?
My guess is, if you thought about it logically, probably not. It just wouldn’t make much sense. Remember, it’s a losing bet!
And because you can afford the consequences of your house burning down or your car getting stolen, the outcome isn’t scary at all.
Certainly, it’s not ideal. But the point is, you can easily afford it. So it’s clear, the solution to insurance is savings!
Because most people have little savings and suck at managing money, almost every bump in the road can mean catastrophe for them. So they load up on insurance for their phone, their appliances, their contents, car etc.
While it sounds smart, one of the reasons people can’t save is because they’re spending so much on insurance! It’s a vicious cycle.
These folks need to build some savings and cut out their insurance policies one at a time.
Once they build savings, they won’t need insurance because they can cover it themselves.
Since insurance can be solved by savings, we don’t need more insurance, we need more savings.
As a minimum, we should all be carrying bank balances of $10,000-$20,000. This type of cash balance will solve most short-term emergencies and kill the need for small-problem insurance.
Instead of treating insurance as a cuddly blanket that makes us feel good, we should see it as a money pit with a negative return.
By building our own insurance company, we can put the odds in our favour. Best of all, we end up with a higher savings rate and a larger pool of investments to call on, should the need ever arise.
Rather than assume you need all of it and cut out one or two, it’s more sensible to assume you need none of it except one or two.
After all, the only ones you need are the ones you can’t cover yourself, and can’t find a work-around.
But here’s where the fear comes in. As soon as you feel that safety blanket being ripped away, don’t be scared. Instead, see it as an empowering choice to provide your own insurance, with your own savings!
Let’s say you build up your savings stash to around $20k or so. And the rest of your steadily increasing savings is pumped into your investment of choice, perhaps some dividend-paying shares like index funds and LICs.
This cash buffer should provide plenty of cushion for a few bumps in the road here and there, along with your ongoing positive cashflow from living an efficient and low-cost lifestyle.
Here’s how it works…
After investing your insurance savings, your investment will begin to grow and produce it’s own income, which further reduces the need for insurance – you have a larger asset base and larger cashflow.
Obviously, the richer you get, the less you need insurance.
Most insurance you won’t use for years and years anyway. So the bonus is there’s much more available when you do actually need it.
If you continue paying the insurance, the premium increases year after year, often large increases!
But investing the money instead, puts you further ahead, year after year – making the gap of self-insuring larger and more profitable for your own little insurance company.
Here’s how I think about some of the most common insurances and how we approach it.
We’re currently renting, so not a factor. But in a home-owning situation, we would have insurance, because finding $300k to build a new house would hurt our early retirement. We’d need to sell investments to cover this cost, so one of us would have to work part-time.
Our priority is maintaining our freedom. But home insurance would become less important for us if we had, say, $5m accessible net worth.
At that point, we could comfortably build a new house and some type of stupid lawsuit and our freedom would be completely unaffected. The remaining investments would still provide more than enough income.
No car insurance currently. If we smash our car, we can easily buy a new one for $5k or so. And we’re happy to pay to have someone else’s car fixed, which might cost $5k-$50k. I actually hit a neighbours car badly about a decade ago and it cost less than $5k to fix (it was a new small car).
Even if it’s more than this, it doesn’t matter, it can come out of our growing pool of investments.
Remember, frugal car ownership means less driving where possible, and choosing low-cost cars, so there’s little to be afraid of in this category.
You’re kidding right? No we don’t have this. We used to, until I convinced Mrs StrongMoney that we really didn’t need it.
After all, it’s just furniture and a bunch of other possessions. If our house burns down, we’ll just be happy we weren’t in it! I couldn’t care less about the stuff in the house. Family photos and heirlooms can’t be replaced anyway, so I think this is a feel-good insurance that doesn’t make much sense.
If we had to start over, I’d aim to buy about half as much furniture etc. to keep clutter down, and less expensive things, just because even basic stuff these days seems pretty fancy to me!
On another note, I hear that many supremely unimportant items are included in the price of contents insurance. Things like cotton-buds and deodorant. I kid you not!
Check out this article from Mrs ETT. This preys on people’s laziness in opting out of this stuff. And it probably works. To me, this is fucking ridiculous! Who the hell insures cotton buds!
We have great health cover, it’s called Medicare – one of the best healthcare systems in the world. We used to have private health insurance, but with so many exclusions, escalating prices, gap charges and so many wiggle-out options for the insurer, I don’t think it’s worth it.
If we need some type of non-urgent surgery and the public system waiting list is too long, we’ll just pay for it ourselves. As for ambulance cover and extras, this is spending $10 to save $9 in my view.
If we need these things, again, they can come straight out of our ongoing cashflow. In the meantime, all that money is working hard, earning income and multiplying over time.
As for the tax benefits, I’m not entirely convinced. I believe we have an irrational love of reducing tax at all costs in this country, even if it means spending more than we get back. For high earners, it might make sense. But just go with hospital cover in that case. Extras are only a few bucks to cover yourself.
No, we don’t have this. Once we managed to live on one of our two wages, there was no need for it. One spouse would have been fine financially, with the other one no longer around.
And once a reasonable net worth was built, any need for income, disability and life insurance also reduced. There’s simply no reason to pay for this ‘safety net’ once you’ve created your own.
My view is pretty simple. You should aim to have a very small number of insurances. The number of insurance policies you have should reduce as your savings and net worth builds up.
By living an efficient lifestyle, many of these out-of-pocket expenses will just mean a month or two where you don’t save. It won’t mean Financial Armageddon.
If you have no savings or investments, and currently have no surplus cashflow – by all means, keep your insurance. But work on improving that financial position ASAP.
Next time you’re hit with an insurance decision, remember, it’s statistically designed for you to lose!
It’s a casino type of proposition, albeit one that makes us feel all warm and secure.
Locking in a negative return isn’t very attractive. Holding that cash in the bank would be better. And investing it in higher income-producing assets like shares, is better again.
The stronger your financial position, the less you need insurance. Since building financial strength is my core message, that’s what I want you to focus on.
Clearly, insurance is mostly a short-term solution. The underlying long-term solution is building a large pool of savings and investments. And eventually, you’ll have little need for any insurance at all.
I’ll let you decide which insurance to keep and which to give the flick. But just keep in mind, chances are you’re sending more money out than what you’ll get back!
Financial strength is gained by building resilience into your life with an efficient lifestyle and a war-chest of savings to deal with life’s hiccups.
It’s incredibly freeing to be mostly ‘self-insured’, and we’re certainly wealthier because of it. I love it. And we feel comfortable in dealing with whatever pops up.
By becoming our own insurance company and relying on our savings for most things, we’re tens of thousands of dollars wealthier with each passing decade.
As your investments grow and you get rid of each insurance policy, you’re increasingly putting the odds in your favour. And every year, those investments produce more passive income for you, reducing your need for insurance even further.
This ever growing pile of ‘insurance money’ can be called on should the need ever arise.
So start investing instead, and create an insurance-crushing snowball of wealth and passive income.
How do you feel about your insurance? Is there any you can cover yourself? Would you keep them all if you received a multi-million dollar windfall? I’d love to hear your thoughts…
Note – There’s likely many cases where insurance makes sense for readers. I can’t know everyone’s situation. These are just my overall thoughts on the subject, and what suits our situation.