Assurance of Insurance — Do I Need it? — (A Primer)

Hey guys….once again, happy to be back with you all. Sincerely hope that you all are fine. Unfortunately, no one can be sure of their plans in these confusing and terrifying times anymore. As I found out firsthand after avoiding Covid for almost 2 years, it finally caught up to me, leaving no choice for me but enduring it and let me tell you that it is certainly not the experience anyone will want. Fortunately, I have been vaccinated, and therefore, symptoms were mild, but it almost wrote off the entire week. Thus, from personal experience, I would say that if you do not have any serious medical issues, there is no need to be scared of Covid. Still, at the same time, it would be much nicer if you could manage to stay away from it. So, get vaccinated and believe me, all that troublesome precautions are really worth it.

Ok….lets move on to our next topic — “Insurance”. We had discussed it briefly during our previous series on Mutual Funds. Still, I think it deserves a more detailed discussion, and in present circumstances of uncertainty, it certainly looks like a very relevant topic.

What is Insurance?

It is a legally binding contract between a financial institution (insuring company) and a person or the organisation where the company promises to pay a certain pre-decided amount in case of loss of the insured object. The most common object of insurance could be ‘life’ leading to life insurance, ‘health’ leading to health/medical insurance, ‘motor vehicles’ leading to ‘vehicle insurance’, house leading to house insurance or even ‘travel-related losses’ leading to ‘travel insurances’. The insurance is always provided for a limited period against payment of certain money (known as a premium) as agreed between a person seeking insurance and the company providing it. It may be for a period as short as a day in case of travel or maybe more than 50 years in case of life insurance.

The underlying principle of insurance is that if a group of people seek insurance and pay a premium, only a fraction of them will actually require the insured amount to be paid out to them because of the fulfilment of the condition. Let’s take an example to understand it better. Imagine if a group of 100 people take life insurance policies with insured value as Rs 1000/- and pay a premium of Rs 100/- (only 10% of actual insured value), the insurance company would have collected Rs 10,000/-. However, suppose less than 9 people actually lose life. In that case, the insurance company will make a profit while also providing a payout to the families of the deceased, thus ensuring their financial needs are met. It is a win-win situation for all, and everybody is happy in the end.

But what if this group of 100 has a probability of more than 10 people dying? It’s simple, the insurance company will seek more premium from everyone for the same amount of Rs 1000/- payback. For ease of calculation, let’s assume that of these 100 people, only 80 survive the insurance term…..then certainly insurance company should have charged Rs 200/- from each member so that it remains profitable while fulfilling its commitment. This kind of sums up the insurance philosophy which primarily has a foundation in the probability of occurrence of an event vs the premium charged for insuring against that event.

Why do I need it…or don’t need it?

The answer is straightforward, if you have anything you fear losing either because of its monetary or emotional value and the possibility that it may disrupt your and your family’s lives, you should consider insuring it. The examples may vary from Life Insurance to House or Car Insurance, protecting livelihood by insuring businesses, shops, even expensive tools of the craft, or it could be that antique painting that has been in your household since Akbar’s times. People have insured weirdest of things, including body parts and even memories. But, the takeaway from this is if you have a requirement be rest assured that someone will have the product to match your needs. Fortunately for us consumers, after the de-regularisation of the insurance sector in 2000, there are now a dozen public or private companies to choose from for either life or general insurance. For lack of a deeper understanding of emotions and motives, I would be restricting this post on insurance to a pure finance perspective.

Pro Tip: — If a loss of an asset, including your life, is likely to affect your or your family’s financial conditions, you must consider insuring it.

Life Insurance of Non-Earning Members of the Family?

By the logic above, while it might make sense to seek life insurance of breadwinner as the absence of him will deny the pay-cheques to the family, but what about minor children or for people who do not plan to work for money (elderly people, house-wives etc.)? Then, by pure mathematical calculations, it does not warrant life insurance. Yes, I know it is controversial, but guys, I am restricting myself here to pure finances and nothing else. I fully agree that their lives are as important as the breadwinner and maybe even more because of the support they provide to the breadwinner to go out and earn, but, financially, it may be prudent to invest that amount in better-paying investment options and not in insurance.

What to Insurance and What Not?

There can never be one answer that fits all. Like many other questions related to personal finance, this too has to be answered by you alone. There may be broad guidelines to help you, but finally, you have to decide what to insure and at what cost? Let’s take an example of health insurance, which I advise as a must for all, whether young or old, rich or poor and even employed or unemployed. Suppose you do not have any scheme either provided by your employer or gifted to you by friends and family, ensuring medical cover to you and your immediate family. In that case, it is vital to get one medical/health insurance as early as possible. But the question here is, for how much value? Now, think rationally, can there ever be any valuation to health or capping of expenses on medical treatment……. therefore, the answer to this lies in your paying capacity and not those imaginary dreadful illnesses your mind wants to protect you and your family.

Similarly, while car or motor-bike insurances are very common, would you also like to insure your cycle, which you might be using for your daily commute to the office? Probably not, because while a car, if stolen or met with an accident, would be extremely hard to replace in the near future, the probability of a cycle being stolen is far lesser, and if damaged in an accident, the cost of repairs may not be exorbitantly high. However, if I add that your cycle is a high-end racing cycle costing lakhs, will it change your decision? Certainly yes……..and that is understandably correct too. The same principle applies to anything and everything, be it household items or business/shop’s property. The only underlying principle in insurance is that it is a product — to keep you insulated from sudden significant losses. You pay a fraction of the cost at a regular interval and incur expenditures to secure this assurance. Therefore, higher the probability of threat to your valued items higher should be your sum insured on it while keeping in mind that it will raise your expenditures.

That’s all for this post, guys…..the intention was simply to motivate you to think rationally about this very important subject that is rarely understood in totality and generally remains in shrouds of jargon thrown at us by insurance companies and their glossy advertisements. Obviously, there cannot be any doubts that we all need some form of insurance, be that life, vehicle, travel, health or general insurance for some costly items but how much insurance is good and how to choose the instrument wisely remains a mystery to most of us. Therefore, ponder over the generic concepts discussed in this post and using this primer as a base, we will build on these concepts into actionable points in the next few posts.

Buy till then……I sincerely hope you will like this series, too, similar to the previous series on Mutual Funds. I am banking on your support in my mission to spread financial awareness among the masses, and for that guys, if you like the post, please share it with as many people as possible. Please do not forget to hit the CLAP button to show your appreciation. For new readers, please do FOLLOW to continue receiving the posts.

See you soon next week….happy reading and happy investing.

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