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Why Insure?

by Money Puzzle   ·  March 27, 2019   ·  

Why Insure?

by Money Puzzle   ·  March 27, 2019   ·  

1. Why do you need insurance?

Before getting into why you need an insurance policy – let me state one thing clearly – you don’t need an insurance linked policy for your child’s higher education or for your retirement. Insurance is not investment. To insure means to arrange for compensation in the event of damage to or loss of property or injury to or the death of someone, in exchange for regular payments to a company or to the state. This is how the Oxford dictionary of English, defines the word insure.

The key terms that you should understand are compensate, loss, injury or death. In simple words, the intention of an insurance policy should be to fill in the money gap or remunerate the beneficiary when there is a loss of earning capacity from an asset or a person.

There is no purpose of investment or wealth creation in insurance.

You need life insurance if your death is going to impact the earnings inflow for a family or any one who is dependent on that income for their survival. You need property insurance if damage to property can severely dent your financial assets or if the property was contributing to your and accidents. Similarly, you need health insurance to recompensate costs attached to hospitalisation and treatment which can be rather high.

There are other kinds of insurances but ascertain that the purpose is to compensate from loss or damage. The most efficient type of insurance is where there is no element of any investment involved.

2. Why insurance is not an investment?

The investment section on this website will tell you what purpose an investment fulfils. Insurance products come in many forms. The dilemma of whether to take insurance or insurance plus investment occurs in case of life insurance, where policies are sold with insurance and investment.

However, when you buy an insurance policy there are many costs attached to it. A unit linked insurance policy, which is often considered advantageous because you get both investment and insurance has additional costs like premium allocation, policy administration, fund management and mortality charges. Only after your premium allocation charge and other charges are deducted does the rest of the money get allocated for investment. Now a pure investment security will not have so many charges, hence, the net return at the end of the period can be potentially higher.

The reason for all these charges is the insurance side of the product.

What happens as a result is that a premium amount that could buy a higher death cover or insurance cover in a simple term policy (insurance only) will now be able to give you a much lower guaranteed death sum assured. For example, a one lakh annual premium will get you say a sum assured life cover of Rs 10 lakh as most of the money goes in for investment. The same Rs 1 lakh annual premium can get you a sum assured going up to a few crores in a pure term insurance policy depending on your age.

Insurance companies portray that the gap that a low sum assured leaves gets filled in by the investment corpus.  

Firstly, as you will understand from the investment section of this website, market linked investments require time to generate wealth. If you were to say die within 2 years of the policy, your family is left with a low sum assured and a low investment value.

It’s simply inefficient to mix the two. Get a term insurance and use pure investment products for creating wealth.

3. Why life insurance is not the only one you need?

When we think insurance, its life insurance that immediately comes to mind. Death benefit. While life insurance may be the foremost priority, it isn’t the only important insurance. For starters, you must consider medical or health insurance. The terminology can differ; there are subtle differences in say a Mediclaim and a health insurance. However, they both work to compensate medical costs. Most medical insurance policies do cater to hospitalisation expenses, but there are those which also account for pre hospitalisation expenses, day care procedures and even health check-ups. The premium will differ, so you will have to do a cost benefit analysis depending on what you or your family needs.

The rule of thumb is that the younger and healthier you are the lower is the premium for health insurance. Hence, its always advisable to start early on this front too. You can always start with a basic policy and increase coverage features as required over the years.

The other important types of insurance are vehicle insurance, home insurance and travel insurance. Insuring the theft or damage of your vehicle is mandatory as per the Motor Vehicle Act in India. However, the mandatory insurance is a basic cover and you can choose to increase the parameters as per your requirement.

Home insurance will protect the cost of damage to your house and household items from any deliberate actions or natural calamities. There is also something called a homes loan protection plan which insures the outstanding loan amount in the event that the borrower dies.

Travel insurance gains more importance in case of overseas travel given that you will not have medical or health insurance in the country you are travelling to. Travel insurance also covers loss or theft of your belongings and cost of loss from flight delays.

4. Why you should never buy a child insurance plan when your child is born?

A child education plan or a child plan in short is an insurance cum investment policy which is designed specifically for providing for your child’s higher education. What it does is gives you an insurance cover which gets paid out to your child during the tenure of the policy, in case you die. Additionally, any other pay outs and benefits continue as defined without any need to pay more.

Yes, it sounds great. Not only do you get the sum assured but also the policy continues and the child will get all the pay outs without having to pay any more, that is called premium waiver. Usually such policies also come with accidental death riders, which protect your child and give the benefits in case of death by accident. There will be a lot of emotional tug in any literature you read about child plans.

However, the logic is not flawed, the numbers are. It’s a great strategy, but it’s very expensive. Why is that?

Its simple, as mentioned earlier – an insurance when coupled with an investment becomes unreasonably expensive. In child plans the premium gets invested and in some cases you will be shown historical returns of 15%-20% per annum on the corpus.

A child plan with an annual premium of Rs 10,000 is likely to give you a sum assured of Rs 1 lakh on the death of the parent. Assuming that you buy a unit linked plan for 15 years and the rest of premium is invested, your maturity corpus can be anywhere between Rs 3.5-20 Lakhs depending on the expected return (12%-20% per annum).

Instead if you take out a pure term cover at the age of 30, for a sum assured of Rs 1 crore, which will get paid to your family in the event of your death – you will have to pay Rs 10000 (approximately, depending on the insurer) a year. That is a total premium pay-out of Rs 1,50,000 in 15 years.

You decide, in the event of death – is receiving a sum assured of Rs 1 lakh + an investment corpus of Rs 3.6 lakh (calculated at an annual return of 12.5%) more efficient or is it better to get a sum assured of Rs 1 crore (in case of death) and invest in surplus saving in a pure investment product to yield you more efficient returns?

5. Why does health insurance need to be a priority?

Insuring your health should always be a priority. Being healthy means you can work as you like and earn as you like. Illness reduces your time at work, time with family and eventually if not treated can impact your capability to earn. Its critical that you take care of your health and when it comes to treatment you shouldn’t be worried about how much you are spending or if you are digging into the recesses of your savings.

To do this you need to get an appropriate health insurance cover or a mediclaim. There are several available in even more combinations and permutations. At a basic level, cover all the likely hospitalisation costs. If you are part of a family with children then look for a family floater cover that can be like an umbrella for your children and your spouse.

Taking a health cover lets you get good quality treatment when you need without worrying about costs. Moreover, you don’t need to break into your savings for making this expense.

There are policies which also cover maternity related hospitalisation expenses. Whether you get a Mediclaim or a health insurance (there are differences) you have to consider your own requirement, age and pre existing illnesses before finalising a plan.

6. Why you must question your insurance agent?

Insurance agents sell dreams and feed on your fear. Everyone is afraid of dying and leaving loved ones behind, but don’t let that fear make you stupid. Ask questions. Ask questions about the claim ratio of an insurance company. Ask questions about the persistency ratio of an insurance company. Do not ask about the returns of the policy – because remember that insurance is not an investment.

If they show you the ULIP returns, ask if the returns showcased are what you will make or are there going to be other charges involved. If they showcase the pay outs on an endowment policy. Ask them to compare the pay out versus the total premiums paid and the return then earned over 15-20 years. Ask for a breakup of all the charges in a life insurance policy.

In case of health insurance ask even more questions about the percentage of claims settled, time take for reimbursement, hospitals which are impanelled, whether it is cashless or not. Also ask about pay outs for rare treatments and critical illnesses.

Don’t be in a hurry to sign the documents. Ask the questions and better yet, if you can take the time out, read the documents. You have to question the intent and cost when a health insurance policy offers you returns,

7. Why does the life insurance company matter?

The insurance policy and what is covers is important but so is the company that issues this policy. The track record of the company in settling claims is very important. If you go for a policy only based on the premium, you may end up with an insurance company which has a very poor track record in say accepting claims or another with a poor track record in settling claims.

There are other issues like time taken to settle a claim or in case of health insurance the time taken for reimbursement or the extent of the claim approved by the insurer could be lower than the treatment cost.

The track record of the company in these matters is an important indicator towards the outcome in case you were to put in a claim.

8. Why you and your spouse both need a life cover?

A life cover or a life insurance protects the surviving dependents in the event that the earning member in a family dies. Cleary if you and your spouse both are earning then there should be a life insurance policy for both. When both are contributing similar earnings into the family financial pot, it is a simple decision to have life insurance cover for both. This is because in the absence of the earnings of either one can leave a gap in the household’s financial kitty. But what happens when one spouse earns significantly lower? Should you take a life insurance cover for the lower earning spouse?

If you have young dependent children or plan to have children, then the answer is yes. Here is why. While one spouse may be the primary earning member, the other is sure to the primary caretaker. One should ideally insure the spouse who earns lesser but spends more time caring for the family as well despite low earning because in their absence, while there will not be a direct impact on the spending capacity of the family – there can be a significant impact on the financial balance.  One of the two things can happen – either the primary caretaker steps back from a busy workload and contributes more with the children, in which case the earning capability will likely reduce. Or it could be that additional help has to be hired at home to take care of the children. In both cases the financial burden on the family in the absence of one spouse increases. It increases relatively more if the primary earning member dies but lets not ignore the impact if the primary caretaker dies.

9. Why you need to review and upgrade your insurance?

This is a simple one. As you grow in your life and work, lifestyle changes and earning presumably increases. Hence, you need to keep revaluating the amount of insurance cover you have taken to protect the interest of your family. Secondly, with product innovation the cost structures tend to go on changing as well. For example, with one click online term insurance policies, there is a category of people who can get very inexpensive term life policies without much ado.

Take a year or maybe two but do revaluate your insurance policy, the amount of cover, cost and the riders that you may want to take along with the policy.

10. Why you shouldn’t fall for feel good insurance advertisements?

Let’s get this straight, an insurance policy is not going to make your life better. It will not put your child through college and will not build your home. At the most your insurance policy will help you sleep better at night with the knowledge that if something were to happen to you soon, your family’s financial health is covered.

Insurance is not investment planning for the future it is contingency planning or taking care of financial strain arising from the unknown.

A health insurance will help you navigate the soaring medical expenses in case of an unexpected accident or illness. It will not help you create wealth for travel or retirement. A travel insurance plan again is more for your peace of mind that if there is an accident in a foreign land, your medical expenses are covered.

In most case, thanks to the laws of probability, the cost of insurance that you bear is going to be just that – a cost. There are many plans which will offer you premium back but keep in mind that any such plan will be very expensive and while you get your premium back, you have actually paid a lot more in the first place for a similar cover. Instead, take a cheaper basic plan and use the difference in the premium to invest in wealth creating products like equity or even in property. But be wary of over paying in insurance premiums just because the picture of the family in the advertisement looks very alluring.

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