It’s no secret that a stock market is a risky place. What most people don’t realize is that in order to make money in this type of investing, you should take steps to protect your investment. And even though you can theoretically invest yourself into the market and let it ride, there are several ways for investors to reduce their risk without losing their shirt – and some of those methods come from insurance companies! This post gives an overview of who typically insures investments in the stock market as well as what sort of benefits investors may receive with insurance included.
Basic Types of Investment Insurance
There are three basic types of insurance that investors can purchase: policies to cover their investment’s principal, policies that cover their investment’s return on investment, and policies that cover all three (principal, return, and the market itself). Since all investments carry some sort of risk – even a savings account is prone to inflation – it’s important to have a good grasp of any insurance offerings from the broker or agent you’re working with.
The three types of insurance coverage are described below.
Primary Insurance:
This form of extra coverage helps protect the actual principal amount invested in your portfolio. For example, if you invest $100,000 in stock and that investment loses value and is worth $90,000 at the time of your claim, you can receive up to $10,000 from the insurance company to replace your original investment (and potentially more depending on your policy). This type of coverage is typically purchased before any losses occur; it isn’t retroactive.
Secondary Insurance:
This form of extra coverage helps protect up to 100% of your investment’s return potential. For example, if you invest $100,000 in stock that yields you $10,000 after 4 years, and then 2 years later your investment is worth only $90,000 at the time of your claim, you can purchase secondary insurance to cover that loss. There are several different types of secondary insurance policies; they’re typically sold as “return riders.”
Market Insurance:
Finally – and this is something a lot of investors don’t realize – most financial advisors believe it is prudent to have some sort of market coverage on their portfolio. This coverage helps protect against losses in the case of severe market volatility due to crashes like the one we saw recently (see chart above). Market insurance is typically sold in 100% increments up to a maximum coverage level (the upper limit varies based on the nature of the policy, but it’s typically around 10%). In other words, if you purchase this type of coverage you are buying protection for your entire portfolio from market drops.
Insurance Itself is Not Risk-Free
If you want to reduce the cost of the insurance itself you’ll have to shop around; not all companies offer coverage at each level or each type of coverage (i.e., secondary or market insurance).
1. Go for the lowest loading ratio
The best place to start is by looking at how much the company keeps from you in order to determine what the loading ratio will be. If you’re a novice investor, this means that you need to look closely at any insurance policy offered by your broker or agent and find out how much money you will lose before any claims are paid out. This is a significant point because every dollar lost in the value of your investment is one less dollar of profit for the insurance company so as long as they keep enough from each policy holder's premiums they’re going to do even better than they normally would.
You also have to be wary about the fact that insurance companies take on risks when they issue a policy. They’re in business to make money just like any other company, and if they had their way they would price the policies so high that nobody would be able to buy them. This isn’t the case, however; if you walk into any insurance office with your broker or agent you should be able to get more than one quote on how much it will cost to insure your portfolio. One company may charge 5 percent of your portfolio while another might ask for 6 percent – a big difference in some cases – which is why it is important to shop around.
2. Understand who is writing the policy
Since an insurance company’s job is to make money, it’s important that you understand who is writing the policy for your portfolio. The insurance company that writes the policy is an important piece of information because you also have to take into account underwriting factors such as whether or not the company has been paying claims as written or if it has been trying to avoid them. Have they been in business for a long time? Do you know anyone who has ever worked there? Have they had any problems of any kind with claims in the past and how did they handle them? All of these questions should be answered before you decide on which policy to purchase.
3. Negotiate the cost of the premiums
There is one final piece of advice related to how you can cut down on how much your insurance policy costs: negotiate. Many companies give you the opportunity to get a better deal if you want to purchase life insurance, but few people ever take advantage of it. In fact, many people don’t even know they have this option. If you’re trying to create a portfolio that costs less than 2% per year to maintain (which most people should be considering) then you have a lot of negotiating power because you really only need a policy that will cover your portfolio against market drops or the loss of principal. You can also negotiate with the insurance company to get less than the maximum coverage available, so don’t be afraid to ask.
