How to think about insurance

Jim Dahle: ©The White Coat Investor

Too many physicians and others lack the proper perspective on insurance. Financially speaking, insurance is generally a losing bet. It has to be or the insurance company would go out of business. An insurance company charges premiums and then uses those premiums to not only pay its operating expenses, but also to help all of the people for whom the risk insured against actually showed up in their lives. Hopefully, they also have at least a little money left over for profit or they will not be around long. Since the average cost of the premium is less than the average benefit paid out, insurance is not a good deal. That does not mean you should never buy insurance, but it does mean that you should only buy the insurance that you need. You can then use the money you saved from not buying insurance to decrease the need for future insurance.

What you really need to insure against is financial catastrophe. The list of these in the life of a typical physician is generally pretty short:

• Becoming seriously ill or injured and needing to pay for extensive medical care
• Becoming disabled for a long period of time while you depend on your income
• Dying while somebody else depends on your income
• Being sued for professional or personal liability
• Your house (or other expensive property) burning to the ground or otherwise destroyed

That’s it. Anything you can afford to replace without serious financial hardship does not need to be insured. You can generally cover these risks with five types of insurance:

1. Health insurance
2. Long-term disability insurance
3. Term life insurance
4. Malpractice insurance
5. Property (homeowners, renter’s, and/or auto) insurance including personal liability (umbrella) coverage

People often feel they need more types of insurance than these because they do not keep enough cash on hand to take care of life’s little emergencies. It is generally recommended to keep an emergency fund equal to the amount of money you typically spend over three to six months. This money should be kept very safe and very liquid because in an emergency situation the return of your money matters far more than the return on your money. Typical locations for this money include high yield savings accounts at banks and money market funds at brokerages, although some of it probably sits in your checking account most of the time. Building an emergency fund should be a major priority for anybody trying to get control of their financial life. When you have adequate emergency reserves, you can increase the deductible paid when risk shows up in your life. This will lower your premiums and thus the total amount of money you spend on insurance. Raising deductibles and getting rid of unnecessary insurance (cancer insurance, whole life insurance, travel insurance, iPhone and other consumer insurance) frees up your income so it can be used to build real wealth, reducing the need for some types of insurance at all.

Not all insurance needs to be carried throughout life. When you become financially independent, and thus you and those who depend on you can live comfortably for the rest of your lives without you ever earning another cent, you can cancel your disability and term life insurance. When you stop practicing, you can stop paying for malpractice insurance, although you obviously need to make sure you either had an “occurrence” policy or someone (you or the employer) has purchased an appropriate “tail” policy for a “claims-made” policy. As you become wealthier, you may feel comfortable getting rid of comprehensive and collision coverage on some or all of your vehicles as well. When you reach age 65, you may opt to switch from your health insurance to Medicare, which often reduces your cost significantly. Personal liability and some property insurance will typically be carried throughout life.

Some insurance is more expensive than other insurance. This is simply because it gets used more often. Physician disability insurance tends to be pretty expensive, perhaps $200-$600 per month to provide a benefit of $10,000 per month. That’s because something like one out of four Americans becomes disabled before age 65. Term life for young healthy people on the other hand can be a steal. A dollar or two per day might buy a million dollar death benefit. Life insurance tends to be more expensive for men, since they die younger, and disability insurance tends to be more expensive for women, since they are more likely to be disabled. Malpractice costs vary highly by geographic area and specialty. Many physicians who engage in “geographic arbitrage” find that moving to a different state increases their income while reducing their cost of living, taxes, and malpractice costs. This often results in them becoming financially independent five or more years earlier, further allowing them to reduce their disability, life, and malpractice insurance costs.

Personal liability insurance is generally far cheaper than professional liability insurance. It would not be unusual for a physician to pay $20,000 a year for malpractice while only paying $300 a year for the same amount of umbrella coverage. Perhaps the most expensive insurance for any American, including physicians, is health insurance. Due to employer and government subsidization, too many people expect their health care costs to resemble their cell phone bill more than their mortgage. Unfortunately, when we spend 18% of GDP on health care, we should expect a similarly high percentage of the average income to also go to health care costs. Many early retirees are surprised to find that health insurance is their largest expense. Even once they go on Medicare there are ongoing costs, even if they are generally significantly less.

By using a broker, you can often save time and money when purchasing insurance. While the broker generally earns a commission for helping you, those commissions are usually already baked into the premium. While you shouldn’t rely on a conflicted broker to tell you what kinds of insurance you need and how much insurance to buy, they can certainly help you get a better deal on what you have already chosen to purchase.

Being smart about insurance will allow you to use more of your income to build wealth, provide for those you care about most, and have a little fun along the way.

James M. Dahle, MD, FACEP, is the founder of The White Coat Investor