The Truth About Investing: Back to Basics
The Truth About Investing: Back to Basics
Life Insurance: What Is It? How Does It Work?
Use Left/Right to seek, Home/End to jump to start or end. Hold shift to jump forward or backward.
Season 5?? How are we even to this many? Tying up to a nice round number of episode 30... we think... is to talk about Life Insurance. We know that this was a daunting concept. Correction, Sean knew this was a daunting concept and we decided to break it down into small and digestible chunks. Join us on life insurance, learning more about they types and if it's right for you!
Welcome back!
This is the truth about investing back to basics podcast where we want to help you take control of your personal finance and long term investments. If you're looking for a way to learn the why and how of investing, then you found the right place. Thank you for taking the time to learn how to better yourselves. Welcome, welcome back, everybody, ladies and gentlemen, to another episode of The Truth about investing back to basics. My name is Chris Holling.
Sean Cooper:And I'm Sean Cooper.
Chris Holling:And we are starting off, it's, I think we've turned this into season five, I think that's what this is. Because we are going to do this block, which we're going to touch on. It's like an insurance block. Specifically talking about life insurance and how the conversation just went was, Hey, we should do this episode. And Sean's saying, Oh, no, no, it's gonna be two episodes. Wait, it's gonna be three ep no. It's gonna, it's gonna be 200 episodes of life insurance. And I said, Sean, that's, that's too much. It's too many episodes. Okay, I can, I can knock it down to like, two two eight hour sessions or for like, five. Anyways, we're going to do a block here, where it is going to be focusing on life insurance. And the honest thing I did tell Sean was, Sean, we're gonna have to make it smaller doses for this topic, so that I can actually digest it and remember it rather than zone out like I did in some classes I've taken before. So
Sean Cooper:You mean season four.
Chris Holling:I only zoned out like twoish three times how many episodes were there? Six, I probably zoned out five times.
Sean Cooper:Ouch.
Chris Holling:Because No, I'm kidding. It was
Sean Cooper:I know, I know.
Chris Holling:But this way we can we can get out and we can touch on some of these things. And then have it not be overwhelming for really for me, but for everybody. And then we've just we just decided to put it all together to keep it cohesive. And so I believe this is this season five, which maybe you already know that if you just downloaded season five, I just haven't decided yet. We haven't gotten that far yet. So welcome back to I think series season series season five. Yes. And
Sean Cooper:series season 5.
Chris Holling:And Sean, we are talking about life insurance. And I know that I know that there's like term life insurance and whole life insurance. And that's about the extent of my knowledge goes. Are we are we touching on one of those today? Or is it like a foundational thing that we go over today? What are we talking about? I don't even know,
Sean Cooper:I'm thinking we go more foundation. I know we've talked about I mean, season one obviously was all about insurance as well. But it was specifically about health insurance. And I don't know that we ever covered insurance as a general concept, we kind of started just delving into some of the the terms you need to understand for health insurance specifically. So
Chris Holling:okay.
Sean Cooper:And some of those terms will apply to life insurance as well. But yeah, I was kind of thinking maybe we just cover the very the concept of insurance as a whole.
Chris Holling:Okay, well, insurance is a thing you pay money into. And then if something bad happens it, it pays money out to you. And you should find the right cost to benefit. Thank you and good night. Right. Is that how we?
Sean Cooper:That was pretty good.
Chris Holling:All right.
Sean Cooper:Yeah.
Chris Holling:I mean, that's that's the base understanding. I know about I know, we've talked about health insurance, and we've referenced car insurance we've we've talked about, I don't know, we've we've talked about a lot of different ones, but as far as I understand, life insurance is when they should call it death insurance, I think but like life insurance.
Sean Cooper:Technically yes
Chris Holling:When you when you die, right.
Sean Cooper:Yeah.
Chris Holling:Okay, so, now that we're talking about
Sean Cooper:I don't, I think they'd sell as much if they call it death insurance.
Chris Holling:Yeah, well
Sean Cooper:maybe they should switch.
Chris Holling:I think maybe they should. So, uh, so to collect on your death insurance. You have to die. And it actually goes to your benefactors. And yep, now you're caught up on my knowledge. So
Sean Cooper:that was good. I liked it.
Chris Holling:Okay, yeah. Cool. Now tell me more about death insurance then.
Sean Cooper:I mean, basically, the whole concept of insurance is convenience and affordability. You're you're paying out a small, either monthly or annual premium in exchange for them covering a large financial loss most likely Okay, so insurance, that loss would be the loss of a family member, typically, potentially some other relatives or very close friend, but you're offsetting some financial risk typically, like they're in that case, their income. So there are a number of different ways to cover or to address risk, obviously, you know, one option is you just accept the risk for what it is and you go along with your life. Another is to avoid a risk altogether. You don't want to get in a car accident, so you don't get in a car ever.
Chris Holling:Yeah, solves that.
Sean Cooper:It does
Chris Holling:take that car.
Sean Cooper:It's a bit of a challenge, but it solves the problem. Yeah, life insurance a little a little more difficult to, you know, avoid the risk associated there, there, you know, you could choose not to take certain risks that might lead to your death. But ultimately, it's impossible to avoid it forever, at least at this point in time. Another would be to reduce the risk or mitigate the risk. So, like,
Chris Holling:partial coverage, is that what you're saying?
Sean Cooper:No, not necessarily partial coverage. But you know, my, if we take like the car, example, as opposed to Okay, well, I'm never going to get in a vehicle again. I'm going to take defensive driving courses, so that I'm better capable of handling different situations or ice driving or, you know, different things to help reduce the chance of me getting in an accident, or I'm going to buy a Hummer that's, you know, if something hits me, you know, a car hits me I'm less likely to be injured in the accident because I'm driving a tank
Chris Holling:you know, I think I need to buy a Hummer. It's good. Good. Insurance. Yeah. Why not?
Sean Cooper:It's yeah, it's risk mitigation or risk reduction. My mom was all in favor of me buying a Humvee when I was buying my first vehicle instead I bought a Toyota MR2 Spyder which is the tiniest thing you can possibly imagine and basically just accepted the fact that if I was ever in an accident, I was dead.
Chris Holling:Oh, yeah. Mine is the total opposite. I got a an old 1980 F 150. A ol'.
Sean Cooper:Nice.
Chris Holling:Not steel. It's not real kind of build.
Sean Cooper:Oh, yeah.
Chris Holling:I I certainly never got any dings or dents placed in that truck. But I placed several myself. I was on the opposite end of that
Sean Cooper:My my MR2s still in good condition. Man. It was built to be the light. But do you still have it, it that what you're saying Yes, I do.
Chris Holling:Oh my God, good for you
Sean Cooper:2001 They stopped producing it in 2004, which was the same year I bought it.
Chris Holling:Wow. Okay,
Sean Cooper:it's only only got 53,000 miles on it. 54 Now, something like that.
Chris Holling:Okay, I have so many more questions about that. But it's, it's not going to touch on on what we're doing here. Okay. All right. Well,
Sean Cooper:okay.
Chris Holling:Yes, or mitigation? Understood.
Sean Cooper:Yes. And then the last option would be risk transfer. So obviously you can't make it so that someone else gets in an accident for you or dies on your behalf but that doesn't work but you can transfer the financial risk associated with it. And that is where insurance comes into play.
Chris Holling:I'm just visualizing like you get in a car wreck this guy shows up he's like no no, I'm here for you. takes the place in the scene. Ah Oh sorry.
Sean Cooper:No as soon as you started to started talking about it I was visualizing it I was already like cracking up because the whole concept is hilarious
Chris Holling:It hurts it hurts no no yeah your your ankle hurts Oh my ankle
Sean Cooper:or even if they're not like directly, you know, your concept is they get somehow get transferred direct to your spot. And I was originally thinking like, as opposed to like, you still go through it. But somehow they are actually the ones that experience the like whatever happens to you say like you break your leg and this random person walking down the street al of a sudden just falls over because they're like, Oh, I took that risk. I shouldn't have done it. But my legs broken now. You were fine a second ago. I know he paid me like
Chris Holling:shut up just just ordered me the white chocolate. White chocolate hot chocolate. I just I just I'll just I'll be over here with my broken leg
Sean Cooper:this is way more more enjoyable than most insurance conversations I got to tell you
Chris Holling:Oh, yeah, I'd say every time that you bring up insurance, you should talk about breaking some random person's leg. I think that's, I think that's good, I'd say.
Sean Cooper:Yes, yes, true risk transfer. But yeah, that is the point of insurance is to be able to transfer the financial risk associated with whatever. In this case, we're talking predominantly about life insurance. In, there's a couple of pictures that I want to paint for you that are not nearly as enjoyable as the ones we've already done so far. thanks to
Chris Holling:Do it Bob Ross, let's see what you got. Chris.
Sean Cooper:To give you an understanding of insurance and essentially how it works. So the first thing I want you to do is picture a place where you walk in, and you pay small amounts of money for the chance of a large payout.
Chris Holling:I mean, looks like 7/11
Sean Cooper:where did you just go?
Chris Holling:711?
Sean Cooper:Where you went to 711?
Chris Holling:Well, I mean, that's where you're gonna get the lotto ticket. I feel like that's okay.
Sean Cooper:lotto. Yes, absolutely. Where else might you go?
Chris Holling:A the lotto ticket store? I don't know. Uh, let's, let's say, let's say Walmart, you could probably probably get a loto ticket Walmart.
Sean Cooper:Okay, so you're, you're stuck on the lotto ticket, which is accurate. My thought was a casino. Same basic premise.
Chris Holling:Oh, okay. Yes,
Sean Cooper:you're literally going into, and you're paying a small amount for the chance of a large payout. In the case of insurance, you're paying a small amount, your monthly premium, to offset the risk of a large payout. Or in the case of life insurance, for a large payoff out to offset someone's passing, both casinos. And insurance companies employ the exact same well educated actuaries to crunch the numbers to make sure that they are profitable. In order for either of them to be profitable. People have to pay more in than the company is paying out?
Chris Holling:Absolutely.
Sean Cooper:After we account for interest and things of that nature.
Chris Holling:Well, and including the expenses of like, staff and stuff too just to run
Sean Cooper:Correct? Yep. Yep. So basically, the, the odds have to be stacked in the insurance or the casinos favor in order for that relationship to hold. If it doesn't hold, then they're not profitable, then they go out of business. And then as an insurance holder, you're stuck relying on reinsurance companies or FDIC insured coverage to you know, cover any potential claim. And that's not a good situation. So you want the insurance company to be profitable. But it's important to understand that in order for them to be profitable, the relationship has to hold that it works in their favor overall.
Chris Holling:No, that totally makes sense. I mean, like, I knew that that's the only way that the, you know, the business would continue to move forward. Do you know of any insurance companies that like, say their their numbers weren't great, and then they're paying out too much? And then they went under? I mean, I've never thought about that
Sean Cooper:yeah. Like, dozens in 2008.
Chris Holling:Okay. Makes sense?
Sean Cooper:Yeah. That was huge for insurance companies, predominantly insurance companies that were not, not specifically life insurance companies that when that wasn't an issue for them that period, but annuity companies, specifically.
Chris Holling:Interesting. Okay. Yeah, that makes sense.
Sean Cooper:Yep. But yeah, and you've actually touched on some of the concepts in the second picture, I was going to paint. So if you were to take, you know, a very basic level, so strip everything away, and you just got, like, you and 10 friends that are all roughly the same age, same sex because otherwise your life expectancies change. So for insurance purposes, you stick to the same sex for pooling purposes. Or if you don't do that, then you have to either have a larger pool or their their age, the age of the other sex would have to be slightly offset in order for the pooling to work and the averages to work, but that we're getting into the weeds there. Anyway, so assume a group of you and a few friends get together and you decide, okay, we're going to pool our money for insurance for insurance on each other. Okay, so you all agree We're going to dump in this much per month, you've done the math, and each of us is going to get, or our beneficiaries are each going to get this amount for as a death benefit, you know, call it a million dollars. So you back into the math to figure out how much you each need to invest and, you're going to pool your funds. Right?
Chris Holling:Right.
Sean Cooper:Okay, so in that scenario, so if you take a group of guys, that life expectancy of 79, roughly half of the the people in that group are going to die prior to age 79. And roughly half are going to die after age 79. That's why 79 is an average.
Chris Holling:Okay.
Sean Cooper:Okay, that means the half that dies before, they've, you know, I guess they've gotten the short end of the stick in terms of life expectancy there. However, their beneficiaries got the benefit, because they're actually getting more out of the policy than what they've paid in. On the flip side, the people who die after age 79 put more into the policy than what they're getting out. But they live longer. So they, you know,
Chris Holling:and I'm sorry, starting starting at what age when you start putting into it? Or does that
Sean Cooper:it doesn't matter what what age you start at is irrelevant. It's only relevant to how much you have to put in
Chris Holling:Gotcha, okay, got it.
Sean Cooper:What's relevant is the life expectancy. And we're dealing with the averages here. So what we're saying is, so if 10 guys get together and pool their funds, and roughly half of them will die prior to their life expectancy, which is 79. In this case, I was dealing with a group of guys who are 45, life expectancy of 79,
Chris Holling:okay,
Sean Cooper:at the time. And roughly half will die after age 79, the half the die, prior to age 79, will get more out of the policy, their beneficiaries will get more out of the policy than what they put in. And the half that dies after will get less out of the policy than what they put in. Now, we're not factoring in interest in this scenario. But if if they were to invest the funds, whether they went with the policy or without the policy, the result is still the same. The point is, roughly half of them come out ahead, based on the insurance and rough of them come out, roughly half of them come out behind based on the insurance. So what we have here are basically 50/50 odds, perfectly balanced odds. That's our base case scenario.
Chris Holling:Sure, that makes sense.
Sean Cooper:And that applies to any of these insurances. Now, in this case, we're dealing with this would be whole life insurance, as opposed to term but we'll talk about that later. But 50/50 odds. Now the issue with a very small group like this, like 10 people, is someone could, you know, randomly get into an accident, they die in the next year or two, and there's not going to be sufficient funds in the pool to actually pay the the beneficiaries the insurance that was agreed upon. So that's the issue with the small groups, the averages can get thrown way out of whack by one, one event. And that's why insurance companies deal with the law of averages as it relates to large numbers. So where the averages actually average out, then they actually have enough people paying in to cover those one offs where somebody dies very, very early, relative to the life expectancy.
Chris Holling:Right. Right.
Sean Cooper:But as you were talking about the second you put in that insurance company, you institute that, that corporation that is acting as a middleman to pool all the funds, there are costs associated with that. You have to pay the executives, you So your your best case scenario is less than 50%. have to pay the sales, you have to pay the actuaries that are crunching all the numbers, you have to pay the service department, you have to pay for the buildings, you have to pay for the people cleaning the buildings, you have to pay for, you know, the you have to show some kind of profits for the owners, otherwise, they're not going to invest and there would be no company. All of these costs add up. So if our base case scenario was 50/50, then b definition, if we add costs t it, then your odds of coming ou ahead, go down. In that scenario. Now, I don't bring this up to say that you should never buy insurance.
Chris Holling:Sure.
Sean Cooper:The point is that insurance is you're not buying insurance to try to come out ahead. That is not the purpose of insurance, insurance is to off set or transfer risk. So people that view insurance as an investment that's very shaky ground in my opinion.
Chris Holling:And that makes sense. And I I don't know if this is going to get too far. off the topic of what you're talking about when but in my head when you're talking about insurance and like the the time to decide insurance and I know I always revert back to, to auto insurance just I think just because it seems most relatable to me, but when when I think about car insurance, I think about the fact that you are not getting car insurance. Okay, let me reword that. You are getting car insurance for the possibility of needing to replace your car, period. And the fact is that they, as a company would need to replace the car if it's totaled. And that's that's the purpose of car insurance. And there are some half steps in between and some things that might get covered and might not and premiums and whatever. But because I understand it, that way that I'm I am looking to have coverage to have my car replaced, then that's when I can objectively look at whether or not I want insurance or what level I'm comfortable with having. And the reason I think of that, I think I addressed this when we were talking about deductibles in the first season. So if, if this is familiar, then just just saddle up along with me here. But when when I'm talking about deductibles and talking about the ability to go, Okay, well, now I have, I have this amount of funds that can go towards, in this example replacing my car, and then they cover the rest whatever you're comfortable with past that point, and then you start to go okay, I can actually put this much so you start to increase your deductible or increase the amount that you're looking at, I can handle this much towards replacing my car. Once you get to the point of where you have enough funds that are set aside or dedicated or you know where you would pull them from? to buy yourself a new car if your car became totaled? That's when you can decide with yourself okay? Am I comfortable with self insuring and having something like a liability only at that point, maybe you have a$3,000 car that if you wreck it, you already had $8,000 set aside to buy a new car that would be better than this one anyway, you just don't see any reason to get rid of it. Because it's still running type thing. Like that's a good example to me of thinking about, should I go the extra mile? Do I really want this full coverage for this car that might not be worth a lot, or for that matter that I'm just gonna wind up replacing with this amount that I have prepared for it anyway. And that's the type of stuff that I look at. I guess I don't know if that was relatable. Now I'm wondering if I've completely fell off the trail with all
Sean Cooper:No, that's good. No, honestly, what you were talking about with self insurance. That is a great example of an alternative to instead of risk transfer with insurance. So self insuring you are basically accepting the risk originally setting aside funds to mitigate the risk. So in the early phases, because yo're setting it aside yourself in the early phases of that proc ss, you're not going to ave sufficient funds to fully pay for in your example the ar, you're not going to have en ugh funds for it early, early on. But over time, you will th t's the point of it. And so yo're mitigating that risk over ime in initially, I would cons der it risk acceptance, because you're basically just accept ng the risk, and in hopes that ou can defer enough funds to c ver it as time g
Chris Holling:Sure. Yeah, that that's exactly what I'm saying. Just better words. Good job, Sean.
Sean Cooper:But that's absolutely an example. And that's part of why I bring this up, because you do have options associated with these risks, whether it's accepting it, mitigating it, or reducing it, or transferring it.
Chris Holling:Right.
Sean Cooper:avoidance, again, is it can be an option sometimes,
Chris Holling:right? It's, it's, I guess, just objectively and why I wanted to mention that it doesn't make sense to me to spend. These numbers aren't right or anything, but like, it doesn't make sense to me to spend 350 bucks a month to cover a car that's worth $1,500. Like,
Sean Cooper:right
Chris Holling:that I at the very least like unless I'm expecting to go careening off a road with it in the next week or so. Maybe but like,
Sean Cooper:I mean, with the car insurance, most states technically require you to unless you post a bond to offset it. But, yeah
Chris Holling:sure, I'm not saying no insurance. I'm saying that like, it doesn't make sense. Sorry. Maybe I should reword that. It doesn't make sense to me to have 350 a month for full coverage on a car that's only worth $1,500 Because even at that point, you know if I'm waiting Say it's four months from now. And then I wreck it. Well, then I'm even if there is no deductible, then at best I have paid what the insurance company is going to pay to me because of the value of the car itself. At best. Okay, good. I'm glad. See, isn't this isn't this great when we just we just see easily eye to eye on things and I and I understand what we're talking about. It's it's great. It's cohesive
Sean Cooper:We're in your territory now.
Chris Holling:Yeah, you know, I'm back up against the like, I got it. Got it. I mean, nice one two jab in there.
Sean Cooper:Yep, yep.
Chris Holling:Okay. Is this
Sean Cooper:The biggest the biggest challenge I see with these decisions, though, overall. So do I take the risk? Do I accept the risk? Do I mitigate the risk do I transfer the risk is the emotional response associated with these risks, which tends to be fear fearing fear of leaving your family with piles of debt, limited income, potential fear of causing an accident and having to pay hundreds of 1000s of dollars in medical bills and repairs, a fear of your house burning down all sorts of different things that come, you know, conjure images in your mind, that tend to push people towards risk transfer over any other option. So statistics, strictly statistically speaking, your best bet is the self insurance. However, that's not necessarily the the most prudent option for many people depending on their situation. But my point is, you have to try to consciously control your emotional decision making and make a logical decision on each insurance, whatever it is, for your situation.
Chris Holling:Right. And it's, it's also not unreasonable at all to to understand what that is, and move towards that that's at least for for one of my cars, they're not both this way, but one of my cars is self insured, which is what makes me think of this as a relatable example. And it's just because it's not worth a lot nowadays. And so I don't, I don't put a bunch of money into it. And I'm, I'm ready to accept if I do something stupid, and I completely wrecked my car. But I wasn't ready for that. Immediately, I knew I wanted to get to that point. And I had to start setting aside funding, start setting aside what I was comfortable with, to get to that state. So even if this is something that you go, I would like to get to that stage, going through stages of insurance to get there is also totally reasonable. These are just, it's just informational to be able to, to see what's in front of you and how to get there, I guess to me.
Sean Cooper:Exactly, exactly. And as we go through this, you know, some of the next topics we'll be talking about will will actually cover, you know, the different types of life insurance, term insurance, versus Whole Life Insurance, as well as annuities. And we'll talk about some of the places where we feel they make sense where you might want to consider them as well as some of the pitfalls and things to watch out for. So that you have, you know, both perspectives. And hopefully just, again, more tools for the toolbox and or the tool belt. I don't remember which one you use. One of the two
Chris Holling:it is. It's tools for the toolbox. No, I was I was picturing poor little Johnny finding the pitfalls is what I was picturing. Like you get oh, that's Johnny, John eh I'm on it. Squish. That was Johnny.
Sean Cooper:Okay. Poor Johnny.
Chris Holling:Okay. Well. Seems like a pretty good intro to me. How do you how do you how do you feel?
Sean Cooper:Yeah, I feel good.
Chris Holling:Good. Okay. Well, thank you, everybody, for joining us. In this in this next insurance block Season Five Question mark. approach that we're doing insurance here and trying to break it down digestably. For me, it's really all for me, and that's that's fine. But thank you again for joining us and continuing to want to learn how to better yourself. Here on the truth about investing back to basics. My name is Chris Holling.
Sean Cooper:And I'm Sean Cooper,
Chris Holling:and we will catch you next time. Podcast disclaimer disclaimer. The disclaimer following this disclaimer is the disclaimer that is required for this podcast to be up and running and fully functioning and moving forward. This is going to be the same disclaimer that you will hear in each one of our episodes. We hope You enjoy it just as much as we enjoyed making.
Sean Cooper:All content on this podcast and accompanying transcript is for information purposes only opinions expressed herein by Sean Cooper are solely those of fit financial consulting LLC unless otherwise specifically cited. Chris Holling is not affiliated with fit financial consulting, LLC nor do the views expressed by Chris Holling represent the views of fit financial consulting, LLC. This podcast is intended to be used in its entirety. Any other use beyond its author's intent, distribution or copying of the contents of this podcast is strictly prohibited. Nothing in this podcast is intended as legal accounting or tax advice, and is for informational purposes only. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. This podcast may reference links to websites for the convenience of our users. Our firm has no control over the accuracy or content of these other websites. advisory services are offered through Fit financial consulting LLC an investment advisor f rm registered in the states of Washington and Colora o. The presence of this podcast on the internet shall not be d rectly or indirectly interpret d as a solicitation of inv stment advisory services to per ons of another jurisdiction unless otherwise permitted by s atute, follow up or individ alized responses to consume s in a particular state by our irm in the rendering of perso alized investment adv ce for compensation shall not e made without our first complyi g with jurisdiction requirem nts or pursuant an applicable s ate exemption. For informa ion concerning the statu or disciplinary history of a br ker dealer, investment adviso or their representatives, the consumer should contact t eir state securities administr tor I'm a big dark chocolate fan and white chocolate bars should not exist.
Chris Holling:I need to I need to start making a list on things I need to buy you just on principle and white chocolates
Sean Cooper:It will go in the trash. I won't even try it.
Chris Holling:I need to find no what I need to find is I need to find some kind of chocolate that's got like a white chocolate center to it. So you have to like actively go around it like cookies and cream
Sean Cooper:why wast it why w st it cookies and cream. were f r the most part that's not neces arily talking about white choc
Chris Holling:No, you're true that I mean that's accurate but like that it's like a HERSHEY's Bar cookies and cream and it's got like it's
Sean Cooper:not a fan too sweet for me,
Chris Holling:too sweet.
Sean Cooper:Now I'm 70 to 80% cocoa content.
Chris Holling:Well, I'm just sweet enough for you to tolerate. Okay, let's record some stuff.