Top Ten Insurance Mistake that Fighter Pilots Make

Insurance is the least sexy part of financial planning.  Estate Planning could possibly convey an air of “hey, we’ve got money and we want to micro-manage it from the grave,” but insurance can be boring, complicated, and frequently over-sold.  Perhaps the only thing worse than talking about insurance is not having the right insurance.

Okay, now that your adrenaline is pumping, let’s dive into the top ten insurance mistakes you might be making!

Philosophy of Insurance

Insurance as a product is simply a way to transfer the risk of a loss from you to a shared pool of people looking to avoid the worst effects of a similar loss.  You pay a periodic premium and if you experience the loss, the insurance company indemnifies you (makes you whole) per the contract.  Sometimes it’s that simple, sometimes the devilish details of the contract muddy the waters a bit.

On a good day, insurance is a money-loser.  You pay a token amount compared to the size of a loss you could experience. You probably never experience the loss.  The insurance company keeps your premiums.  Because most of us have a hard time experiencing any value from this transaction, it’s hard to feel really satisfied with insurance.

But the value is twofold.  First, proper insurance should give you peace of mind that you and your loved ones will be made economically whole after a loss.  Second, with some exceptions, you’ll pay far less than you get in return for the cost of the insurance.

Of course, there are situations where you might pay more than you get, or even exactly what you get.  If you pay for car insurance from age 16 to 85 but never have an accident, you probably could have bought a few cars for the aggregate of your premiums.  (You’d have a harder time paying for the total liability you were covered for though.) Whole Life policies often have you pay the face amount of the policy (e.g., $100K) if you live to be 100+, but since so many of these policies are surrendered before death, most folks won’t pay them off.

Philosophically, there are three key concepts that should guide your insurance purchases:

1. Only buy insurance for catastrophic occurrences that would be ruinous if uninsured. Examples include:
   1. You die before your family is financially independent from the need for a paycheck.
   2. Your teenager plows their 1986 rust-mobile into a Mercedes G-Wagon full of personal injury attorneys.
   3. You own a home on the Gulf Coast where every summer storms obliterate human dwellings.
   4. Side and back-lobes of that APG-63 have your cells mutating into some funky shapes…
2. Only keep insurance until you’re self-insured against the catastrophe. For example:
   1. As long as you might drive, you need auto insurance to fix cars and pay for damage to people and things.
   2. As long as you live, you need health insurance maintain your health.
   3. When your nest egg would provide for your surviving spouse’s needs (and probably wants), you may be self-insured against early death.
   4. If you have a multi-million-dollar net worth and a small home in a disaster-prone area with high insurance costs, you may be able to self-fund a rebuild.
3. It’s better to have a little too much insurance, starting a little too soon, and kept for a little too long than any of the opposites.

Let’s look at how these concepts apply to the Top Ten Mistakes.

The Top Ten Insurance Mistakes

10. Too little Life Insurance. Many families leave the autopilot switch configured at SGLI + FSGLI. SGLI plus the $100K death gratuity means that $500K shows up after a death.  $500K is great when it’s an unexpected windfall but it’s rarely enough to pay off a home, fund higher education, and provide income for the surviving spouse.

Fix: Analyze what you want to happen after one spouse dies.  Common goals include paying of a house; providing income until the surviving spouse can assume bread-winner duties; funding college, etc. Use an online calculator, talk to non-captive insurance broker, or meet with your financial planner to determine the right amount.  Consider layering policies of different term lengths and then canceling them as your insurance need dwindles.

9. Wrong type of life insurance. SGLI is term life insurance. The term ends when your service does. Term insurance is very cost effective, but it does require that you know when you’ll die or continuously calculate your insurance requirements.  You’ll have to settle for the latter.  Companies sell Term policies for just about any length of time you could want, but if that Term extends past your early 60’s, Term Life can get very expensive.

Whole Life, Universal Life, and Variable Life (and the endless variations of each) are often called cash value policies and are policies designed to last until you die.  They are more expensive than Term policies for a variety of reasons that I’ve belabored here.  It’s common to see a cash value policy provide $100K of coverage for a higher premium than $500K of Term Life.

Life insurance can be used to cover final expenses such as burial and funeral costs, but these are four-figure or low five-figure costs.  Over the course of few decades, it’s reasonable to just save up for these expenses—they can be funded from the nest egg.

Inflation gobbles up the value of an insurance payout as well.  If you buy a $50K cash value policy in your 20’s because a slick insurance salesman gets to your worry gland, plug this into Excel to see what it’ll be worth to your spouse if you die in your 80’s (=FV(-0.03,60,0,50000,0)).  Thus, a cash value policy seems like a lot when you buy it, costs a lot while you own it, but doesn’t pay a lot if you keep to the bitter end.

As always, I’ll point out that there are use cases for cash value policies, but most readers will come out ahead with a Buy Term, Invest the Rest approach.

Fix: Talk to your financial planner about what insurance you have, what you might need, and how to reconfigure any problematic policies.  Avoid the sunk-cost fallacy of staying with an inappropriate product just because you’re already several years into paying for it.

8. No Disability Insurance. While on active duty, we don’t tend to think about Disability Insurance. Companies generally won’t sell it to us because combat tends to disable folks at higher rates than carpal tunnel syndrome.  After active duty, large employers frequently provide disability insurance, but small ones do not.

Even if your new employer offers Disability Insurance it may not be enough. We are far more likely to become at least partially disabled than we are to die young.  Yet most of us have life insurance and no disability insurance. What’s more, employer-paid Disability Insurance is taxable and usually doesn’t keep up with inflation.

Self-funded private Disability Insurance is paid with after-tax dollars and while the payments still probably don’t keep up with inflation, any payments received are tax-free.

While Social Security does have a component that pays out for disability, you must be totally and completely disabled, not just unable to do the type of work you had been doing. It also pays barely enough to keep you at the poverty line.

Disability Insurance isn’t meant to make you wealthy or give you an incentive not to work, but it should give you an opportunity to maintain your standard of living and potentially still save for your future.

Fix: As soon as you leave active duty, start shopping for Disability Insurance with a non-captive broker.  If your company offers Disability Insurance, review the options with your financial planner to make sure you’re getting the best coverage you can get.

7. Home/Auto Liability coverage is too low. The liability portion of home and auto policies covers you for harm you cause in a vehicle or that comes to people on your property. Because we don’t like paying a lot for insurance, many of us choose the bare minimum that our insurance company offers based on state law.

For example, if your auto policy has $100K/$300K/$50K of coverage, your insurance company will pay no more than $100K to any one person for injuries, no more than $300K for all the people involved, and no more than $50K for the property damage you cause.  Setting aside compensation for injuries, have you seen the cost of vehicles lately?  Cars that you might have considered beneath your standards a few years ago cost more than $50K now.

Reference that teenager totaling a G-Wagon full of litigious attorneys… their suits might cost more than $50K.  The G-Wagon certainly does.

Fix: Talk to your insurance professional or financial planner to understand your risks if you’re sued for an above-policy-limits amount.  This isn’t a good area to be penny-wise and pound-foolish.

6. Homeowner Dwelling Coverage is too low. This is another area where recent increases in labor and material costs drive an increased insurance need. If you paid $300K five years ago and your policy doesn’t automatically inflate (most don’t), then there’s a good chance you can’t rebuild for $300K.  What’s more, if you’ve let your coverage fall below 80% of the rebuild value, you won’t be fully covered for a partial or total loss.

Let’s say your $300K home would now cost $400K to rebuild but your Dwelling Coverage is only $300K.  If the house burns to the ground, you only have 75% coverage.  You should expect to have about $300K (minus your deductible) covered, leaving you with about $100K of extra rebuild cost.  Ouch.

Fix:  Contact your insurance professional to ask for an updated assessment of your home’s rebuild value.  Also inquire about an automatic inflation adjustment.  Revisit every 1-2 years to verify adequate coverage.

5. No Umbrella Insurance. Umbrella Insurance add an “umbrella” of additional liability coverage on top of your home and auto policies. This link gives more information on Umbrella Insurance, but the reason you might need it is that as your wealth outside of certain retirement accounts grows, your exposure to an above-policy-limits lawsuit could eliminate more of your hard-earned nest egg.

Circling back to our teenager vs. attorneys in G-Wagon example, if you have $300K of personal liability coverage on your auto policy and a $1M Umbrella Policy, then not only will the plaintiffs have to win a judgment above $1.3M, but your insurance company also has a great incentive to defend you well to avoid paying out $1.3M!

Umbrella Insurance is generally inexpensive unless you’re already on your insurance company’s naughty list.  Like all insurance coverage, you should update your need every 1-2 years.

Fix: Talk to your financial planner to understand how much coverage you might need based on what types of assets you have, then call your home or auto insurance company to inquire about a policy.

4. Insurance on small-dollar items. In 2007, the original iPhone cost $499. A year later the successor iPhone 3G cost $199.  Today, an iPhone SE costs $429 and an iPhone 13 costs $799.  A refurbished or used iPhone with a warranty can be had for less.  Compared to the costs incurred in a serious car accident, these are budget dust numbers.

Insurance (including extended warranties) on these items can easily run $150+ per year even though with a decent case, the phones will usually last years.  The replacement of these phones prior to a planned refresh is a disappointment, not a catastrophe.

Save the money that would go into an insurance policy, keep an emergency/contingency fund, and consider yourself self-insured for the replacement of things like TVs, small appliances, and other electronics.  The time spent trying to activate an extended warranty or insurance policy on a small-dollar item may dwarf (what should be) your hourly rate.

Fix: Cancel insurance on small-dollar items, but make sure you keep an emergency/contingency fund to replace such items.

3. Deductible is too high. If your homeowner’s insurance deductible is set at a percentage of the value, versus a fixed dollar amount, you’re at the mercy of inflation when a loss occurs. For my fellow Gulf Coast dwellers, 10% of a $500K home is $50K.  How’s your emergency fund?

For each policy, it’s important to consider the likelihood of loss, the frequency of losses, and the opportunity cost of keeping cash on hand to cover deductibles and other emergencies.  If your deductible is very high, it probably keeps your premium low.  That’s great if your emergency fund can cover a loss.  If you’re still building out your emergency fund, it might be appropriate to keep a lower deductible on some policies.

Fix: Talk to your financial planner to analyze your policies, deductibles, and emergency fund planning.

2. Deductible is too low. The potential for whiplash notwithstanding, if a deductible is too low, then the premium might be too high. A good example is car insurance deductibles. Cars and repairs are pricey.  What’s more, your premium usually increases with each claim.  A low deductible creates an incentive to make a claim for a minor swapping of paint.

If the repair costs $1,500 and the deductible is $250, then you save $1,250 on that repair.  When the next cycle’s premium goes up $100 per month, you’re out $1,200.  A year later, you’re out another $1,200. A year later… same problem.

If your deductible was $1,000, you probably would just pay the additional $500 out of pocket and then drive safer next time.  The trade off is, what would you have to earn on that $1,250 you saved to compensate for the addition $1,200 you paid in future years?  Ouch.

Reasonably high deductibles lower your premiums and incentivize safer behavior, but they do require that you keep cash on hand for repairs.

Fix:  Talk to your financial planner about your current deductibles, your cash on hand for repairs and deductibles, and how this impacts your other goals.

1. No Flood Insurance. You don’t need to live in a high-threat flood zone to need flood insurance. Your normal homeowner’s policy doesn’t cover water unless it comes from above.  If you need convincing that locations that aren’t adjacent to bodies of water also flood, I recommend turning on cable news.  (There are few other reasons why I would turn on cable news…)

Flood insurance isn’t terribly expensive.  It’s also not terribly comprehensive.  This is a great discussion to have with your insurance professional.  But if your home could be affected by a water that seeps in from the ground up, flood insurance could be well worth the modest cost.

Fix: Talk to your insurance professional.  They should be able to evaluate your flood risk and help you understand what’s covered by your basic homeowner policy vs. a flood policy.

Cleared to Rejoin

Talking about insurance is so not-sexy that I fell asleep several times writing this article.  The fact remains, being over-insured costs some money and being under-insured costs a lot of money.

It would be nifty if insurance were like AMRAAMS, fire and forget (as the brochures say…). The reality is, just like your investments, your cash on hand, your estate documents, your college funds, etc., things go better if you review and update them from time to time.

If this article overwhelms a bit, how about picking two items on the list and working them in the next six months?  You’d be well ahead of most Americans, and you’ll feel great about making traction towards peace of mind.

Fight’s On!

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