Thursday, September 06, 2007
Insurance Demystified
I can imagine insurance to be the pet peeve of many people. Just think insurance, and the first things that usually come to mind would be aggressive sales tactics, stories of mis-selling or misrepresentation by unethical advisers. And because of these negative connotations associated with insurance, advisers and consumers tend to avoid it like plague or try their darndest to thread around it very carefully in fear of waking the sleeping angry giant! It is a great pity really because insurance is the most misunderstood of all financial instruments in my opinion and it is one of the most important (if not the most important) aspects of financial planning. Without which even the best financial plan, with all its high yielding investments and other sophisticated instruments, will fall through when an unforeseen situation arises. Here, I’ll like to address a few misconceptions of insurance and hopefully through this, to provide you with a better understanding of what insurance is all about.
First of all, it is not about whether you can afford insurance but whether you can afford not to have insurance! The rationale behind insurance planning is not to risk more than you can afford to lose. If a particular loss has severe consequences for you, then you should not retain the risk but to transfer it to another party, in this case the insurer, who will bear the consequences of the risk in return for a specified amount of premium. Some examples of such risks with severe consequences are death of a breadwinner, having to suffer from a long-drawn serious illness or disability, loss of property, facing litigation etc. In a way, insurance helps to optimize the usage of capital or to provide the necessary capital when there is none. If there were no insurance, individuals and companies would be required to hold substantial amounts of funds in their reserves to offset any significant losses arising from the risks. And in the event that such huge reserves are not available, the individuals and companies will have to bear the full brunt of the very significant financial losses if there were no insurance in place.
Another misconception is that insurance is for the rich. But if you were to think about it carefully, who do you think is more likely to afford a medical bill of a few hundred thousand of dollars – a millionaire or someone who has only a few thousand dollars in his/her bank account? So who do you think needs insurance more? The only reason that I can think of which explains why many believe that insurance is only for the rich is because the rich have long been the popular target of hungry advisers and they are often sold more insurance on the basis that they can afford it and not so much because they need it.
Some people think that they are already very well-insured because they are paying a whole load of money each month on insurance premiums. Needless to say, this is not the case. You can spend a whole lot of money on insurance policies but if you haven’t got the right policies to cover the right risks for the right amounts, you are just wasting your money! And you may be surprise to know that getting adequate coverage doesn’t necessarily come at an exorbitant price.
First of all, it is not about whether you can afford insurance but whether you can afford not to have insurance! The rationale behind insurance planning is not to risk more than you can afford to lose. If a particular loss has severe consequences for you, then you should not retain the risk but to transfer it to another party, in this case the insurer, who will bear the consequences of the risk in return for a specified amount of premium. Some examples of such risks with severe consequences are death of a breadwinner, having to suffer from a long-drawn serious illness or disability, loss of property, facing litigation etc. In a way, insurance helps to optimize the usage of capital or to provide the necessary capital when there is none. If there were no insurance, individuals and companies would be required to hold substantial amounts of funds in their reserves to offset any significant losses arising from the risks. And in the event that such huge reserves are not available, the individuals and companies will have to bear the full brunt of the very significant financial losses if there were no insurance in place.
Another misconception is that insurance is for the rich. But if you were to think about it carefully, who do you think is more likely to afford a medical bill of a few hundred thousand of dollars – a millionaire or someone who has only a few thousand dollars in his/her bank account? So who do you think needs insurance more? The only reason that I can think of which explains why many believe that insurance is only for the rich is because the rich have long been the popular target of hungry advisers and they are often sold more insurance on the basis that they can afford it and not so much because they need it.
Some people think that they are already very well-insured because they are paying a whole load of money each month on insurance premiums. Needless to say, this is not the case. You can spend a whole lot of money on insurance policies but if you haven’t got the right policies to cover the right risks for the right amounts, you are just wasting your money! And you may be surprise to know that getting adequate coverage doesn’t necessarily come at an exorbitant price.
