Wednesday, 10 February 2010

Insurance.. Precaution? Investment? or.. Unnecessary Expense? (1)

Yes, I know.. repetitive calls from insurance agents can be very annoying, especially when the calls are blind calls, and you are not considering taking insurance.. ;-)

However, what if you are thinking about having an insurance policy, but you feel that you don't know enough about it, and you are not sure how to decide about which type of insurance you should choose?

What we need to understand, to begin with, is that insurance is 'transferring part of our future risks to a third party (insurance company)'..

Why do I say 'part'? Because, we still have to pay a regular fee to the third party as a bind. This regular fee is known as a premium.

There are different types of risks that can be covered by insurance, some common examples are:
home/building against theft or fire,
vehicle (car/motorcycle) against theft, break down or accident,
health for hospitalisation or accident,
education for future plans, and
life in cases of accident or death.

There are also other types of insurance, but in this post, I will only discuss the common ones.

There are certain aspects that will be taken into consideration to decide the amount of premium we have to pay for the insurance we take, for instance:
total value of building and contents, in the case of building/home insurance,
age and make of vehicles, in the case of vehicle insurance
age and health condition, in the case of health and life insurance
age of child(ren) to be insured and how much to be collected at due date, in the case of education insurance.

All these aspects are explicitly stated in the insurance application form, and your insurance agent is able to explain in more detail if you need more information.

Once all your details are collected by the insurance agent, the agent can then tell you (based on the insurance company rule) how much premium you need to pay for each insurance period. Most insurance policies require annual (yearly) premium payments, while others, might present their calculation in an annual amount but allow clients (you) to pay in monthly or quarterly installments.

Referring back to the point where I mentioned that having insurance is 'transferring' part of risks to a third party is the only way to save you the shock of learning about the amount of premiums you have to pay for the insurance you need.

Insurance cannot cover any risks suffered by their clients, unless they accept enough money from clients to re-invest in other businesses to grow their profits. Insurance companies are businesses, and more than that, insurance companies are running a high-risk type of business.

Therefore, if the insurance company who approaches you offers a very low premium for a high coverage that you ask, BEWARE! You really need to check further any relevant details about the insurance company background!

However, in this era, with the strong competition in the insurance industry, insurance companies need to 'manage' their clients' expectation very well and make offers that can benefit their clients more.

This condition, resulted in various packages of insurance that do not only require premium payments by clients for insurance cover as a benefit, but also offer additional benefits, such as, retirement savings or investments.

How is it possible?

Here is how..Insurance companies, as a business entity, must ensure their ability to keep running and paying their clients' insurance covers whenever their clients claim it. At the same time, to stay competitive against other insurance companies, they have to keep the premium they offer as low as possible. Therefore, insurance companies must re-invest some of the money collected from their clients in other businesses after allocating the necessary amount to be placed in another insurance company, to insure their business.

The amount that insurance companies invest in other businesses is aimed to generate ongoing profits to support their main business, which is covering people's assets and lives (clients' insurance policy). From this operation, when successful, insurance companies can do a lot more than simply pay clients' claims. They can also offer some return to clients, at least to give back some (or all) premiums that have been paid by clients after a few years.

These types of packages give better offers when clients choose the long-term insurance policy (10 years or above). Some of the common packages are:

health insurance + retirement package, where you have to pay a premium for the health insurance until the age limit (usually around 55-60 years old), and you can collect the retirement benefits a few years after (usually between 75-90 years old). With this type of packages, you might still be covered for sickness or hospitalization up to the benefit collection age, although not all insurance has the same rules.

health insurance + education savings package,where you have to pay a premium for the health insurance until the age limit (usually around 55-60 years old), and you are entitled for some part of the total benefit payout when your children are entering new stage of education (entering elementary school, junior high school, senior high school and university).

The types of packages offered by each insurance company are different, so you should have a look at more than one company to find the one that suits you the best.

A new development of an insurance package is health insurance + unit link. This type of insurance is directly linked to a set of investment units (shares/stock) that are chosen by the insurance company's investment managers.

This type of insurance is riskier than the saving packages, although whenever the share market is going well, the unit link investment is going well too and clients can reap high profits from their investment linked to the insurance.

Why is it riskier?

Here is why.. by offering a unit link insurance policy, insurance companies are transferring back to clients, some of the risks they are facing when they are re-investing their funds to support their business. So, rather than offering a set amount of money, they will pay clients in later years, insurance companies offer clients the choice of having limited control over their wealth invested in the insurance companies. By doing this, insurance companies are limiting their loss, if the businesses they re-invest in suffer losses or even go bankrupt.

Clients having unit link insurance usually are not allowed to change the units (shares/stock) placements. However, they can choose how much (in percentage) of their premium to be allocated in the share market and/or money market. This gives clients some (limited) control over their money invested in the insurance company.

The fact that clients have some control, means that they need to be in a position to take decisions to protect their own wealth. Therefore,clients must have sufficient knowledge about financial markets and keep themselves up-to-date with any development in the financial market, in order to ensure the safety of their investment linked to their insurance policy.

Having discussed about various types of common investment policies, I hope this post can provide some useful information for any of you wondering about insurance.

I will discuss more about insurance from clients' perspective in my next post.

Have a nice day :-)

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