Great Savings #47 – Insure Against Catastrophic Loss

 

Don't leave yourself at risk. Protect your hard-earned cash.

A catastrophic loss can end up costing a bundle.

Where our personal wealth is concerned, we eventually accumulate enough of it that the mere possibility of a “catastrophic loss” is unacceptable. And while any loss can be bad, a catastrophic loss is a large loss, one that creates a significant strain or hardship on our financial situation. As everyone is different and has a unique situation it’s hard to put an exact dollar figure on such a loss. Yet no matter where you stand, a catastrophic loss means you end up taking a huge hit to your finances—one difficult if not impossible to recover from.

 

What exactly does a catastrophic loss look like? There’s no one formula. It could look different to everyone. Here are just a few examples:

 

The neighbor's house burned down. I wonder why?

Your loss may not look as dramatic as your neighbor’s, but that doesn’t mean it won’t wipe you out.

♦ You’re uninsured. You suffer sudden chest pain and rush to the hospital. They explain your only option is a heart transplant. Out of pocket cost: $200,000.

 

♦ You own a small business, which is not incorporated. A customer was recently injured by a product you manufacture. You’re hit with a product liability lawsuit and end up with a huge judgment that exceeds the limit of your product liability insurance: Out of pocket cost: $2,200,000.

 

♦ Though you have homeowner’s insurance you discover it’s inadequate to rebuild your home after an electric fire unexpectedly burns it to the ground. Out of pocket cost: $150,000.

 

♦ You’ve been out of work for months, but thankfully your wife is employed. A policeman rings your doorbell. Your wife was just hit and killed by an uninsured drunk driver. Out of pocket cost: $15,000 in funeral expenses and the loss of her income (i.e $75,000 per year).

 

Great Savings Tip #47 - Insure Against Catastrophic Loss♦ Your husband is underemployed and uninsured, but he’s handy with tools. You jointly decide it’s time to downsize and sell the house. He agrees to make a few repairs to get the house in shape for a sale. You suddenly hear screaming from the garage. He cut off his leg with a power saw. Out of pocket cost for medical bills: $35,000. For his new prosthetic leg: $12,000. For ongoing physical therapy: $9000.

 

JB's fallen off the ladder. Better call 9-1-1.

Looks like JB’s in trouble. I hope he’s insured for disability.

♦ You’ve been saving for retirement. A well-off friend suggests investing as much as you can in the company he works for, which is about to go public. It’s been raking in money. You invest half of your retirement savings and buy shares. The stock starts well, but a sudden overseas crisis means the parts supply pipeline is completely cut off. The stock takes a nosedive, losing 50% of its value overnight. You decide to bail. Your out of pocket cost: $75,000.

 

With just a few examples, it’s easy to see why a catastrophic loss looks different to different people. We all start in different places. We have different incomes. We own different types of assets. We’ve taken different steps to prepare for potential loss. And life’s little surprises hit under a variety of circumstances in seemingly random fashion.

 

 

For some, trying to protect against financial losses may seem irrelevant: It’s not hard to imagine a homeless man who owns nothing other than a few simple possessions and the clothes on his back. To such a man, a hurricane may destroy his cardboard shelter, but it’s easily replaceable. In fact, the debris from the hurricane may provide him with an abundance of “treasure” to build an even better home.

 

Or imagine a woman diagnosed with pancreatic cancer and given only a few months to live. Why should she spend any time worrying about a big potential loss to her wealth? True, she may have family members who’ll be affected should they stand to inherit, but the reality is she won’t be around to deal with the fallout.

 

There are also those who prefer to gamble on life. Gamblers assume incredible risks hoping to beat the odds and win their wealth. Yet, gambling isn’t investing as there’s little or no concern for the long-term consequences of a gambler’s actions. For more on the difference between gambling and investing read our post, “Are Speculators Gamblers?

 

A tree landed on the house. What do we do now?

A sudden gust and that old tree fell down. The house took a hit. It destroyed the lower and upper roof and damaged a bedroom. Thank goodness no one was hurt.

 

While some people may seem indifferent to or unaffected by catastrophic loss, for most of us wealth is something we’ve fought long and hard for so it’s worth doling out time and money to protect it—at least to a point. Thankfully, we have many options for minimizing it and that means we can limit the hit to our wallets. How? We might:

 

♦ Buy insurance or increase our insurance limits.

♦ Spend time better diversifying our assets (for more on this topic see our last savings tip).

♦ Incorporate a small business we own to separate it from our personal estate.

♦ Try to improve our health, perhaps by adjusting diet or getting more exercise.

♦ Avoid certain activities like smoking, parachuting, race driving, taking drugs, etc.

♦ Improve or fix assets in need of repair.

♦ Sell assets that we learn are too risky to own.

 

A simple chart displaying the relationship of wealth and the need to protect it.

This simple chart shows the relationship between the wealth we own and our need to protect it. As our possessions accumulate and income grows, so does our need to insure against potential loss.

 

Unfortunately, we can’t prepare for or protect against every possible outcome. And sometimes the cost of financial protection exceeds any potential benefit it might provide—for example, excessively high insurance premiums may put the protection they provide beyond our reach. In such a case, our only option might be to skip the insurance and take on more risk, or limit the risk by selling the asset or declining to participate in the activity that creates it in the first place.

 

JB takes a beating in the stock market.

Poor JB, recently bought 1000 shares of X-Mart. He should have diversified.

Since catastrophic losses are something we’d all prefer to avoid, how do we know when we’ve done enough to protect ourselves? The answer doesn’t come easy. People are different and have different tolerances for risk. Thus, a plan to mitigate potential loss is going to vary substantially from person to person. Still, everyone can and should (a) inventory their assets and income so they know what they have to protect, (b) take the time to know the types of risks unique to their particular situation, (c) make plans to lower risks appropriately, (d) get expert advice where needed, and (e) sell items or limit activities they ultimately decide carry too much risk.

 

No matter how much wealth you have (or how you define it), it’s worth remembering what you had to do to accumulate it. Many spend countless years toiling away at a job. Others purposefully hold back on certain types of buying. Some save and invest carefully over the years. A lucky few invent some new product or discover they possess a unique talent and become sports stars, actors, or entertainers. Most do a variety of things and rely on their skill, smarts and a bit of luck to scrape together their wealth over a lifetime. The point is this: However you acquired it, don’t take wealth lightly for a big loss can come without reason or warning.

 

As you go to save and build a brighter future, planning to minimize the risk of catastrophic loss should be a key part of your process. It’s a step as basic and vital as an ongoing savings plan. Without it, any significant loss has the potential to wreck havoc on your life, and that means it can severely limit or restrict opportunities you might otherwise enjoy.

 

Action Item: Are you adequately protected against a large financial loss? When was the last time you reviewed your coverage with your insurance agent? Do you carry the right kinds of liability insurance? Do you have sufficient medical coverage? Are your invested assets sufficiently diversified? Have you separated personal and business assets? Is your home or property in good repair? Are you doing what you can to watch your health?

 

Make the time and set up an appointment to talk with an insurance agent, a lawyer, a financial planner, a contractor, a personal trainer, or otherwise. If you don’t have one, get one. This isn’t simply a matter of buying more insurance coverage, fixing a broken sidewalk, buying bonds instead of stocks, or of spending money on protection you don’t need. It’s about making prudent, conscious decisions to protect the assets you’ve spent your lifetime accumulating. Don’t rely on luck alone for something so critically important.

 

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