The Price of Your Seat on the Planet

How much insurance does a middle-aged couple need to buy?
The Price of Your Seat on the Planet

Some societies have a strong social consensus that everyone will take care of each other. The United States is not one of these societies. No, we are all rugged individualists, each out on the frontier with his six-shooter and axe, hewing an independent living from the wilderness. Or something. Problems? The free market solves all problems!

While I am a big enthusiast of the free market, some problems – like needing extended care in a skilled nursing facility – are not easily solvable with a six-shooter and an axe. For these problems we need to purchase insurance. The key question is: how many different kinds of insurance does it take to patch together a reasonable semblance of the missing social consensus and how much will these different insurance policies cost?

First a Word About What Insurance is and Is Not

The original concept of insurance was brilliant: identify a problem with low probability of occurrence, but with devastating impact to an individual, pool resources over a large number of individuals and cut the financial impact of the problem down to a manageable size for any one individual.

Unfortunately, over time the American public has lost site of the original concept and in many cases come to think of insurance as something that is “free” and “pays for everything”.  For example, I would love to have “Martini Insurance” just in case I happen to feel the urgent need for a martini on any given Saturday evening. Unfortunately, this sort of product would be financially ridiculous. Putting an insurance company between me and my Martini would only add lots of paperwork and drive up the cost of the Martini.

Curiously, we also have financial products that actually are insurance being marketed as something other than insurance. The best example of such a product are the so-called “extended service agreements” that major electronics retailers offer for product such as televisions, vacuum cleaners and stereos. These retailers have absolutely no intention of “servicing” your product. If you show up with a broken television, it goes directly into the trash bin and they provide you with a new television. This sort of service agreement is actually simply a product failure insurance policy based on a straight actuarial risk calculation.

Insuring the Middle of the Risk Probability Curve

Reasonable risk reduction for a reasonable price.
The Personal Insurance Sweet Spot

With this clarification of the purpose in mind, we set out to identify useful insurance policies that protect against devastating financial impact for relatively unlikely occurrences. However, we also need to recognize that we don’t want to spend either the time or the money chasing the most obscure risks to the far corners of the planet.

Examining the diagram to the right, we don’t want to try to use insurance to cover risks on the left side of the chart that are almost certain to occur. For these cases, we will either want to simply pay the costs as they come up or perhaps look for some sort of bulk purchase agreement or discount payment plan.

Likewise, we don’t want to try too hard to cover risks on the right hand of the chart that are extremely unlikely to occur. Generally we can identify such risks by noting which risks the insurance companies refuse to cover with normal consumer insurance policies. I think that the reasons that insurance companies avoid covering these risks (acts of war for example) are many:

  1. It is very hard for them to make a reasonable actuarial estimate of what the actual risk is.
  2. The number of clients who would pay for the coverage is small.
  3. If the event happens (war for example) both the clients and the insurance company would have so many bigger problems that the insurance policy would become irrelevant or meaningless.

Note that these “mega risks” represent a definite hole in the “free market solves all problems” theory. One one of these huge problems occurs (The present Japan earthquake,  tsunami, and nuclear disaster is a good example) there is simply no choice but for the rest of society to pitch in and try to help the people affected

The Different Flavors of Insurance Required

Part of the “stepping off the cliff” problem is that several of the risks that we need to consider (disability for example) are typically covered by the large employer and the employee may not even be aware of the coverage.

As you step off the cliff, you really need to take a fresh look at the entire problem. I have just completed such a fresh-look audit. Here is a list of the types of insurance that seem to be needed and my recent experience with either confirming the coverage or buying new coverage.

1 – Medical
Medical insurance is the biggest problem. Health care is the one risk for which it is not unusual for individual impact to quickly reach into the hundreds of thousands of dollars. Even though I am personally very interested in the subject, I am not going to attempt here to discuss the current U.S. healthcare mess in general. I am likewise not going to delve into the merits and weaknesses of Democratic and Republican party thinking on the matter. For those who are interested in a fascinating comparison of how all the major countries in the world are grappling with this problem, I recommend the highly engaging and readable book  The Healing of America by T.R. Reid.

Following the philosophy outlined above, I went looking for a “High Deductible HSA Policy”. The policy we selected assumes that we cover the first $11,900 of family medical expenses. After that, the policy pretty much covers everything else. (There is a higher deductible if you use out-of-network physicians or facilities). The policy is compatible with the use of a Health Savings Account but does not require you to use one. The monthly cost for a middle-aged couple in good, but not perfect health is just under $400 – not too bad.

I also confirmed that our existing family doctor (who we absolutely love!)  is a registered provider for this plan. In fact, when I was comparing plans, I figured out that he is a registered provider for every plan known to man, which simply reflects his strong commitment to family medicine and providing excellent service and value to real world patients.

2 – Dental
Dental Insurance is one of the misnomers mentioned above. Really, such policies are a dental services payment plan with a group discount. In fact, the plan we selected is formally called “Dental HMO Payment Plan”. We considered not purchasing anything at all, but observed that the list price of the dental services we had been receiving has averaged $1,000-$2,000 per year for the last several years.  The DMHO price was $29 per month for two of us and should at least put a significant dent in this amount.

3 – Long Term Care
What if you end up in a nursing home? Opps! Did we forget to mention that health insurance doesn’t cover nursing care? Nursing home care is quite expensive. One web site I visited while doing this research quoted an average figure of $78,000 per year.

Actually, we have been paying for Long Term Care Insurance since 1990. I went back and looked at my records and massaged the numbers a bit to correct inflation out of the numbers. The figure below shows what you can expect to pay in constant dollars for the coverage shown.

Inflation Adjusted Monthly Price of Long Term Care Insurance

Interestingly, coverage for women is more expensive than coverage for men. It starts out 35-40% more expensive and the price climbs more rapidly with age. My guess is that this price difference reflects an actuarial reality wherein men either never make it to the nursing home in the first place or die more rapidly once they get there. Women are survivors; it seems they can last indefinitely in a nursing home.

I should also mention that long term care is one of the areas in which the industry excludes part of the statistical right hand long tail. Coverage is limited to five years. My wife and I discussed this limit and decided that the risk of living in a nursing home for more than five years was small enough that we would live with it.

4 – Disability
What if you are rendered completely unable to work? One family in our circle of close friends suffered the tragedy of the father being afflicted with Huntington’s Disease a genetic neural disorder. A highly skilled semiconductor design engineer, he was rendered completely incapable of working in his mid 40s.  It can happen to anyone. While medical and long term care insurance may take care of the medical costs, who is going to replace the lost income for the rest of the family?  Disability Insurance covers this sort of risk.

Purchasing such insurance is not cheap. For me, the price seems to be about $2600 per year.

5 – Catastrophic Disability
One might think that purchasing Disability Insurance would cover the problem. Unfortunately, there is some additional complexity to disability insurance. It appears that the maximum coverage limits are tied to government limits for Worker’s Compensation plans. The maximum available benefit is $6500 per month.  This number probably has not been updated in 30-40 years or more.

Unfortunately, $6500 per month is no longer the enormous number it was 40 years ago. Your existing household expenses may be greater than this number. Furthermore, if you are disabled, you may incur new expenses for things such as professional lawn mowing or other services that you are no longer physically able to handle.

Catastrophic Disability insurance covers the gap between Worker’s Compensation or Regular Disability insurance and reality. Fortunately, the extra coverage is quite inexpensive. In my case, the additional coverage only costs around $160 per year.

6 – Life
What if I die? Who is going to take care of my spouse?

Many major employers provide life insurance as a fringe benefit. When you are young and have children, the general recommendation is to purchase additional term life insurance so that the combination of the extra insurance and your employer’s plan is enough to take care of your children’s education through college and your spouse’s living expenses forever.

When you are young, it also may make some sense to carry some additional life insurance for a full-time homemaker spouse. If that spouse dies and leaves you with three small children, not only are you going to be emotionally devastated, you are also going to have some significant financial impacts as you scramble to replace that spouse with purchased services such as day care, house cleaning, counseling, concierge services and so on.

Life Insurance companies tend to want to sell fancy policies that offer complex savings benefits. These are not recommended by most financial analysts. You are better off investing in a low-fee mutual fund for savings and buying only the risk insurance from the insurance company. This sort of “risk only” policy is known as term insurance.

In our case, we had several term insurance policies in addition to the life insurance provided by my former employer.  We also carried some insurance on my wife Tomoko. For this review, we sat down and discussed the contingency plans. Our children are all grown and pretty much set in terms of education. We discussed and decided as follows:

  • If I die, Tomoko will wrap up affairs, sell the house, and return to Japan. She is still a Japanese citizen and Japan is one of those countries that has a strong take-care-of-each-other social consensus. We decided to retain the cheapest ($810k) policy on my life and cancel the others.
  • If Tomoko dies, I will be emotionally crushed, but the financial impact will no longer be significant. We agreed to cancel the term insurance on her life.

That remaining term insurance costs $1,150 per year.

7 – Auto Regular
We have two cars that we purchased new in the Summer of 2001 when we returned from our last assignment in Japan. We have a fairly high deductible ($500) with high liability limits which in turn connect to an umbrella liability policy (See item 12 below) to provide even more coverage. The cost of covering these two cars for Tomoko and me is $1,665 per year.

8 – Auto Uninsured Motorist
This insurance is actually rolled into the auto insurance mentioned in item 7 above. However, I have broken it out for the moment because the philosophical implications are interesting. As mentioned at the beginning of this post, we have little or no social consensus that we will take care of each other when bad things happen. That is why we have to purchase so many different kinds of insurance. Interestingly, however, the government requires us to purchase insurance to cover the risk that some other moron causes an accident and also is breaking the law by not carrying his own insurance. This insurance is not optional and it costs us an additional $302 per year.

9 – Home Owner’s
The Texas basic form HOA home owner’s insurance is very good. The policy is written in clear, easy to understand language and there are very few things that it doesn’t cover in terms of potential damage to your house. We pay $959 per year for home owner’s insurance.

10 – Flood
Flood damage is one of the few risks excluded from the basic home owner’s insurance policy. We pay $284 per year for flood insurance.

11 – Earthquake
Earthquakes are not covered by the Texas home owner’s insurance policy and apparently the state of Texas does not allow anyone to sell earthquake insurance in Texas. The legislators in Austin sat around the campfire one night playing harmonicas and roasting marshmallows. One of them stuck a toothpick in his teeth and asked if any of the others could remember an earthquake happening in Texas and none of them could rightly remember any such thing. The issue was settled; they decided that earthquakes did not exist and forbid anyone from selling insurance policies to cover them.

All of which is fascinating, because the tour guide at Inner Space Caverns in Georgetown just North of Austin spends considerable time showing the earthquake fault in the strata in the rock and discussing the effects of the last one to hit the area.

Oh well, I guess we just have to trust the cowpokes, I mean “legislators” in Austin and hope that earthquakes in Texas really are legitimately are part of that right hand tail of very low risk events mentioned above.

Needless to say, if you live anywhere on the West Coast of the U.S. or in Japan, earthquake insurance needs to be a key item in your insurance portfolio.

12 – Umbrella Liability
The umbrella liability policy rides on top of your home owner’s and auto insurance policies and extends their coverage limits to several million dollars. The umbrella policy also covers problems like a neighborhood child wandering onto your property unsupervised and hurting themselves.

Some other societies would probably consider that the fault was with the parents who did not supervise their child. In the U.S., however, the property owner can be held responsible and the umbrella insurance policy protects you from such claims.

Summary of the Costs

Putting it all together, the picture looks like this:

How much does a middle-aged couple need to spend?
Overview of Personal Insurance Costs

We need to spend just under $14,000 per year to cobble together a semblance of a replacement for the missing societal consensus to take care of each other.

As mentioned above, we are also covering a portion of the risk ourselves. Adding up the deductibles gives something that mathematicians would describe as a measure of the magnitude of the problem. However, the specific number $17,850 shown about does not imply much more than this measure of the scale of the problem. The health insurance is a maximum per year. The other deductibles, however, tend to be a maximum per event. It is possible to have multiple events in a single year.

The other thing I have calculated is how much income you need to bring in as a self-employed entrepreneur to have enough cash available after taxes to cover the $14,000 of insurance. As an entrepreneur you have to pay a 15.3% self-employment tax. (There is a slight discount for 2011 only which I have ignored since it is temporary).  Insurance is also not the only thing you need to provide for. Therefore, I have assumed that overall you are in at least the 25% marginal federal tax bracket. From these assumptions we can calculate that you need to produce about $23,500 of income just to cover the price of your seat on the planet.

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2 thoughts on “The Price of Your Seat on the Planet

  1. (Transferring a comment and reply from Facebook – 5/10/2011)

    From a Japanese Friend – “I think losing health insurance is the biggest drawback to start own business. I don’t know how much typical coverage health insurance costs these days in the US. $500/month?”

    David Hetherington – The question about “typical” health insurance is hard to answer because policies and individual circumstances vary wildly. Our policy is a “high deductible” type which means we cover all routine and minor illness/injury expenses ourselves up to $11,900 per year after which the insurance takes over. The insurance cost around $400/month and I expect that our routine healthcare expenses will normally be something like $2000 per year which puts us in the range of $7000 per year. This number also matches the amount that local employers (Williamson County Government was quoted recently) spend on average per employee for healthcare.

  2. Following up on the risk of earthquakes in Texas. The Open Hazards Group maintains a tool that will estimate the probability of an earthquake greater than magnitude 5 by address. (See http://www.openhazards.com) The tool estimates that the probability of such an earthquake occurring in the Austin area in the next year is 0.062%. That works out to one major earthquake every 1,613 years. That is a low probability, but it is not a zero probability. Furthermore, it is certainly not something like one earthquake per billion years. Texas issues flood plain risk maps and our house is a few meters outside the 500 year flood likelihood line. We are required to carry flood insurance. Once per 500 years and once per 1600 years are really not very different from a statistical risk perspective…

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