Insurance Contracts

Insurance vs. Investments: Part 1

Several years ago, I got a job as a Part Time Flex (PTF) at the Harrisburg Main Post Office. I needed a part time job (so I was told by the family.) I thought that the name meant part time but I forgot I was dealing with a federal government corporation who does not know that slavery ended in 1865. I worked 12 hour days for 5 days then one day at 8 hours. Most of the time, when a holiday was not involved, I got one day off. That day was for sleeping.

One day, someone got me out of bed by ringing my door bell. It was an insurance salesman who came to give me a free book that I ask for. I did not know that this free book was connected with an insurance company. I filled out the card in the Post Office Cafeteria and mailed it in. This man wanted to talk to me about buying an annuity giving me 6% guaranteed. All I had to do was give his company so much money a month for so many years and I could get $25,000. I calculated the payment over time in my head then said, "You mean to tell me, if I give you $51,000, you will give me a guaranteed $25,000 back?" He looked at me then looked over at my book shelf, full of mathematical, computer, and financial books. He got up, collected his information, and said good day. That was the last that I seen of this salesman.

Most people do not know that insurance and investments are two different subjects. Insurance is protection against loss. You buy insurance to protect your families way of life incase you, the bread winner dies at a young age. You buy car insurance to protect you from being sued and loosing everything you have because you killed someone in an accident or caused some property damage. You buy umbrella insurance like O.J. did so that you can hire high priced lawyers to defend you in court in case you slander someone or incase you are involved in a wrongful death suit.

According to Dictionary.Com, the definition of insurance is;

1. The act, system, or business of insuring property, life, one's person, etc., against loss or harm arising in specified contingencies, as fire, accident, death, disablement, or the like, in consideration of a payment proportionate to the risk involved.

2. coverage by contract in which one party agrees to indemnify or reimburse another for loss that occurs under the terms of the contract.

3. the contract itself, set forth in a written or printed agreement or policy.

4. the amount for which anything is insured.

According to Dictionary.Com, the definition of investments is;

1. Investments are Property or another possession acquired for future financial return or benefit.

2. A commitment, as of time or support.

You buy an $18 US Savings Bond for 10 years giving $25 at maturity. That is an investment. You buy a corporate bond for 3 years, giving you 4% a year with payments to you of $20, every six months. These are investments. You know them because they give you more money in the end than you put into them at the beginning.

Annuities are insurance contracts. Along with insurance policies, it will pay you so much money in case you do not suffer the loss that you had expected. Some people use them as expensive savings accounts like the insurance salesman was trying to talk me into buying. You must know what product to use to meet your objective, protection against loss or to later maintain your own way of life.

By now, you heard of financier Bernard Madoff. The 70-year-old former NASDAQ stock market chairman was arrested Dec. 11 on securities fraud charges alleging he duped investors out of as much as $50 billion in a giant Ponzi scheme. The real problem was, he took the rich for everything they had. If it was a bunch of poor people, it would not be in the news and he would not have been arrested.

What he appeared to have done was bought stock then wrote "PUTS" against the stock and made 1% a month on the investment of "PUTS". He also wrote what is called NAKED PUTS". "PUTS" are insurance contracts against loss in case the stock unexpectedly would go up. "NAKED PUTS" are "PUTS" that are written but are not backed by stock. In the 1980s, 1990s, and until last year, stocks in general, always went up. So the people who bought his "PUTS" lost their money and Mr. Madoff made his money.

Then we had the big crash from 14,000 to 8,475 in less than a year. Many stocks fell 60% or more. Mr. Madoff had to pay off the people who bought his"PUTS" in stock. If he did not have the stock, he had to pay them off in cash. Just like in 1929, he had to give away his new clients money to cover his old clients contract obligations. So he and all his clients went broke. The clients had no idea that they were in the business of writing insurance contracts.

Moral of the story, know if you are dealing in investments or insurance. Next time, we will learn about using insurance to cover your children’s education fund.