A Beginner’s Guide to Insurance
Having the right kind of insurance is central to sound financial planning. Some of us may have some form of insurance but very few really understand what it is or why one must have it. For most Indians insurance is a form of investment or a superb tax saving avenue. Ask an average person about his/her investments and they will proudly mention an insurance product as part of their core investments. Of the approximately 5% of Indians that are insured the proportion of those adequately insured is much lower. Very few of the insured view insurance as purely that. There is perhaps no other financial product that has witnessed such rampant mis-selling at the hands of agents who are over enthusiastic in selling products linking insurance to investment earning them fat commissions.
What is Insurance?
Insurance is a way of spreading out significant financial risk of a person or business entity to a large group of individuals or business entities in the occurrence of an unfortunate event that is predefined. The cost of being insured is the monthly or annual compensation paid to the insurance company. In the purest form of insurance if the predefined event does not occur until the period specified the money paid as compensation is not retrieved. Insurance is effectively a means of spreading risk among a pool of people who are insured and lighten their financial burden in the event of a shock.
Insured and Insurer
When you seek protection against financial risk and make a contract with an insurance provider you become the insured and the insurance company becomes your insurer.
In Life Insurance this is the amount of money the insurer promises to pay when the insured dies before the predefined time. This does not include bonuses added in case of non-term insurance. In non-life insurance this guaranteed amount may be called as Insurance Cover.
For the protection against financial risk an insurer provides, the insured must pay compensation. This is known as premium. They may be paid annually, quarterly, monthly or as decided in the contract. Total amount of premiums paid is several times lesser than the insurance cover or it wouldn’t make much sense to seek insurance at all. Factors that determine premium are the cover, number of years for which insurance is sought, age of the insured (individual, vehicle, etc), to name a few.
The beneficiary who is specified by the insured to receive the sum assured and other benefits, if any is the nominee. In case of life insurance it must be another person apart from the insured.
The number of years you want protection for is the term of policy. Term is decided by the insured at the time of purchasing the insurance policy.
Certain insurance policies may offer additional features as add-ons apart from the actual cover. These can be availed by paying extra premiums. If those features were to be bought separately they would be more expensive. For instance you could add on a personal accident rider with your life insurance.
Surrender Value and Paid-up Value
If you want to exit a policy before its term ends you can discontinue it and take back your money. The amount the insurer will pay you in this instance is called the surrender value. The policy ceases to exist. Instead if you just stop paying the premiums mid way but do not withdraw money the amount is called as paid-up. At the term’s end the insurer pays you in proportion of the paid-up value.
Now that you know the terms this is how insurance works in plain words. An insurance company pools premiums from a large group of people who want to insure against a certain kind of loss. With the help of its actuaries the company comes up with statistical analysis of the probability of actual loss happening in a certain number of people and fixes premiums taking into account other factors as mentioned earlier. It works on the fact that not all insured will suffer loss at the same time and many may not suffer the loss at all within the time of contract.
Types of Insurance
Potentially any risk that can be quantified in terms of money can be insured. To protect loved ones from loss of income due to immature death one can have a life insurance policy. To protect yourself and your family against unforeseen medical expenses you can opt for a Mediclaim policy. To protect your vehicle against robbery or damage in accidents you can have a motor insurance policy. To protect your home against theft, damage due to fire, flood and other perils you can choose a home insurance.
Most popular insurance forms in India are life insurance, health insurance and motor insurance. Apart from these there are other forms as well which are discussed in brief in the following paragraphs. The insurance sector is regulated and monitored by IRDA (Insurance Regulatory and Development Authority).
This form of insurance provides cover against financial risk in the event of premature death of the insured. There are 24 life insurance companies playing in this arena of which Life Insurance Corporation of India is a public sector company. There are several forms of life insurance policies the simplest form of which is term plan. The other complex policies are endowment plan, whole life plan, money back plan, ULIPs and annuities.
All other insurance policies besides Life Insurance fall under General Insurance. There are 24 general insurance companies in India of which 4 namely National Insurance Company Ltd, New India Assurance Company Ltd, Oriental Insurance Company Ltd and United India Insurance Company Ltd are in the public sector domain.
The biggest pie of non-life insurance in terms of premiums underwritten is shared by motor insurance followed by engineering insurance and health insurance. Other forms of insurance offered by companies in India are home insurance, travel insurance, personal accident insurance, and business insurance.
There are an umpteen number of policies to choose from. Because we cannot foresee our future and stop unpleasant things from happening, having an insurance cover is a necessity. But you need to choose carefully. Don’t simply go with what the agent tells you. Read policy documents to know what is covered, what features are offered and what events are excluded from being insured.
1. Know your Needs
Determine what asset or incident must be protected against loss/damage. Is it you life, health, vehicle, home? Next determine what kinds of damage or danger exactly would the assets be most probably be exposed to. This will tell you what features you should be looking for in a policy. Of course there will be losses which cannot be foreseen and the cost of dealing with them can be very high. For instance nobody can predict that they’ll never suffer from critical illnesses no matter if they’re perfectly healthy at present.
The biggest mistake while it comes to buying insurance, particularly life insurance is to view it as an investment. Clubbing insurance and investment in a single product is a poor idea. You lose out on both fronts because for the premiums you’re paying more cover could’ve been got in a term plan and if the premiums were invested in better instruments your returns could’ve been several times more.
Be wary of agents who want to talk you into buying unnecessary policies like child life insurance, credit card insurance, unemployment insurance and so on. Instead of buying separate insurance for specific assets or incidents look for policies that cover a host of possible events under the same cover. Whenever possible choose riders that make sense instead of buying them separately. Unless there is a fair chance of an event happening you do not need insurance for it. For instance unless you are very prone to accidents and disability due to your nature of work or other reasons you do not need an Accident Insurance policy. A good Life Insurance policy with accidental death rider or waiver of premium rider or a disability income rider will do the job.
2. Understand Product Features and Charges
The worst way of choosing an insurance product or insurer is to blindly follow the recommendation of an agent or a friend. The good way to do it is to shop around for products that suit your need and filter out the ones offering lower premiums for similar terms like age, amount of cover, etc. All details you need about the product features and charges will be provided on the company’s website. Many insurance policies can now be bought online. Buying online is smarter because premiums are lower due to elimination of agent fees. If buying offline in case of life insurance, tell the agent that you’re interested only in term insurance.
Before you sign on the contract make sure you have understood what items are covered and what items are exempted from the cover. It would be so devastating to learn in the event of damage or loss that the item you hoped to cover with the insurance was actually excluded. So many people rush to their insurers after being treated for diseases only to realize that the particular disease was excluded. Understand details like when the cover begins and ends and how claims can be filed and losses be reported.
Don’t choose an insurance company because your neighbourhood friend is their agent and never let them coax you into buying from them. Insurance premiums run for years and it means a sizeable amount of money. Apart from the premiums charged look for the service provided. When you are faced with a peril you want the claims collection processed to be complicated with non-cooperating staff in the insurance company’s office. Seek answers from people who have had previous experience with the company for questions like how customer friendly and responsive the company is when it comes to handling claims.
3. Evaluate and Upgrade in Time
As you walk from one life stage to another or when the asset insured changes your policies must be reviewed. Perhaps your cover will need to be increased (or decreased) or you’ll need to top it up with a rider. Some instances when you need to review your cover are when you getting married, when you have children, when your income increases your decreases substantially, when you’re buying a house/car and when you’re responsible for your ageing parents.
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