Insure against risks economically

Step 8 of "10 Financial Planning Steps in the Right Direction"


While value, affordability, risk exposure, and risk tolerance should affect insurance purchase decisions, insurance is often sold and purchased emotionally. Yet, insurance premium payments reduce personal funds that might otherwise be available for additional investments. Many people could spend all their net savings on insurance premiums and have nothing left to invest and to build an investment portfolio. The issue is where to set a rational rather than emotional balance between expected risk and return.

Risk and return tradeoffs between insurance and investments

Insurance affordability inevitably dictates that most people will bear some insurable risks without insurance coverage. Individuals may be more or less comfortable with this situation. Having a good understanding of one’s risk exposure and risk tolerance is a good start.

In general, individuals can significantly lower insurance premiums by focusing solely on buying catastrophic risk coverage and using self-insurance for more minor risks. For insurance you must have, shop around and chose high deductibles to reduce premium payments. Carefully evaluate the scope of coverage to assure that it is good quality catastrophic coverage. Then, invest the premium savings achieved through higher deductibles, rather than spending those savings. Over time, these premium savings and investment returns on them will build up your self-insurance asset pool.

Catastrophic personal events can drain assets and destroy the best of investment plans. Property, liability, life, and disability insurance can be rational purchases, because of risk pooling with other risk adverse people. 

However, these types of insurance are not investments in and of themselves. Instead, they limit the financial impact of potential, but relatively unlikely, negative future events. The question comes down to finding good quality insurance at a competitive price and determining the tradeoff between money spent on premiums versus money retained and invested.

Optimal investment planning focuses on enhancing expected risk-adjusted portfolio performance. An optimal investment plan assumes that the necessary labor-based net income will be earned over time to build up your investment assets. In addition, the plan reasonably assumes that your assets will appreciate over time, albeit with substantial and unpredictable price volatility.

By adopting optimal investment practices, individuals increase the chances of financial success that can be attributed to investment returns. However, other risks are inherent in life planning, and there are no guarantees. Personal financial and investment plans may fall short of goals due to a long list of non-investment risks. These risks include inadequate savings, personal tragedy, and family misfortunes.

Insurance can address some of the other financial risks that people face, which are not directly related to investment risk. Generally, these insurable risks are risks to one’s future income stream or to one’s future expenses. Such insurance is designed to replace lost income or pay higher expenses resulting from risks that do manifest themselves.

Insurance-based annuity income guarantees are not investments

Many investors rationally seek retirement income guarantees through annuities and related insurance products. When they purchase such insurance with their labor income and/or investment assets, they change the complexion of their portfolios. When they shift investment risk bearing to an entity providing a guarantee, they cease to be investors for that portion of their assets. Furthermore, they often must pay a high price to shift asset risk to the guaranteeing organization.

Insurers intend to make a risk-adjusted profit on the asset beyond the guarantees provided. Therefore, on average an individual can expect to receive less total value than he would likely have received had he kept the asset and retained the corresponding risk. However, there is one risk that individuals retain and cannot shift. This risk concerns whether the assets of the guaranteeing entity will be adequate to fulfill its future obligations. The sad, yet still ongoing saga of the 1991 collapse of Executive Life Insurance Company is a reminder of this nontransferable risk.

Shifting risk and return to an insurance company can be rational, since the length of one’s life span is uncertain and tolerances for risk vary from one individual to another. Risk pooling based upon longevity can benefit participants, if the price paid for the guarantee is not excessive. The total price of shifting asset risk in such arrangements is the key issue to individuals – in addition to the future risk of the insurance contract non-fulfillment.

Combined insurance and investment products confuse personal financial planning decisions

In recent years, insurance firms have expanded their products and services from offering only pure insurance to selling hybrid products that combine insurance and investment characteristics. The industry also has garnered certain tax treatments that can make their products more appealing to persons with particular tax situations.

Unfortunately, some of these hybrid insurance/investment products are characterized by inferior returns, high costs, unwanted tax implications, significant insured risk limitations, and other problems. Ultimately, the issue that the potential buyer must sort through is whether the purchase of separate insurance-only and investment-only products will yield better insurance risk reduction and/or superior risk-adjusted investment performance.

About the Author
best personal finance software
Larry Russell
MBA (Stanford University)
MA (Brandeis University)
BS (M.I.T.)

All content on this website is written by me. My goal is to provide in-depth and objective knowledge about what really works in personal finance and investing, so that you can increase your knowledge and improve your ability to manage your own financial affairs.

  • I am an experienced financial planner, the author of extensive personal finance publications on the web, and the developer of the sophisticated VeriPlan DIY lifetime financial planning software. At a creaky 70+ years of age (it's an old picture), I have gained expertise in economics, finance, investments, accounting, taxation, probability, statistics, and software.
  • In 2003, I began development of a highly automated and customizable lifetime financial planning application, VeriPlan , which I designed to serve as a decision support toolset for my advisory clients. In 2006, I released a standalone configuration of VeriPlan that do-it-yourself individuals can use themselves.
  • VeriPlan is the most automated, customizable, and sophisticated do-it-yourself lifetime financial planning software available directly to end users at a very reasonable price. To learn more about VeriPlan, click on the graphic at the upper left of this page.
  • I am also that author of several books. My most recent book is the "Buyers Guide to Low Cost No Load Mutual Funds ." This ebook will improve your understanding of investing by summarizing what the research literature indicates does and does not work when investing. It conveniently provides a directory of the lowest cost, diversified no load mutual funds available to US investors for direct investing. Included are over 200 of the very lowest cost mutual funds in 30 global, international, and US stock, bond, real estate, and money market fund asset categories.
  • This book delves into what is a mutual fund and it clarifies why only certain funds are worth owning. With it, year after year you can easily save money and time, while increasing diversification, lowering risks, and dramatically reducing investment costs. This ebook will help you to put your investing strategy on autopilot and allow you to get on with your real life.



This link will take you to our Terms of Use

This link will take you to our Privacy Policy

This link will take you to our Copyright Policy

This site is solely for informational and educational purposes related to your personal, private, and non-commercial use.

  • In no way does this site constitute or provide investment advice under the laws and regulations of the United States of America and its various States or of any other country in the world.
  • This site does not collect any specific information on the investment situation of any reader.
  • In no way does this site constitute a solicitation or offer to sell securities of any kind.
  • It is not a solicitation or offer to sell advisory services in any jurisdiction. You should seek professional advice, if you need help with budgeting, savings, investing, asset allocation or asset management, including help in analyzing calculator returns, discounted cash flow, compound interest growth, return on investment, net present value, future values, net worth or any other output of our calculators.

This site is a financial publication of general and regular circulation. Except for reading and browsing via the World Wide Web, no part of this document or website may be reproduced, modified, disseminated, published, adapted in any manner or transferred without permission in writing from Lawrence Russell and Company.

Unless otherwise stated, there are no business arrangements of any kind between The Skilled Investor and any mutual fund, ETF, or other investment security or any company that may be featured in our articles. We do not accept any payments to influence what we write about or what we say. The Skilled Investor may allow advertisers to post their messages on our site, and it is entirely your choice whether or not to patronize any of these advertisers.


"The Skilled Investor", "Skilled Investor", "VeriPlan", "Personal Finance Software for Your Lifetime", "Your Personal Financial Lifecycle Planner", and "Sensible and Scientific Financial and Investment Planning" are some of the trademarks of Lawrence Russell and Company. Other trademarks and service marks are the properties of their respective owners.

© Copyright 2005 to Lawrence Russell and Company, All rights reserved worldwide. The particular year of the copyright will depend upon the year of first publication.