Why Over Insuring Is Like Buying Lottery Tickets

by Mike Holman

In a previous post I indicated a simple formula that can be applied to determine how much life insurance you need. I also went through a real life example (moi) and talked about how you should try your best to calculate how much insurance you need (and how long you need it for) and only buy that amount or even a bit less since your financial situation should improve over time which will lessen your insurance needs.

Sometimes people are tempted to buy large amounts of insurance because they want financial freedom if their spouse dies. Or in some cases they really believe they need an excessive amount of life insurance.

In my opinion the best level of life insurance is an amount that ensures that the surviving spouse can maintain their current lifestyle. Typically a million dollar 20 year policy will provide the surviving spouse with a large increase in their standard of living. Now you might be thinking that the monthly premiums are not that much larger for a million dollar policy than say for $750k but those monthly amounts add up. As well, getting a million dollar policy for 20 years will result in a lot more premiums being paid compared to someone who gets insured for $750k for 10 years and $250k for 20 years.

The problem is that they are paying extra money for premiums for extra insurance that will increase their standard of living. The reality is that they are extremely unlikely to collect this money so this extra money is similar to buying lottery tickets where typically someone might take a small amount of money ie $25/month and play the lotto in hopes of an unlikely payoff which will result in an increase in their standard of living.

The best insurance you can have is financial independence which is usually a long time coming for most of us but saving even $25/month on insurance premiums will hasten its arrival.

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{ 7 comments… read them below or add one }

1 Mr. Cheap

I agree completely. With insurance companies, they have large numbers of smart people working on the odds. Protecting yourself against catastrophe is a far better approach to insurance then hoping to improve your life (which certainly isn’t what insurance is for).

2 TheFinancialBlogger

Your certainly don’t want to win this lottery 😉
I guess people would be better off putting this extra premium into a disability insurance as most of them are not enough covered for this type of insurance.

Statistically speaking, you have much better chance to become disabled for a short period of time than dying over the next 20 years.

3 FourPillars

That’s a good point FB – disability insurance is important as well.

Mike

4 telly

Thanks Mike! I’m going to go buy a couple lottery tickets with my insurance savings this month…wish me luck! 🙂

5 FourPillars

Good luck – and feel free to share if you win the big one.

Mike

6 Brip Blap

I’m not sure I agree… I don’t intend for my life insurance policy to replace my lifelong earnings if I die, but it is there so that my wife will be able to pay off the mortgage and have enough to live without working – if necessary – for at least long enough for our son to be a teenager and help support the family. I agree that I’m not trying to set her up to be a lounge-about millionaire.

My “disabled” insurance is my fairly weak disability insurance plus my substantial emergency fund. And even though statistically the chances that I might die are much lower than disability, I am more worried about how my stay-at-home wife could cope with the sudden loss of our entire family income. Car accidents happen – I came within inches of being slammed into at an intersection this weekend.

And I agree that ideally I’d write a book and the royalties would provide financial independence for my family forever, but until then I’ll keep my life insurance.

7 Four Pillars

BB – it doesn’t sound like you have excessive insurance from your comment since your wife won’t be experiencing a large increase in her standard of living.

My point had to do with the fact that some people do want a large increase in their standard of living if their spouse dies which I think is financially misguided. Bottom line though is that financial planning is about determining your own goals and my opinion is not important in that regard.

Mike

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