Nothing to Chance

Adam M. Grossman

IN THE SUMMER of 1789, George Washington got into a dispute with his Postmaster General—a fellow named Ebenezer Hazard—and removed him from office.

Looking for a new profession, Hazard decided to start an insurance company. He called his new firm the Insurance Company of North America and specialized in providing life insurance to ship captains. The business was a perfect fit for the times and quickly prospered. Still, I’m sure that even Hazard would be surprised to see his company still in business more than two centuries later. Today, Insurance Company of North America is the “i,” “n” and “a” in the company’s new name, Cigna.

Ordinarily, insurance companies would not be the most interesting topic, but there is one thing about them that is worth your attention: They are disproportionately represented among the world’s oldest surviving companies. In addition to Cigna, several other American insurers date back 150 years or more. And outside the U.S., many go back as far as the 1600s.

In my opinion, it is no coincidence that so many insurance companies have survived for so long—and I believe it’s worth taking the time to understand the secret to their longevity. Once you do, you may be able to apply their playbook to your own finances.

So what is their secret? It’s not any of the most obvious explanations for business success: None has monopoly power. None possesses unique technology. And none has a Steve Jobs-type visionary leader.

Instead, the strategy that they all employ is something that, in industry jargon, is called “liability matching.” In plain English, that means that they plan very, very carefully to be sure they can meet their future financial obligations. For example, suppose that hurricane season typically results in $2 billion worth of claims each year. If you looked at the internal books of any homeowner’s insurance company, they all would be able to point to a set of dollars that are specifically earmarked for hurricane season 2018, another set for 2019, and so forth. Similarly, a life insurance company will have funds set aside to meet the claims they expect this year, next year and every year into the future for which they have sold policies.

In short, insurance companies leave nothing to chance. They don’t hope and pray that there will be enough cash available to meet future claims. Quite the opposite: They have teams of actuaries who spend their days preparing risk models to ensure that there will be enough cash (or investments expected to produce cash) to match every single projected future obligation of the insurer. That is why it is called liability matching.

As individuals, none of us has the resources of an insurance company. We don’t have our own team of actuaries and we don’t have the ability to increase our own household incomes in the way that insurance companies can raise rates on policyholders. Still, the principle of liability matching is a powerful technique that anyone can employ.

What would this look like in practice? Insurers maintain hundreds of individual accounts—one for each group of future claims. Clearly, you don’t need to go that far. But I would think about it in the same way. Start by asking yourself how many different major obligations you have in your future. For virtually everyone, retirement is a consideration. In addition, some of the following might apply: private school or college tuition, a home down payment or renovation, a wedding and perhaps a major charitable gift. If you are just getting started, you might be focused more on student loans you want to pay off. These are just examples. Take some time to write out your own list of major obligations, being sure to attach an estimated dollar value and timeline to each.

In drawing up your list, I have found that it makes sense to stick to five or fewer individual goals. Go much beyond that and things can become too unwieldy. Indeed, if you focus on funding a small number of very specific and quantifiable goals, I think you’ll find it enormously helpful. You’ll have a yardstick against which to measure your progress. And with that yardstick in hand, you’ll likely find yourself making progress more quickly than you otherwise would, as you strive to accumulate assets to match your future liabilities.

Adam M. Grossman’s previous articles include In the CardsYou—But Better and Happily Misbehaving. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.

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