Repeat After Me: Insurance Is Not An Investment
Right before my wife and I met, she was in the crosshairs of someone who called himself a "financial advisor." He worked for one of the big insurance companies. He was actually an insurance salesman and almost sold her on a way to "invest" her money. This fellow was trying to confuse insurance with investments.
My wife and I are going to the north shore of Lake Superior soon to go on some cool hikes. Here are some things that might go very, very wrong:
I could break my leg falling on a steep part of a trail. The medical bills associated with this would be huge.
My wife could fall and become paralyzed. It would be hard to be a physical education teacher if she was paralyzed. We would have to change our lifestyle if we lost her income.
On the way home, I could get distracted in our vehicle and swerve and hit someone on their bicycle. I would be sued, for sure. That settlement could wipe us out.
If I crashed our vehicle in the process, we would have to buy a new one. That is another expense we don't need right now.
We could get home from the trip and find an electrical problem caused our house to burn down. I don't need to tell you how much it would cost to build or buy a new house.
I could die. It would be difficult for my wife to keep up our current lifestyle without my income.
We could become so healthy from our activities that we end up living until 115 years old. We would run out of our savings if we lived that long.
What Is Insurance
At its core, insurance is risk management. Every one of those examples represents a large financial risk to my wife and me. The risks are very unlikely to happen, but if they do there are huge costs associated with them. That's where insurance comes in. There are risks that, even though they are unlikely to happen, would wipe us out if they did.
This is what insurance companies do. We can pay them a little bit of money and they bear those financial risks for us.
Medical insurance covers my hospital bills if I break my leg
Disability insurance pays us part of my wife's salary if she becomes disabled
Liability coverage with my auto insurance covers the costs associated with me being liable for injuring someone with my car.
Auto insurance covers the costs associated with fixing or replacing my car.
Homeowners insurance pays to rebuild or repair our house.
Life insurance pays the salary that I can't make anymore if I die
An annuity offers protection against living too long
What Is An Investment
An investment, on the other hand, is when you decide that you don't need your money right now, so you give it to someone or something who does, in exchange for an expected return. You can lend your money to your bank or a company in exchange for interest. You can buy part of a company (stock) in exchange for dividends. You can buy a property in exchange for rents.
The expected returns you get for giving your money away are higher when there is more risk involved (stocks, real estate) and less when there is less risk involved (CDs, savings accounts). But the general rule is the same; you give you money to someone else in exchange for the opportunity to get more than your money back.
Insurance Is Not Investing
Repeat after me: insurance is not investing! We don't buy insurance policies hoping that they pay off. Insurance is merely paying someone to take financial risk away from you. It's not a mechanism to pay premiums hoping that someday you can file a claim. The comedian Chris Rock had a bit where he said, "you buy insurance in case sh** happens. If sh** don't happen shouldn't you get your money back?" That's a funny joke that plays on people's ignorance about insurance, but the answer is literally "no." They took on the financial risk for you. The fact that sh** didn't happen is a good thing, but you were covered in case it did.
Investing Should Not Be Done In Your Insurance Contracts
Many insurance salespeople calling themselves "financial advisors" try to sell life insurance policies that invest some of your premiums. Life insurance covers lost income in case a key earning member of a household dies and can't earn income anymore. Think of the "old days" when the dad was the only one with a paying job. If dad died, his family would lose his income. The same could be said if mom died and dad had to hire someone to do all the work mom did at home. In both cases, it pays for the financial loss of losing someone's income stream. This has nothing to do with investing. Investing comes with risks. Insurance is about getting a financial payout when something bad happens. You don't want to take risks with your insurance policies.
Annuities are insurance against living too long. They should be called living-too-long insurance. Again, some people will try to sell this as if it's an investment; they'll even help you pick investments inside this insurance policy. Don't do it. Plain annuities make sense in very few instances, but the exotic ones almost never make sense for anyone (except the salesperson). If you are in a situation where an annuity makes sense, don't take investing risk inside the insurance policy.
Teachers Beware
403(b)s in many school districts are full of annuity options. It's very common, if you're a teacher, to have a list of 403(b) providers that's a page long. Of course, it's up to you to determine which one of these is best. Hopefully, you have access to an investment company and not just insurance companies, but you have to beware of the dangers of annuity salespeople praying on teachers. The story is the same, though; saving for retirement with a 403(b) should be done with investing, not with insurance policies.
Final Note
Recognize that insurance offers us protection against FINANCIAL pain. It has nothing to do with EMOTIONAL pain. The emotional pain of losing a loved one or losing the house you grew up in will be hard. I totally understand that. But don't be fooled into thinking that having some kind of insurance payout will alleviate that pain.
