What is Insurance - Really?

As we approach the last month of the fiscal year, the inevitable mad scramble for saving taxes is bound to commence sooner than later. Tragically, the month of March is also synonymous with countless instances of the “buyers regret” syndrome, with clients succumbing to the age-old fallacy of buying insurance to save taxes – only to regret their decisions deeply later on. This unfortunate outcome really stems from a poor understanding of what insurance really is. Is it an investment? Is it a savings tool? Is it an income generator? All of these? None of these?

The Concept of Risk

To understand that insurance really is, you need to have a basic idea of the concept of insurable risk. From a personal standpoint, we all bear certain financial risks. The easiest to understand is the risk of the loss of one’s life, which is bound to impact the ones who are financially dependent upon him or her. Other risks could be –bearing huge medical expenses due to an unexpected illness or accident, contracting cancer, suffering from a heart attack, having an accident, damaging your vehicle and heaving to bear huge expenses in its repairs, and so on. These are all personal risks that, if they materialise, could severely damage your financial plan and set you back in your goal achievement.

Here’s the important point to note: the purpose of insurance is a singular one - covering these risks!

It’s as simple as that! The only money that’s worth committing towards insurance is the “risk premium”, or the cost that you must bear to transfer these insurable risks to an insurance company. Every rupee you pay over and above this is a waste.

But then, you may ask why the market is flooded with so many complicated insurance products that are loaded with enough jargon to make your head spin. There are two reasons for this. One, the cost of “pure” insurance is really small. A 30-year-old needs to pay just Rs. 8,000 to 10,000 a year to get a life cover of Rs. 1 Crore! These small ticket sizes are not very remunerative for conflicted agents who are not working in your interest – and hence, in come the bundled products that create very little value but net the agents a hefty commission! The second problem lies with clients themselves, who are unable to wrap their heads around the fact that pure risk products so not “pay” anything back at the end. Why would they? The money you’ve paid is the cost of transferring that risk to the insurer for a year; so, it’s money well spent, isn’t it? Agents capitalise on this mindset to pitch unrewarding products such as endowment plans and ULIP’s to their clients.

So: the bottom line is: when it comes to insurance, just buy pure risk products. Don’t see them as an investment, and don’t buy insurance to save taxes. There are better options available to serve these two purposes. A moment of prudence will save you a whole lot of buyer’s regret later on!