There are many ways to reduce investment risk. The most common strategies include holding a portion of your investable assets in cash or other short- term bonds, or by diversifying into various asset classes so that the impact of any one investment is mitigated. In some cases, investments or a portfolio may be "hedged' using a number of strategies, including in some cases buying a put contract or other "insurance" against investment risk. While it may be more interesting to discuss credit default swaps, put transactions and short hedges, traditional insurance may offer a better and more straightforward way to reduce risk for a reasonable expense.
It’s important to analyze traditional insurance, and review where you may benefit from improved insurance coverage. There are two main areas of insurance that impact most clients: Life and Disability Insurance, and Property Casualty Insurance. In each area I will just touch on a few key issues to consider. There are other forms of insurance beyond the two areas noted below (long-term care, health insurance, etc.) but these are the two that are most common across our clients.
Life Insurance has two main functions: create value for your family in the event of an untimely death, or help pay the tax on a large estate. In the first case, if your financial plan is designed to work if you and invest for 15 years, what happens if you are not around to work and save? A simple term life insurance policy pays a cash benefit to your heirs, and can be purchased so that the amount fills the gap of lost earnings and savings. In the case of a very large estate, it may be beneficial to have insurance proceeds available at the time of your death to help cover the estate tax bill. In either scenario, we can help you to both quantify the risk and understand the cost.
Property Casualty Insurance protects against a loss or damage to your assets (or other liability) having a large negative impact on your net worth. In exchange for offsetting a very large or even catastrophic risk, you pay smaller monthly or annual premiums. Due in part to the endless advertising from GEICO, Progressive, and other companies the whole goal of insurance coverage may seem to be to pay as little as possible in monthly premiums. But as the saying goes, you often get what you pay for. Low cost insurance may be saving you a few hundred dollars in premiums, but it exposes you to hundreds of thousands, or even millions of dollars of risk due to inadequate coverage. A few hundred, or even a few thousand, dollars will not be missed, but the impact of a multi-million dollar event would.