Most people know that they need some insurance. Protection is part of making a comprehensive financial plan. You must buy that insurance through a licensed broker. Those brokers are trained and incentivized to sell you insurance products. Insurance is basically gambling in the casino of life. It is a game of chance – with odds, losses, and winnings. With the higher assets and liabilities of a professional, the stakes are higher. You will need to play, but should understand the rules of the insurance game before you take a seat at the table.
Rule #1: The insurance company makes the rules.
You won’t win. Don’t lose.
Just like a casino operator, insurance companies know the odds very well. Similarly, they also set the rules of the game. The premiums and fine print make sure that the odds are stacked in their favor. You won’t outsmart the professional actuaries that price and design policies. However, unlike a casino, with insurance you can also lose by not playing.
Not enough insurance is gambling that the bad event either won’t happen or that you can handle it on your own. Bad idea. Do not put off getting insurance when you need it. Don’t lose.
Too much insurance is betting against the house that you will beat the odds and win more money than you paid (by something bad happening!) You won’t really win, but at least you won’t lose.
Rule #2: Insure against calamity and to buy service.
You must insure against catastrophes that you don’t have the resources to handle on your own. Those resources are both financial and logistical. Further, it is important to consider that your mental and emotional bandwidth may be reduced during a time of crisis.
What you need vs what you qualify for.
From a financial perspective, the question to ask yourself is how much money will you need to cover the crisis. At high-income or net worth levels, that is often a lower number than how much you qualify for. You definitely do not want to under-estimate your needs and a buffer is not a bad idea. However, if you think you are going to win by grossly over-insuring, then remember Rule #1.
Insurance as a service.
Logistically, insurance companies can be helpful. A good insurance company provides service by connecting you to service providers for your disaster. They also know about the issues that arise and can give some direction to make sure that you handle things properly.
Just be aware of their motivations. The insurance company will be highly motivated to not have a claim escalate because important things were not attended to properly. You can use that to help you.
For example, some wind blew shingles off of our previous monstrous house. It had a scary steep-pitched roof. After a couple of weeks of being unable to woo a roofer into fixing it, we called the insurance company to express our concern about a potential water damage claim, if not fixed soon. They had a roofer out the next day. We had to pay since it was below our deductible, but at least it got done.
On the other hand, if something seems like a cheap band-aid, then question it and be prepared to advocate for yourself. Again, raising the specter of further costs from neglect may help.
Rule #3: Use insurance for protection & investments for investing.
Insurance is a product. When you have a product, it is natural to want to make it in different models or wrap it in different packaging to market it to a larger clientele. That doesn’t mean that it is bad. However, the further you redesign something from its original intended use, the more complex it becomes. That generally means more cost, it is harder to figure out, and more to go wrong.
Permanent Life Insurance by Many Names
A good example of this phenomenon is permanent life insurance. Permanent life insurance means that it will pay out when you die. The human mortality rate is still 100%. So, the insurance company will use those odds when designing and pricing the product. It will be much more expensive than a shorter term life insurance policy that is based upon the odds of you dying in a limited time period – usually while you are younger and unlikely to die.
Insuring to get a payout later in life when you are likely to die and less likely to have a negative net worth or dependents is not attractive. So, permanent life insurance is packaged in various ways to make it marketable. It is promoted based on the feature of insurance payments being tax-free. Bending that into an investment makes for a complex and opaque product compared to traditional investment products.
Permanent life insurance comes in different flavors with shiny labels like “infinite banking”. Whole life or universal life sounds like a universal solution to your whole life. Awesome. Does it wash dishes and sort laundry too? Participating whole life is another great name – who doesn’t want to participate and feel left out? Not me. Even if you try to look under the wrapper, it is hard to understand what you are looking at.
The Risks & Return of Permanent Life Insurance
Traditional investments have an expected return linked to the risk profile of the underlying investments (investment risk). In contrast, insurance is usually manufactured to give a defined return. The company designs it to pay that out, but also to make a reliable profit. That is done based on the odds and they set the price based on that. So, the insurance pay-out may be tax-free, but it is also going to be a relatively safe low return. Using it that way may be reasonable as a small part of a larger plan.
The actual return could be higher or lower, if the actuaries mispriced the product compared to what unfolds from a lifespan and underlying investment performance perspective. That is actuarial risk. So, it could be a way to diversify risk even though the underlying performance of investments in the policy are still subject to them.
Determining the real-life return of permanent life insurance is complex and opaque compared to what is marketed and reported on statements. The tax treatment is favorable. Unfortunately, you must also account for the excess cost of insurance compared to what you actually need, the fees charged for contributions, underlying investment management costs, and the “adjustments” made to “dividends”. Again, see Rule #1. Most of those costs are front-loaded and the positive return for whole life happens towards the end of your predicted lifespan.
Permanent Life Insurance For Mitigating Risks
One use of permanent life insurance is to cover the risk of business partners dying. An insurance pay-out could be used to give cash to help keep the business afloat while seeking another partner or smooth the buy-out process. Again, that is mitigating a risk. Not investing. There are also other ways that you could plan for this inevitable event. Further, if you plan to get out of the business before your late 60s or have built up some financial cushion before then – a term policy would be more cost effective.
Similarly, permanent life insurance may also be useful to protect against your heirs being forced to sell something to pay the taxes. That could be an asset with high transaction costs, cyclical valuation, or that you want kept in the family. For example, a family business as eluded to above, or real estate. There are other ways to plan for this that are more transparent, liquid, and cost-effective. However, it could be used to insure against a poor-planning-calamity for someone happy to pay for that. Of course, it would give me pause if an advisor is advising to insure against poor planning. Just sayin’.
Rule #4: Re-evaluate your insurance needs when they change.
Insurance brokers love this rule, but they may have a different perspective on what that means. Their perspective may be to maximally insure whatever is insurable. Your perspective should start with your needs as the anchor. Your insurance needs may be different from what you can qualify and pay for – see rules #1 & 2. Further, those needs also change as you move through life.
Their perspective: what you can buy.
“Yes, we should meet! I am sure that your income has risen and you can qualify for more disability insurance. You also have more assets. We should make sure to protect them all!” That is a direct quote from a broker that I have dealt with. I requested a meeting to review my insurance and they were really excited before our meeting. Not so much afterwards. I will tell you why at the end of this section.
Your perspective: what you need.
Come to the table with the perspective of buying the insurance that you need. You may need more life insurance, if you develop more liabilities. For example, kids. You may need more disability insurance if your costs of living have risen with your income and you aren’t financially independent enough to absorb income-loss. That is very common, if you fall into the earning-spending trap.
You may have needed critical illness insurance when you did not have an emergency fund or liquid assets to draw upon in a pinch. Fortunately, now you have lots of financial reserve to bridge you to either disability or death insurance. Similarly, if you are financially independent by a wide margin, then you may no longer require disability or life insurance.
An example from my perspective.
After about fifteen years in practice, my income had risen dramatically. However, I am also fully fattily financially independent.
I have enough liquid assets that if I became disabled, I could pay for my costs of living, increased care costs, and retirement for my wife and I. I don’t need any disability insurance.
So, I cancelled it when I had my insurance review meeting. This elicited a vigorous response aimed at rule #5.
Rule #5: Know your emotions. Beware of anecdotes.
The prospect of bad stuff happening is scary. That makes fear one of the strongest tools used to sell insurance. That is not a bad thing, if it is insurance that you need. Fear can help us to avoid trouble. However, it can also be used to overcome rational thinking. There are some classic moves that get used.
Fear for your family.
If your family is dependent upon you for income or other tasks that would be expensive to replace, then insuring against loss of that is vital. You would need enough insurance to see your liabilities taken care of (for raising small children, that is a long time). However, what strikes the most fear into most parents is something happening to our kids. Fortunately, the risk of that is low and we are not dependent on them. However, that fear makes insuring kids a great target, even though there are many logical reasons not to.
Fear of missing out.
Remember rules number 2 & 4. Insure against calamity for things that you otherwise may not be able to handle and revisit that when it changes. When I cancelled my disability insurance for logical reasons. The counter-argument was why wouldn’t I insure all of my income? I could miss out on it if I stopped working. That would be a valid argument if I needed the income, but otherwise it is a wager on the premiums being less than the pay-out. Remember Rule #1.
Rolling out the big guns: anecdotes & testimonials.
If you are weighing things logically despite the emotions, that is usually when anecdotes are trotted out. Insurance brokers have plenty of people that can tell you their story of “winning” at the insurance game. How they used their critical illness insurance for their bucket list or to pay for off-label treatments at foreign clinics. How they became disabled and were glad for the disability insurance. Some will tell you how they borrowed against their life insurance policy and felt like sophisticated geniuses (not realizing the alternatives they would have otherwise have had). Etcetera. Etcetera.
Anecdotes and stories are powerful because we can personally identify with them. If you needed insurance for the above situations, then you would be grateful that you had bought it too. However, anecdotes do not change your insurance needs. That said, some people really do want the comfort of excess insurance even if it is not logical. Paying for comfort and security can be a good use of money. Just be aware enough to make an educated choice.
Know the Rules. Play like a pro.
Now that you know the basic rules of the game, let’s focus on how to play like a professional. We must all play the game and there will be an insurance professional sitting across the table from us. Most are not bad people. They have just been trained by the insurance industry and approach insurance from that perspective. To lead your financial team for the best results, you must also be trained and know your perspective. To help, next week I will turn to Kenny Rogers, as The Gambler, to share his insurance wisdom.
What are your thoughts on private health insurance? There are the anecdotes/fears of “what if I need a biologic or some equally expensive med?”. So, at what point can we self insure? Or, should we?
Here in Ontario OPIP gets quite expensive once you are disabled /retired and no longer subsidized. Especially in ‘more mature’ age brackets. And there is the provincial Trillium Drug Plan that will cover ODB listed drugs – I believe the deductible is 4% of household income.
Hi David,
It is a great question. The policies will be priced based on the odds (rule #1). On average, you are likely to pay more than you get out. If it is a group plan, then the odds/risks are pooled. So, a low risk person overpays and a higher risk person gets discounted coverage. A large group may also have better pricing power.
I guess the really tough question is around Rule #2. Can you handle it if something goes wrong? Biologics are crazy expensive, but the risk of needing one is probably still pretty low. Many of the autoimmune diseases also manifest while younger. There is also increasing attention to public pharmacare. I will get into this some more next week, but one of the biggest alternatives to insurance is planning ahead. If you work buffer into your financial planning that you could handle expensive drugs or non-publicly funded costs, then you probably don’t need insurance for it. If you don’t do that (most average income people struggle to get much buffer), then it is a judgement of how much risk you are willing to tolerate. Rule #5 plays on us – especially as doctors who see a disproportionate number of unhealthy people relative to the general population. The right answer is probably what let’s you sleep at night. Spending money for comfort is not a bad thing and tolerance varies.
Personally, I don’t plan on getting private health insurance in retirement. I plan to have a enough buffer in savings and trimmable fat in my budget that will cover that biological drugs (without jumping through hoops) plus the wide variety of emergencies or expenses that insurance policies don’t. I am part of a group health plan currently with my University job, but I can say for sure that we pay way more than we get out of it as a healthy family of four. In contrast, I definitely get health insurance when travelling outside of Canada (even now at a young age) because the costs would be easily catastrophic and the service element is very also important to get things done and repatriated to Canada (both parts of rule #2 apply in my opinion).
-LD
Thank you for the post,
as you mentioned above i would like to ask this question?
What insurance would you recommend while travelling outside Canada? Which company? and do you pay this yearly or only for the period you are outside Canada?
Hey Ed,
We use Blue Cross since we get it through the University part of my job. However, I would buy it if I didn’t. You can get it on a per day basis. All the major insurance providers have their own version though.
-LD
Any merit to getting insurance while one is young and healthy (even if financially independent) vs. putting it off to the future when liabilities and spendings increase, but health may deteriorate (and premiums are higher)?
Hey Cody,
It is cheaper while younger since the risk is lower. The company sets the premiums based on the odds. The question is when will you need the insurance and what is the risk between now and then. If that risk bothers you, then you should get insurance (and know that you are paying more for that piece of mind). If it does not bother you, then on average, you don’t save money by getting insurance before you need coverage. The fear of something going wrong and anecdotes are used to sell you insurance before you need it (rule #5), but the insurance company knows the odds (rule #1).
How would I handle that personally? I would insure myself for what I need now. I would possibly also get what I need in the near future if the stakes are high. For example, when starting out I got as much disability insurance as I could because I knew my costs of living were going to rise dramatically in the near future with kids likely to materialize, I had invested a lot of time and effort into my future income, and there was a long runway ahead. Same with life insurance. It also saves me on getting bloodwork done more than once 🙂 However, the other approach is to get what you need now and increase it later. That can be done with multiple policies.
The other thing to remember is that when you are older and the odds of health deterioration is appreciably higher, that you also hopefully have less liabilities (debts paid and kids getting older) and more assets. At that point, you should need less insurance. If that is not the case because you fail to work towards financial independence, then that is another problem. I plan to touch on these issues a bit in my next post (on Friday).
-LD
Another great article, thank you for taking the time to write these.
As an advice-only planner, I love reading a different (and informed) perspective.
Steve
Thanks Steve! I learn a few new things every time. Both from the research and the different perspectives brought to the table.
-LD
Hello Doctor,
A quick question regarding “There are other ways to plan for this that are more transparent, liquid, and cost-effective.” under Permanent Life Insurance For Mitigating Risks. What are other ways are available to keep some of the assets within the family? (ex. clinic and real estate) Can you give me some examples?
Hey Mark,
Other ways revolve around planning to have other assets for the tax bill rather than relying on insurance for it. For example, you could make sure that you have other liquid investments that can be sold to pay the bill. When deciding on what to do, you have money to allocate. Either to insurance premiums/funding or a different investment vehicle. The advantage of insurance is that you know what you get. Sort of, depending on when you die and the policy. However, that comes at the cost of likely having less money overall. You pay for the certainty of insurance or accept some risk but a likely higher return. The right answer depends on your situation and preferences.
An investment portfolio of regular investments can be sold at anytime (liquid), the fees are transparent, and overall the return is likely to be higher. Insurance actually has a bunch of costs buried in it and even some taxes. That is not transparent and easy to find information. Many of the people selling it don’t even realize there are taxes baked in there. To access the value before death, it will be at a discount, involve extra costs/interest, and the complexity of getting a loan against the cash value (less liquid). Here is a white paper that looks at it. Page 12 compares after-tax expected returns of insurance vs stocks and bonds.
-LD
Hello Doctor,
Thank you for a quick reply! I completely understand that it’s not as transparent compared to regular investments.
Correct me if I am wrong but what do you think about universal life insurances that allow excess funds to grow tax free? I’ve been told that not only can you write off these contributions, you can also grow them tax-free if excess funds are added – they can go into investment accounts of the owners choosing like stocks, bonds, foreign markets.
So wouldn’t in be a sound financial decision to use this to invest in things like ETFs once you max out on TFSA or RRSP?
I am only thinking this way because passive investment income in corporation gets taxed close to 50%
-MC
Hey Mark,
There are a couple of points in there:
1) For universal life, the excess funding (what gets invested) has extra costs. There is the cost of permanent life when all you likely need is term (about 10X the cost). There are also taxes for overfunded insurance – usually labelled as an upfront fee for the contribution. It varies by province, but is ~5%. The investments held are usually from their funds which will have high MERs. So, you are essentially exchanging some open taxes with conventional ETF investing for hidden ones and extra investment fees. Plus, the decreased liquidity etc. Using your registered accounts for regular low-cost ETF investing instead would make much more sense. Also, the contributions from a corporation are done with corporate money but it is my understanding that they are not allowed to be a deducted as business expense. It isn’t really a free-lunch.
2) The passive income taxes in a corporation are not necessarily a big deal. If you are paying out dividends to live on (most people need corp money to live), then most of that 50% tax is refunded to the corp. All of it in the case of eligible dividends. If you are over the passive income limit, it depends on province. In Ontario and New Brunswick, it is actually an advantage. In other provinces, it depends on how well tax integration works. Again, if you need money to live on from the corporation, then the corp pays a bit more tax but you make much of it up using eligible dividends paid out to live off of. You can essentially spend more or work less to deal with it. The money all needs to come out sometime. The passive income taxes just encourage doing that sooner. Taking money out of a corporation smoothly over time may also be better than deferring all of the tax and taking it out as a massive highly taxed lump later anyway. So, I vote for spending more (or investing it personally if you don’t need it) if hitting passive income limits. It usually takes a 2-3 million dollar portfolio plus what you have in RRSP/TFSA to get there. We have slowly built personal accounts tax efficiently plus work a bit less. If you want to keep spending little and working a lot, then corporate class ETFs are another option. Again, more liquid. Some other risks though. Most incorporated professionals won’t have passive income issues until later in their career, at which time working a bit less or spending/saving a bit more personally usually makes sense anyway. Plus, using registered accounts delays that. So, does asset location (putting high yield investments in registered accounts to keep the corp income down). There are lots of ways to address the potential issue and they are generally much more flexible and cost effective than insurance.
-LD
Amazing!
Thank you for sharing this with me. All your posts are super informative and easy to understand. Thank you for your hard work! 🙂
Any time. Glad it is helpful.
-LD
Hi Doctor,
I’m wondering if you can comment on group insurance (i.e. OMA, which is almost universal for med students and residents and seems like the natural default option) vs private insurance companies? I am approaching the end of my residency, and am grappling with how to choose an insurance provider at all, and would appreciate your insight.
Thanks!
Hi Michelle,
The group insurance that you get as a resident is quite good and if you can carry that forward as an attending, it is a good idea. You then have it as a safety net baseline in case you develop something that makes you hard to insure. That is the beauty of group insurance. When you graduate, your needs will likely rise for disability insurance and you could add more as a new policy. Same with life insurance (if you have debts and someone to collect them from or other liabilities to cover). I have used a few different insurance companies. Most people chase the lowest price. I have. However, the service provided when you have a claim is super important. We have used Co-operators, Sunlife, TD Meloche Monnex, and OMA Insurance at different times chasing the lowest costs. After having some claims over the years, we have found OMA insurance to be the best responders and have some good extras for the price. Just my experience.
-LD