Money Blog

What is insurance?
We all have a life and every asset used by us has a life. We own an asset with an expectation that we will be able to enjoy its benefits till the end of its life. However there is always a risk associated with the life of an asset or in other words there is an uncertainty whether the asset will complete its life of will perish, or become non functional before the expiry of its life. The concept of insurance emanated from the human desire to hedge this risk or uncertainty with respect to the life of the asset. Insurance is an arrangement whereby a number of people using similar assets pool in a small portion the cost of asset to indemnify some of them whose asset does not complete its life. In simple words insurance is sharing of risk by many people who are subjected to the similar risk.

The business of insurance
Earlier this kind of arrangements were made among small groups but with the passage of time, as the number of interested people increased, the need of intermediaries was felt who could manage these arrangements at a larger scale. It emerged as a business opportunity and a number of companies across the world started the business of insurance at commercial levels.

Life and Non Life Insurance
A human life is also an income-generating asset and it also needs protection against unfortunate and unwarranted happenings like early death, sickness for a long time, amputation of limbs, etc. The insurance companies realized this fact and commenced the business of insuring lives of people along with other assets and later on the insurance business was divided in two branches Life Insurance and Non-Life Insurance as life was the most precious asset for anyone, it had to be separated from all other assets.

Purpose of Insurance
From what you’ve read above, it may be safely concluded that insurance is a cost of hedging the risk or uncertainty associated with the asset. Where there is no uncertainty or risk, there can be no insurance. We pay an insurance premium to the insurance company and the insurance company takes the risk on itself. Hence the real purpose of insurance is to hedge the risk on the asset at the cost of a nominal premium. Insurance is always an expense, which we incur to safeguard the life of our asset.

What people do not consider while buying insurance
With the growth in the insurance industry and becuase of fierce competition in this field, the insurance companies are coming out with new and innovative insurance products to lure their customers, and in this race and in order to convince their prospects, they tend to combine insurance products with investment products and tie up riders with main policies. Your insurance advisor would be more keen on selling an investment rather than an insurance, because he believes that he might be able to sell an investment to you by showing the returns coming out of it, rather than a pure insurance which will be a cost of the risk on your life.

What actually happens when you buy an investment cum insurance plan, is that the insurance company will invest a small portion of your premium towards the risk cover of your life and rest of the premium, after deducting various administrative and other costs, will be invested in securities as specified in the plan you opted for.

Now, this is something, which you could do yourself. Instead of the above investment if you would have taken a term plan (a pure insurance policy) of the same sum assured and invested rest of your money in some mutual fund or Government securities, what ever you would have opted in the above insurance cum investment plan, the total returns would be much higher as compared to the above case. You save a lot of money which would have gone in the form of agent’s commission (commissions in insurance industry are very high as compared to the commissions in other investments) and also the administrative costs of insurance companies are much higher than the administrative costs of other investments viz. mutual funds, government securities, post office investments, etc. Generally in a traditional insurance policy about 35 percent of your first premium is actually invested and rest of the money is used in expenses. On the other hand, in a mutual fund generally about 90-93 percent of your investment is invested and rest of the money is used for the costs of the scheme. The broker’s commission in a mutual fund ranges from 2 to 3.5 percent. People, generally, do not consider all these facts before buying an insurance policy and this is something, which you can never expect to learn from your insurance advisor. He will always try to convince you on the basis of long-term yields of your investments.

Also while buying an insurance policy, people generally do not look at the surrender value. You may have an urgent need in future and you may decide to redeem all your investments, you might not get anything in most of the policies if you surrender them within first three years and in case you surrender at the end of 10th year you may get the principal back, don’t expect any returns. Whereas in case of other investments the redemption costs are very low.

Insurance is an expense and not an investment
We must realize that nothing comes free in this world. If you want to hedge the risk on your life there is a cost of it, which is charged, in the form of insurance premium. Always buy an insurance policy as an insurance policy and don’t be taken away by the tied up investment plans or riders. Be informed about all aspects of your policy. You have a right to know, not only the returns of your investment plan, but also the costs and expenses associated with it. And don’t forget to look at the surrender value of your policy.