TFB's Stumbles: Week Ending April 4, 2008

Here are some interesting articles for this week.

IRS making sure your rebate gets spent (Marketplace, audio) - This April Fool's story fooled me. It gave me a good laugh.

Iceland's Biggest Banks Targeted by 'Unscrupulous' Speculators (Bloomberg) - Iceland banks under attack. You can't blame the attackers if your banks  borrowed four times of your country's GNP.

How Many Points Should I Pay On My Mortgage? Do You Like To Gamble? (My Money Blog) - Another great article by Jonathan. Should you pay points when you get a mortgage? It comes down to a guessing game on whether and when the interest rate will go down after you get your mortgage. If you think it may go down within a few years, don't pay points. If you think it won't go down in the next few years, pay points. Also see my previous post "No Cost" Mortgage Refinance: Stepping Down the Ladder.

Accident Victims Face Grab for Legal Winnings (Wall Street Journal) - This article brought out an outcry from many bloggers. Wal-Mart haters, chill. Whoever injured the woman should pay her medical bills and her future income, not Wal-Mart. Wal-Mart already advanced her medical bills. Getting paid back is fair. It's called subrogation.

McCain Rejects Broad U.S. Aid on Mortgages (New York Times) - Also don't miss the included pop-up for Candidates' Proposals on Housing. Although I side with Democrats on many issues, I have to say McCain "gets it" on this one. The mortgage crisis is a result of the burst housing bubble. Mortgage backed securities investors, lenders, and borrowers were all counting on the housing bubble continuing. They bet and they lost. It's that simple. Losing their home? It's not their home to begin with.

My Flexible Spending Account Sent Me a Debit Card

As if I don't have enough cards in my wallet, the vendor for my employer's health care Flexible Spending Account (FSA) sent me a MasterCard debit card. I'm supposed to use it for items eligible for reimbursement from the FSA.

The pitch from the FSA vendor is that I won't have to file reimbursement claims for items I charge to the debit card. But I'm still required to save every receipt. They can come back and challenge me for the eligibility of the purchase and I must then send them the receipt showing what exactly I bought with the card. Using the card is only going to complicate matters. Because the card is good only for FSA eligible expenses, if I buy a 12-pack of soda together with a prescription at a drug store, I must pay for the drugs with the FSA debit card and pay for the soda with cash or a different card. It's also only accepted at stores which installed a special computer system which distinguishes FSA eligible items from non-eligible items. If I charge the co-pay for a doctor's visit to the FSA debit card, and the insurance company later tells me I haven't met the annual deductible yet, I still have to file a paper claim to the FSA but I also have to explain to them that the co-pay is already reimbursed but the deductible isn't. What a mess.

I'm afraid this is just an attempt from the FSA vendor to capture the merchant fees from the purchase. The FSA debit card came with no PIN. All transactions must be processed as "credit."  If I use their card, I won't receive the 5% rebate from drug stores or the 1.5% rebate from elsewhere on my own credit card. Thanks, but no thanks. I cut up the FSA debit card without even activating it.

Related post: Why Banks Push Debit Cards

What To Do If Your Health Insurance Says Your Treatment Is Not Covered

Last Friday, I happened to pick up a copy of the Wall Street Journal somebody left on the train. There was an intriguing article on the front page -- How U.S. Health System Can Fail Even the Insured. There's also an online video for the same story.

It's a long story but the story line is familiar. A Mrs. Barbara Calder has a rare genetic illness but she had to jump through one hoop after another to get her health insurance to cover the treatment she needed. I'm going to use this case as an example to show what to do if your health insurance says the treatment you need is not covered.

Here's a timeline of the events. I'm marking my comments with [TFB].

July 2006 - Mrs. Calder suspected that she had Ehlers-Danlos Syndrome (EDS), a rare genetic illness which can be life threatening. She had health insurance through her husband's employer. She called the insurance company about seeing a specialist. She was told she needed a referral from another doctor.

August 2006 - She received the referral to a specialist who charges $650 for a consultation. She verified that the specialist was in the insurance company's network. Before she made an appointment, she called the insurance company again to confirm coverage but this time she was told the service wouldn't be covered.

[TFB] You got the required referral and the doctor was in the network. So just go. Whether the service is covered or not can be sorted out later. The agents answering the phone are not the ones who process claims. They can be wrong. Whether a claim is covered or not depends on the ICD-9 codes the doctor writes on the claim form. Before you see the doctor, you don't know what the codes will be. Even if the claim is initially denied, it can be appealed. Health is more important than money. Go get the diagnosis. Have the doctor bill the insurance. Worst case you will have to pay $650 yourself. It's not astronomical.

September (?) 2006 - Unhappy about the insurance company telling her the consultation would not be covered, Mrs. Calder showed up unannounced at the office of the HR Director at her husband's employer. She had an argument with him about her insurance coverage. Later, an executive at the employer's corporate office in a different state was also involved.

[TFB] This was totally unnecessary. Managers at the employer don't make health care coverage decisions.

October 2006 - Her husband was laid off. They suspected it had something to do with her condition but the company denied. They decided not to take COBRA because they couldn't afford the $1,200 a month premium.

[TFB] Paying $650 for the consultation out of the pocket would be a lot cheaper than losing a job or paying for COBRA.

December 2006 - Her husband found another job but the new health insurance doesn't start until 3 months later.

[TFB] Still waiting just to save that $650? Health is more important than money.

July 2007 - She finally saw the specialist and got a confirmed diagnosis. The specialist prescribed a drug but the insurance company refused to cover it. They wanted her to use some cheaper drugs first. The doctor also recommended a test to see if her condition was the type that could result in sudden death. She called the insurance company about the test. Because she didn't know the exact term, the insurance company misunderstood and told her that the test would not be covered.

[TFB] If you need the drug, pay for the first prescription. Let your doctor tell the insurance company why you need it. Then your next prescription will be covered. Your first prescription will likely be reimbursed as well. If you need the test, go get the test. Fight it only *after* they deny the claim.

August 2007 - Her husband took another job for better pay. The new insurance had another 3-month waiting period. She became uninsured again because she thought COBRA was not worth it.

[TFB] If you keep skipping COBRA and have breaks in coverage like this, your pre-existing condition might be excluded by your next insurance company for one year. See Department of Labor's FAQs on HIPAA.

November 2007 - Her health deteriorated. She still doesn't know whether her illness is the more serious type because she never took the test. She's worried about her children because the illness is hereditary. She wants to move to Belgium because Belgium has universal health care.

[TFB] How is it fair to have Belgian people pay for your health care? The U.S. health care system isn't perfect. You just have to be willing to pay something out of your own pocket, most likely only for a short while. If the service is medically necessary, it will be covered eventually.

Research Life Insurance Company Ratings

This is the final post in my mini series on life insurance. The previous posts in this series are:

• How To Buy Life Insurance
• Life Insurance: What To Buy
• Life Insurance: How Much Should You Buy?

When you buy life insurance, you want to make sure the company will still be there when your beneficiaries need the payout. Otherwise you just paid premiums for nothing. How can you be sure it will be there? Well, you can't. Insurance companies can and do go out of business. Nobody can predict the future. But that doesn't mean you shouldn't try to pick a financially strong company when you buy your life insurance.

The good news is that you don't have to learn how to read the insurance companies' financial statements in order to evaluate the companies' financial strength. Professionals already do that. When you compare rates on Term4Sale or any other sites, you will see the insurance companies' ratings, for example A+ from A.M. Best. Like a scorecard, the rating is an indication of the company's financial strength. Stronger companies are expected to last longer. Rating agencies are not 100% reliable, but in my opinion they do a far better job than amateurs like you and me. They are as good as you can get.

There are at least five companies who rate insurance companies in the United States -- A.M. Best, Fitch, Moody's, Standard & Poor's, and TheStreet.com Ratings (formerly Weiss). Ratings from A.M. Best are the most often advertised, but A.M. Best also gives out the softest ratings. Just like in college, professors who hand out good grades for mediocre performance are more popular. Fewer students want to take a class from a professor who's tough in grading. Companies like to get their ratings from A.M. Best because it makes everybody look good. Fewer companies apply for ratings from the other rating agencies. They go to the other agencies only when they want to show off they are good.

When you buy life insurance, an A+ (Superior) from A.M. Best is the minimum you should require. You should also look for a good rating from at least one other rating agency like Standard & Poor's or Moody's. In my opinion you should insist on a rating in the top 4 tiers from S&P or Moody's, which means at least an AA- from S&P or Aa3 from Moody's.

A.M. Best and Fitch offer free access to their ratings to everybody on the Internet. Moody's and S&P also offer free access to their ratings online but they require a free registration. Get a user name and password from BugMeNot if you hate mandatory registration. TheStreet.com Ratings only publishes the names of the 10 strongest and the 10 weakest companies. It sells its ratings for $14.99 each. With ratings from the former four agencies available for free, I don't see any point of paying for one from TheStreet.com Ratings. Here are the ratings search links:

• A.M. Best
• Fitch
• Moody's (requires free registration)
• Standard & Poor's (requires free registration)
• TheStreet.com Ratings (10 strongest and 10 weakest)

Reference:

• Steven W. Pottier and David W. Sommer, Property-Liability Insurer Financial Strength Ratings: Differences Across Rating Agencies, The Journal of Risk and Insurance, 1999, Vol. 66, No. 4

Life Insurance: How Much Should You Buy

I ended my previous post on life insurance with the question "how much should you buy?" I will address it in this post.

First you have to figure out how much income you need to replace for your beneficiaries. You don't have to replace 100% of your gross income because if you died, you would stop earning a salary, and you wouldn't have to pay taxes on that salary either. You also wouldn't have to contribute to your 401k and retirement savings any more because you don't no longer need them (you died). For me, taxes and retirement savings take up more than half of my income. Some of the household expenses directly attributable to you would be gone (you wouldn't need a second car); and some other expenses might go up (perhaps your family is on your health insurance).

After figuring out how much income you will need to replace, you can run some numbers. AccuQuote provides a life insurance needs calculator. According to the calculator, a 30-year-old wanting to replace $30,000 income for 20 years, with 3% inflation and 6% investment return, will need life insurance for $463,507.

Should you deduct from the need number the free insurance you already have from work? I didn't. I didn't because the free insurance from work is usually not portable. If I leave my job, my insurance ends. My next employer may not give me free life insurance. I treat the free insurance simply as extra.

All else being equal, the amount needed for life insurance goes down over time. It takes more money to replace income for 30 years than what it takes for 20 years. If you survived the first ten years, you would need less insurance than ten years ago because you only need to cover a shorter time. However I haven't seen a policy that will automatically reduce the face amount over time. So perhaps you should buy more when you are young and review your need again every 5 years.

Term life insurance is cheap, especially when you are young. You really don't have to pinch on the coverage. The cost per $100,000 also goes down the more coverage you buy. See chart below for sample annual premiums per $100,000 coverage at different coverage levels.

 

For this hypothetical 30-year-old male, the cost difference between $100,000 coverage and $250,000 coverage is only about $60 a year.

Next, which is also the last post in this mini series on life insurance, researching insurance company ratings. Stay tuned.

[Update on 9/19/2007] This is the 3rd post in a mini series on life insurance. Other posts in this series are:

• How to Buy Life Insurance
• Life Insurance: What to Buy
• Research Life Insurance Company Ratings

Life Insurance: What to Buy

My last post about life insurance was on how to buy life insurance. This time I'm going to talk about what to buy.

1. Permanent vs. Term. The best approach on the permanent aka cash value vs. term discussion is tuning out. Just buy term. Very few people have permanent need for life insurance. The vast majority of people are better off buying term. So don't even worry about the other kinds of life insurance. Some agents and web sites will try to steer you into permanent insurance. They put up all kinds of false arguments like "permanent is like owning; term is like renting." Just ignore them. For entertainment value or if you'd like immunize yourself from the false arguments, you can see how an insurance salesperson twisted the logic and how the members on the Bogleheads forum rebutted.

2. Level Premium Term or Annually Renewable Term. Level Premium Term guarantees fixed premium for the entire term. You pick how many years you want to insure for. The premium stays the same throughout the entire term. Because the odds of a person dying increases with age, the cost of insurance also increases with age. So while your premium stays the same, you will be paying more than the cost in the earlier years and less than the cost in the later years. Annually Renewable Term is pay as you go. Your premium is lower in the earlier years and higher in the later years. See sample premiums for a $500,000 policy for a 35-year old in the chart below:

I chose Level Premium Term for myself because I like the certainty of knowing my premium won't change. I also think it's more economical. More companies offer Level Premium Term than Annually Renewable Term. More competition drives down the cost.

3. For how long? With Level Premium Term, you choose a number of years you'd like to have the premium fixed. The longer the period, the higher the premium because the higher cost of insurance for the later years has to be averaged out to the earlier years. People usually choose to buy coverage through the year when their kids are out of college, when their mortgage is paid off, or when they retire. I chose 15 years for myself. That's when my mortgage will be paid off.

With annually renewable term, you don't have to pick a specific term up front. When you don't need insurance any more, just stop paying.

4. For how much? This will involve a bit of math. This post is already getting long. I will cover it in the next post. Stay tuned.

[Update on 9/19/2007] This is the 2nd post in a mini series on life insurance. Other posts in this series are:

• How to Buy Life Insurance
• Life Insurance: How Much Should You Buy
• Research Life Insurance Company Ratings

How to Buy Life Insurance

September 2007 is Life Insurance Awareness Month. I won't bore you with what life insurance is or why/when one needs life insurance. If you want to know, just read the info from SBLI. I'm just writing about how you go about buying life insurance.

First let me get this out. This is not a "sponsored" post. I'm not an insurance agent. Nor am I affiliated with any businesses I mention here.

1. Free life insurance from work. Many employers offer free group term life insurance as a part of their employee benefits package. Typical coverage is 2 times base pay. It's free, except the cost of insurance over $50,000 is taxable to you as "imputed income" according to a rate table (pdf, page 3) established by the IRS. Free is nice but the coverage is often not enough. You may still need to buy some more coverage on your own.

2. Extra insurance from work. After the typical free coverage of 2x base pay, you can often buy extra group term life insurance coverage through your employer's group plan. Unless you are in poor health, this is usually NOT a good idea. More details are in my post last year on open enrollment choices.

3. Term life insurance. For most people, this is the best approach for obtaining life insurance coverage. Ignore all the confusing noise about other types of life insurance. Just buy term. And the best place to shop for term life insurance is term4sale.com. Term4Sale does not sell insurance. It lets you compare quotes from many companies. It then gives you names and phone numbers of 3 independent agents in your area.

Agents?! Who needs agents in this Internet age? Do you not get lower rates if you cut out the agents and buy directly from the insurance company? What about those Internet sites where you can compare rates AND buy insurance in one shot, you know, like QuoteSmith (now Insure.com), AccuQuote, SelectQuote, IntelliQuote, etc.? Well, it turns out picking up the phone and working with a local agent is still the smartest way to buy term life insurance.

Insurance is a funny business. It's licensed and regulated by the states. The insurance rates are filed with the states' department of insurance. Unless a company doesn't sell through agents, period, the rate is the same whether you buy directly from the insurance company or go through an agent. If you use an agent, the agent earns a commission. If you go to the insurance company directly, they just pocket the commission themselves. And those Internet sites that let you compare rates and buy insurance at the same time? They ARE agents, just agents with a large Internet marketing budget.

Term4Sale is great because it doesn't sell insurance. Therefore it includes quotes from as many companies as possible. It won't lead you to companies that pay it the most money. There is no conflict of interest. It doesn't ask for your name, phone number, or e-mail address because it's not trying to sell anything to you. You just fill out a simple form and you will get a list of quotes. Change some options and see how the quotes change. After you get an idea of what the policies cost, click on "Find An Agent" and you will get 3 names and phone numbers for agents near you.

Working with a local agent is smart because you get to talk to a real person who is knowledgeable about the business. Life insurance rates are dependent on health underwriting class. Not all companies treat the same health issues equally. You may qualify for preferred plus with one company but only preferred with another. A local agent would know which company is picky on what issues and qualify you for the best class with the right company.

Will the agent try to sell you more expensive whole life, universal, or other "permanent" life insurance? Mine didn't. If they do, call the next agent on the list. My agent Ron was very professional. He helped me with the insurance application. There was one issue the insurance company had to put in a restriction for one year. After one year was up, without me asking for it, he called me and sent me the form to lift the restriction. When I needed disability insurance, he helped me again. There has never been any pushy sales pitch. After all these years, I never had to meet my agent face to face. Everything was done over the phone and by mail. Maybe I got lucky with a good agent. But I suspect if you contact an agent and let him/her know you got their name from Term4Sale, they will know what you are looking for and won't pull a hard sale on you, because they know the next agent is just one phone call away.

[Update on 9/19/2007] This is the fist post in a mini series on life insurance. Other posts in this series are:

• Life Insurance: What to Buy
• Life Insurance: How Much Should You Buy
• Research Life Insurance Company Ratings

Most Valuable Bank In the World

Which bank is the most valuable in the world, measured by its market capitalization? Is it Citigroup? Bank of America? HSBC in the UK? UBS in Switzerland?

None of the above. According to this August 23, 2007 article from Reuters, it's a bank in China, called Industrial and Commercial Bank of China Ltd (ICBC).

"Last month ICBC overtook Citigroup as the world's biggest bank by market value and is worth more than US$280 billion. Citi is valued at around US$239 billion."

According to my rough calculation using data from Reuters, ICBC earned about $6.6 billion net income in 2006. Citigroup earned $21.5 billion in the same period. Hmm ... 1/3 of the earnings, 20% more market value.

And which life insurance company is the most valuable in the world? It's not a Chinese company yet. AIG is still #1, but China Life is #2, larger than the French company AXA, the German company Allianz and the Dutch company ING. The earnings story is the same. The Chinese company has much smaller earnings but it has higher market value than the global giants.

It just shows how out of whack the Chinese companies' values have become. Yes the Chinese economy is growing fast, but having the world's No. 1 bank and No. 2 life insurance company? I don't think it's rational. Back in May I thought China was in a bubble. The bubble just became a lot larger. The Shanghai stock exchange index rose another 40% in 4 months since May 2007, or how about up 220% in one year? The P/E on the other Chinese stock exchange reached 70 [source]. Scary stuff.

$10,000 Lesson On Variable Universal Life (VUL)

Variable Universal Life insurance or in short VUL is sold by insurance agents as a smart investment to unsuspecting people. The pitch usually goes like this:

You invest in VUL. The money in the policy grows tax deferred. You get to choose what you invest in, stocks, bonds, international, you name it. It's like a super IRA, only way better. When you need money after you retire, you can first withdraw what you put in, then borrow from it, all tax free. When you die, your beneficiaries receive money tax free.

Sounds good? Tax deferred investing plus tax free income after retirement. Who wouldn't go for it? If you'd like to read the full pitch, here's an example: Variable Universal Life: Flexibility at Its Best by New York Life, whose slogan is "the company you keep." It's very enticing but you will see the real story at the end of this post.

VUL appeals to people who hate taxes (who doesn't?), especially to people who have higher income and therefore in higher tax brackets. After you hear about this wonderful clever way of avoiding taxes on your investment, you go "sign me up!" Uh oh, big mistake. Let's take a look at a real life example, from this thread on the Bogleheads forum.

Poster John and his wife each bought a VUL policy from a "friend" who works as a financial "advisor" at a "well known financial planning organization" (I'm guessing it's Ameriprise or formerly American Express Financial Advisors). After 9 months into their policies they put in about $5,000 each for a total of $10,000. Now they realize that their VUL policies have high fees and expenses, to the tune of $1,100 a year. But, if they get out before 5 years, they will lose ALL of the $10,000 they paid into the policies (?!?!) because the first $8,300 in each policy goes toward a "surrender charge" or better put, early termination fee like that on a cell phone contract. In other words, if John and his wife put $3,300 more into each policy, the policies will still suck it all in like a black hole with nothing coming out. They paid $10,000 into two policies but they only filled a little more than half way up the big hole that the VUL policies dug for them.

Despite all the help from other posters on the forum, John's options are still limited because the policies are designed to trap them in good with high fees and various charges. John and his wife can:

1. Keep paying into the policies and get plucked by high fees (not good); or
2. Cancel the policies now and receive nothing back (not good); or
3. Stop paying premiums and let the policies wind down by themselves (not good)

None of the three options is good. The 3rd option is perhaps the least of all evils. Basically they will let what they already paid pay for the insurance and whatever is left over stays in some mediocre investment options with high fees. Every month more money is deducted from the investments part towards the insurance part and fees. After the 5-year surrender period is over, I doubt there will be anything left. Their policies may end even before 5 years because all the money will have been depleted by insurance charges and fees. That $10,000 is gone. They won't ever see it again. What an expensive lesson!

I feel really sorry for John and his wife. Having this done to them by a "friend" is even more sad. This VUL saga plays out over and over. It's almost always the same story. I personally know a small business owner who was sold a VUL policy by his "financial advisor" who is also an insurance agent. The "advisor" has nice sounding credentials like CLU and ChFC. The business owner was quite mad at the "advisor" after I pointed out the fees and expenses printed in black and white in the prospectus. Of course he didn't read the prospectus because he was busy running his business and he trusted that his so-called "advisor" would act in his best interest. The same "advisor" also sold him load funds, an expensive 401(k) plan for his business, limited partnerships that were impossible to get out of ... -- altogether the "advisor" cost him more than $200k.

Now let's get back to the wonderful VUL policies New York Life sells. Here's the 80-page prospectus (PDF, 476kB) of their NYLIAC Variable Universal Life 2000 product. Fees and expenses start on page 9.

• 4.5% - 6% charge up front for each deposit, like a load; plus
• $120 a year contract fees; plus
• 0.5% - 0.7% a year for M&E and admin charges; plus
• ~0.8% a year for expenses on investment options

Does it look like a good way of investing money? I like what poster ole meph said [1] on the Bogleheads forum:

"The only way you can benefit from this product is by dying fairly soon."

Oh wonderful. I'm sure the clients didn't want to pursue that route when they bought into the VUL policies.

[1] ole meph has been a veteran insurance agent and manager himself for over 40 years.

Does Your Auto Insurance Cover Engine Failures?

If your car's engine died, does your auto insurance cover the cost of replacing it? That's the question in this post on The Simple Dollar:

How The Simple Dollar Just Saved Someone $2,850 (And A Personal Finance Tip To Boot)

Trent, the blogger who wrote it, claimed that he was able to save someone $2,850 by pointing out that the "comprehensive" part of that person's auto insurance covered engine failures, not caused by a collision, but just during the normal course of driving. Baloney. I left comments for Trent but he doesn't want to admit he was wrong, saying "it varies from insurance policy to insurance policy." I'll assert that no auto insurance policy in the United States covers normal engine wear and tear. Manufacturer's warranty or extended warranty maybe, but not auto insurance. If you don't believe me, please check your policy or ask your insurance company/agent. If your policy covers engine wear and tear (I'm not holding my breath), I'd love to switch to that company.

Open Enrollment, Part 4: Flexible Spending Account

This is the fourth installment of the Open Enrollment mini series. Previous posts in the series were

• Open Enrollment, Part 1: Health Care
• Open Enrollment, Part 2: Life Insurance and AD&D
• Open Enrollment, Part 3: Disability Insurance

I cover flexible spending accounts in this post.

A Flexible Spending Account (FSA) allows you to set aside money before tax and pay for health care and dependent/child care using pre-tax dollars. It's a great deal because you get to use pre-tax dollars. Not only you don't have to pay federal and state income tax on your deposits to the flexible spending accounts, you also get to avoid Social Security and Medicare tax. The only catch is "use it or lose it" -- you lose what you can't use. Because there are many ways to spend the flexible spending account money, and because the tax savings is substantial, you have to be way off in your estimate to lose money in an FSA. For 2007, you also have 2.5 months more time to use up your FSA. If you find yourself sitting on a big balance in your FSA next November, just reduce your contribution for 2008 and use up you existing balance by March 15 2008.

There are two kinds of FSAs, health care and dependent care, each has its own separate "bucket." Deposits into one type can be used only for that purpose. You can't use Health Care FSA to pay for child care and you can't use Dependent Care FSA to pay for health care. You can't transfer funds from one bucket to the other either.

1. Health Care Flexible Spending Account

Health Care FSA can be used to pay for health insurance deductibles, co-pays, medication or services not covered by the health plan, OTC drugs, even contact lens solutions and condoms. Just make a ballpark estimate of how much you will spend on this type of things. Be a little conservative if you want (who plans to be sick anyway?). I've been using around $1,000 for the two of us and we never lost any money.

2. Dependent Care Flexible Spending Account

This is typically used for day care expenses for your child. People usually have a very good handle on the need because they know how much day care costs. The maximum a family can contribute is $5,000 a year and people tell me that they use up that limit pretty easily.

This concludes the Open Enrollment series. I hope you find these useful. Any comments?

Open Enrollment, Part 3: Disability Insurance

This is the third installment of the Open Enrollment mini series. I cover disability insurance in this post. Other posts in the series are:

• Open Enrollment, Part 1: Health Care
• Open Enrollment, Part 2: Life Insurance and AD&D
• Open Enrollment, Part 4: Flexible Spending Account

1. Short Term Disability (STD)

Disability Insurance provides income to you if you become disabled. Being disabled is probably worse than death in terms of its financial impact to someone's life. If you die, you are gone, together with your debt and expenses. If you are disabled and can't work, you don't have income but you still have expenses to pay. For a younger person, the chance of becoming disabled is much higher than death. So if your finance depends on your income, it is very important that you obtain disability insurance. For female employees, time off before and after child birth is also covered under the short term disability program.

Some states, California, Hawaii, New Jersey, New York, Puerto Rico, and Rhode Island, have a mandated short-term disability program [source]. All covered employees must pay into the state program or an equivalent program established by the employer. My employer offers a short-term disability plan at no cost to the employee. It pays 80% of base pay until the long term disability plan kicks in.

No decision for me here because I'm covered by the employer's plan. If you don't have short term disability coverage from either the state or your employer, you will have to save some money in your emergency fund. Your emergency fund will cover the income shortfall if you become disabled.

2. Long Term Disability (LTD)

Long term disability is even more devastating than short term disability. If you recover from your disability in a few months, you can use your emergency fund to bridge the income gap. If your disability is long term and you don't have long term disability insurance, hardly anyone has that kind of emergency fund that can provide income for years and years.

Social Security provides some long term disability coverage, however it's very hard to qualify for payments from Social Security Disability program. Anecdotes I heard from people who helped the employees file the claims were that more than half of the claims were denied by Social Security on the first attempt. On second and perhaps third try, Social Security may finally budge and approve the claim. Because Social Security is quite strict in approving claims, you should have your own long term disability coverage, either from your employer or purchased from an insurance company. Disability insurance is quite expensive. When I worked for a company which didn't offer long term disability, I had to buy a policy myself. The premium was about $1,500 a year for moderate coverage level. I will write about purchasing disability insurance on your own in a future post.

Fortunately my current employer offers long term disability coverage at no cost to the employee. After 180 days of disability, it pays 66.6% of base pay until age 65. The payment is not indexed to inflation, but I think I will do just fine by tapping into my savings for the shortfall or reduce my standard of living.

No decision for me here because my employer covers me. Some employers offer the option for the employee to pay tax on the insurance premium. If the employee pays tax on the premium, the payout will be tax free. This effectively bumps up the coverage level. My employer's plan doesn't offer this option. If it did, I would choose to pay the tax (and make future payouts tax fee), because I think my expenses will be higher if I'm disabled. 

The final post in the series will be on Flexible Spending Account.

Open Enrollment, Part 2: Life Insurance and AD&D

This is the second installment of the Open Enrollment mini series. I cover life and disability insurances in this post. Other posts in this series are:

• Open Enrollment, Part 1: Health Care
• Open Enrollment, Part 3: Disability Insurance
• Open Enrollment, Part 4: Flexible Spending Account

1. Basic Life Insurance

The employer provides life insurance at 2 times base pay at no cost to the employee. The value for coverage over $50,000 is taxable to the employee by IRS rules. No choice here. Take the free insurance and pay the tax.

2. Supplemental Life Insurance

The employer also offers additional life insurance for purchase by employees. Unlike health care, the supplemental life insurance is not subsidized. Healthy employees should look elsewhere, but if you have health problems, you should consider this option. Life insurance through the employer is "guaranteed issue" and not medically underwritten, up to a certain coverage level. This means even if you have cancer, you can still buy life insurance from the employer's group plan. Whether you are overweight or have high cholesterol, your rate is still the same as other employees. Many group plans also do not have separate rates for smokers and non-smokers. Because there is only one rate group, the group rates are higher than the rates otherwise would be for healthy people and lower for what not-as-healthy people can get on the market. This causes "adverse selection" -- healthy, non-smokers tend to opt out and buy insurance on their own, not-as-healthy people tend to stay in the plan. This drives the rates higher and the cycle continues.

I'm not going to buy life insurance from my employer's group plan. Instead I have a policy I bought on my own. This policy belongs to me. I have it no matter whom I work for. A policy from the employer's group plan typically cannot be continued if you leave the employer, unless you convert it to a much more expensive permanent policy.

3. Spouse Life Insurance

I can also buy life insurance for my spouse from your employer's group plan. The same logic for Supplemental Life Insurance also applies here. If your spouse is healthy, buy life insurance on your own from the market. If the spouse has health problems and cannot get private insurance at reasonable cost, consider buying some from the employer's group plan.

I'm not going to buy life insurance for my spouse from my employer's group plan, for the same reason I'm not buying life insurance for myself from the group plan.

4. Child Life Insurance

Generally it's not necessary to buy life insurance for a child. If a child dies, you might incur some expenses and emotional distress, but you are really not depending on the child for income. Chance of a child dying is very slim anyway. Save the money in a college fund instead.

I'm not going to buy child life insurance.

5. Basic AD&D

AD&D, or Accidental Death and Dismemberment, sounds very scary, especially the dismemberment part. If you die from an accident, as opposed to an illness, AD&D pays to the beneficiary. If you lose a hand, foot, limb, or the use of an eye, AD&D pays. My employer provides AD&D coverage for 2 times base pay at no cost to the employee. Nothing to decide here. Take the free insurance.

6. Supplemental AD&D

If I want more AD&D coverage I can buy more, but I'm not going to. AD&D coverage is too limited. The loss must be a result of an accident. If I must be amputated because of a bone disease, AD&D won't pay. Money is better spent on life and disability coverage.

I'm not going to buy additional AD&D coverage.

More to come on disability insurance and Flexible Spending Account.

Open Enrollment, Part 1: Health Care

Open Enrollment is coming up next week. This is a period of time when you can make choices for your benefit plans for next year. In a previous job, I worked in the employee benefits department at a Fortune 100 company. So I know a thing or two about these benefits. Over the next few days I'm going to write about my choices. Please note the benefits and premiums vary greatly from employer to employer. I'm writing from a perspective of an employee working for a large company with comprehensive and heavily subsidized benefits.

The first post in the series is about health insurance -- medical, dental and vision. If you'd like to jump ahead, here are the follow up posts in this series:

• Open Enrollment, Part 2: Life Insurance and AD&D
• Open Enrollment, Part 3: Disability Insurance
• Open Enrollment, Part 4: Flexible Spending Account

1. Medical

This is the most important benefit the employee receives. I have a choice between PPO and HMO. A PPO allows the employee to go to any doctor in the network without a referral. If you see a doctor out of the network, there's still a reduced level of benefit. A HMO is an exclusive network. You must choose a Primary Care Physician (PCP) and you can't go to a specialist directly without first getting a referral from your PCP.

PPO is more flexible but costs more to the employee and the employer. HMO also provides higher level of benefits and lower or no annual deductible and lower co-pay. For example the PPO plan will cost me $25 per pay period (every two weeks). It covers diagnostic services at 90%, has a $500 annual deductible, and $20 co-pay for doctor's visits. The HMO plan will cost me $20 per pay period. It covers diagnostic services at 100%, has no deductible, and $15 co-pay for doctor's visits.

For me, I always chose PPO because I like the flexibility. The employer is usually motivated to move the employees from the more costly PPO to HMO. But I don't want to cut any corners with regard to my health care in order to save my employer some money. It will cost me a little more in terms of employee contributions, annual deductible and co-pays, but all those are pre-tax money when I use money from a Health Care Flexible Spending Account. I will write more on Flexible Spending Accounts in a future post.

After searching for other blogs on this topic, I can see that One Frugal Girl agreed with me and Daniel at My Money Path disagreed.

2. Dental

Dental insurance technically isn't much insurance because the annual payout is typically capped at $1,500-2,000. It's still valuable. Usually the plan offers different coverage level for preventive, basic, and major care. If you have bad teeth, be prepared to save more money in the Flexible Spending Account, because one root canal plus one crown can easily exceed the annual insurance cap. Plus you will have to save for the co-pays.

My company only offers one plan. I chose it. Premium is pretty low at $5 per pay period.

3. Vision

Vision care covers eye exam, lens, and frame. There is also some coverage for contacts. Some plans give discounts to laser eye surgery.

My company only offers one plan. Premium is even lower than Dental. I chose it.

More to come on life Insurance, AD&D, disability insurance, Flexible Spending Account ... ...

Finance Charge in Insurance Payment Plans

I often read on the blogs when someone talks about their insurance

my ___________ (life, car, home, ...) insurance is $______ a month.

or

I saved $_______ a month on my ____________ insurance.

So it seems that a lot of people pay their insurance by month. I've always paid my insurance in a single payment because insurance companies typically charge a small processing fee or service fee if you choose to pay by month. That service fee looks like a finance charge to me. No other business charges its customers by the number of times the customer pays. The reason the insurance company charges extra is because it extends credit to you if you don't pay the entire premium when it's due, the same way the credit card company charges you interest if you don't pay the balance in full. What the insurance companies call service fee is really interest or finance charge in disguise.

I received the bill for my car insurance renewal last week. Here are my options:

1. Make one payment for $736; or
2. Make four payments of $184, plus a $4 service fee for each payment.

So if I take the 4-payment plan, I will pay $752 over 4 months, $16 more than the $736 premium due. That's only a little over 2% of the premium. Not bad for making it easier on the budget? Not so fast. I decided to take a closer look at the embedded interest rate in the 4-payment plan. Here's the insurance company's cash flow for the 4-payment plan:

10/31/2006	-736
10/31/2006	188
12/1/2006	188
1/1/2007	188
2/1/2007	188

The interest rate turns out to be ... ... 19%! Wow, taking the 4-payment plan amounts to charging it on a credit card and paying 19% interest!

To calculate the interest rate, you need the XIRR function in Excel or OpenOffice. I made an Excel spreadsheet for this exercise. You can download it here. If your insurance company charges you a service fee for paying by month, plug in your own numbers and see what interest rate they are charging. If you don't mind, please post in the comments the company, product and the built-in interest rate on their payment plans.

If you want to learn more about the XIRR function, please read this post by Ricemutt at Experiments in Finance. For tips on saving for infrequent bills so you can avoid paying finance charge on insurance, please read this post at Tired but happy.