I’ve been reminded lately about the importance of insurance, as I’m suffering a little with my left hand/arm/wrist (I’m a leftie). It’s making it uncomfortable to type, and of course typing is what I do practically all day both here, and in my day job.Although I know that my discomfort is caused by a specific event, a chronic condition like RSI would have a very detrimental effect on my ability to earn an income.

For most people in the pre-retirement stage of their lives, losing the ability to earn is both financially damaging and more likely than you might think. It’s not often self-insurable (if you don’t need to work for money, then you are self-insured, otherwise you are not), but you can and should consider taking out both short and long term disability insurance, also known as income protection insurance to cover you against such an unfortunate event. You might, however, not need to pay for it yourself.

My employer has just introduced a new benefit, which is Group Income Protection that pays out 50% of pay (minus any other income received) after 6 months of sick leave - during those 6 months you are still employed on full pay. I’ve already got a income protection plans in place, and now I’m not sure whether to cancel. I suspect that having two policies won’t net me any more money, but it’s possible that one could have less stringent requirements than the other.

The question is, should I cancel my own policy, and just rely on my employer’s policy? Or should I keep paying out £26 a month, for my own cover?

Image by openDemocracy

For all women and married men, the relevant figure rises to £1m. As no data currently exists for men in civil partnerships (they haven’t been around long enough), some insurers will treat them as single men, and others as married - I’m not sure whether this does, or should contravene the anti-discrimination laws that exist in the UK.

Interesting, don’t you think?

As a relatively young, and healthy person, I sometimes forget that insurance is based on risk, and for life insurance, that risk increases if you are more likely to get sick. And if you are HIV positive, you are more likely to get sick (although the risk can normally be controlled by medication at the right stage). But similarly, if you’re older, you are more likely to get sick. Or if you have an *interesting* medical history.

Life insurance is a relatively straightforward product though. It’s pretty clear cut when someone is dead (as in, there’s a death certificate) and all that happens then is that the sum assured is paid out. This means that life insurance is a easy to shop around on. Now, this is important if, like me, there’s nothing particularly special about you but it’s even more so, if you have any (perceived) risk factors.

So, if you’re thinking about taking out life insurance, shop around. Don’t attempt to defraud insurers by neglecting to mention relevant information if asked, but also, if you think that a certain requirement is too onerous (like taking, and disclosing the results of, an HIV or Hepatitis test), it’s perfectly possible that another company won’t have it.

Image by Jan the manson

Its not the risk of dying that’s the variable as to whether you should have life insurance, its the risk x outcome that you need to consider.

e.g. the risk of me dying is negligible, the (financial) effects of me dying are negligible
negligible x negligible = low so don’t bother with life insurance plonkee

but

the risk of me become disabled is low, the (financial) effects of me becoming disables are catastrophic
low x catastrophic = high so get disability insurance plonkee

So there you have it. The perfect way to decide whether you need insurance.

If you are single without dependants and you work for a living, then the worst thing that could happen is that you become completely unable to work. In this case the most important thing to insure is your income.

If you are single with dependants and you work for a living, then its still the case that the worst thing that could happen is that you become completely unable to work. But a very close second is that you die before your dependants are able to make their own way in the world. You need to insure your income and your life as the highest priority.

If you are married / whatever with a partner, and no dependants, then you aren’t in too bad a position. The worst case would be that you both lost your ability to provide an income, so you need income insurance, but it might not need to be as generous (since the other partner should still have an income).

If you are married with dependants, then the worst possible scenario is that you both die before your dependants are financially secure. You need life insurance first, with income insurance second for all the reasons above.

If you have a secure independent income with no access to capital (like you have an annuity or similar) and you have dependants, then you need life insurance. Unfortunately, if you are in this position you are likely to be older and not get a good deal on life insurance. Your best bet might be to save as much as possible and hope that you live long enough.

Of course, I’ve painted broad generalisations here. What you should really do is take an honest look at the risks and outcomes of all bad financial situations and plan accordingly. The safety net of an emergency fund will help in almost every situation.

I was watching the news the other day where they did a report on some of the afflicted returning to their homes and surveying the damage. I honestly felt for these people as pretty much all their possessions were trashed.

In one of the areas, they’d previously had a major flood before. Apparently, some of the residents had been told that such a flood was a once in a hundred years event and since they’d had one already they cancelled their insurance thinking that it was too rare to happen again. Ignoring the possibility that the climate is changing or that the odds were incorrect in the first place, they’ve been looking at it all wrong. Its not really how likely it is to happen, its how much damage it will do if it does.

I bet they cancelled the insurance because the premiums went up. The thing is though, that the premium will only go up if there is increased risk i.e. the chance of the event happening has increased or the cost of fixing it has increased. To me, this means that your need for insurance is greater not less.

The lesson for everyone should be that if you live in a floodplain you need insurance against catastrophic floods. Anything catastrophic that has a small chance of happening probably needs to be insured against.

One of the key things that I took out of it that could actually be applied to personal finance was the role of insurance. In the world of Taleb, the important factor that should be determining whether or not you need insurance (in the general sense) is the expeced value (or cost) of the event.

For those of you that aren’t big fans of probability, this means the probability of the event multiplied by the cost outcome of the event. Taleb argues that most people consider only the frequency of the event and ignore the outcome of the event. This is catastrophic if the cost of the event is literally unbearable. An example of this in general life is the event of your house burning down. This is pretty unlikely, but the cost of it happening is unbearable if you cannot afford to rebuild it. In this case you need to have insurance. In fact, Taleb goes further, for example you need to have insurance not against the specific cause of your house burning down, which is very unlikely, but the more general ‘needing to rebuild your house’.

With insurance, its not about how likely it is, its about how likely it is and how bad the worst possible outcome is. Thats what you need to protect yourself from.