Theory of Decreasing Responsibility

Here is a self-explanatory image that describes the “Theory of Decreasing Responsibility”:

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In short, the Theory of Decreasing Responsibility postulates that a person starts off with low assets and high liabilities, and hence has the greatest need for insurance. As his wealth builds up and his liabilities is paid off over the years, his need for insurance will reduce accordingly. He will then reach a point where he needs little to no insurance as he will be able to self-insure using his accumulated wealth.

Indeed, a young person has a great need for insurance. If he were to be incapacitated and unable to work for the rest of his life, the amount of money he will need to replace his income is staggering. An older person in his sixties who is leaving the workforce soon anyway will not need a great amount of income replacement (provided he has been prudently saving and investing) if he was rendered unable to work.

I believe the Theory holds true for most people, aside from certain people with special circumstances, i.e. parents of a special needs child.

This is also one of the greatest supporting arguments for a Buy Term Invest the Rest (BTIR) strategy. A cost-effective term policy gives high coverage at a lower cost than a whole life policy, and allows one to invest the savings to accumulate wealth for retirement and self-insurance. One would then have accumulated a sizeable amount of money when the term policy ceases.

Unfortunately, there are quite a few misconceptions when it comes to insurance planning. There are people who believe that they are more likely to claim when they are older and hence feel that a whole life policy is “more worth it”. While it is true that the chances claiming is higher as one ages, a BTIR strategy is able to outperform a whole life policy quite easily. Moreover, a higher chance of claiming does not equate to a higher need for insurance, as the Theory describes.

There are also young people who believe that they are indestructible just because they feel that health is a guaranteed feature of youth. Again, a low chance of claiming does not mean that they have a low need for insurance. Some rather invest, never mind the fact that investing before getting properly insured can be a dictionary definition of “putting the cart before the horse”. Many others plainly choose to remain ignorant. They squander their young age and good health, putting their family and themselves at risk by being the subject matter of the Theory of Having No Responsibility.

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