| Ranjeet s Mudholkar, Ceo, Fpsb India Most people believe that having a few lakh of rupees is a reason good enough for them to |
There is some element of risk in every aspect of human endeavor and many of these risks might not have any financial consequences. Insurance deals with those risks that involve
a financial loss.
Individuals must have a basic understanding of risk and insurance in order to properly assist
themselves in assessing their insurance needs and evaluating their current insurance coverage. Too often the concept of risk, or the chance of a loss, is confused with the terms "peril" and "hazard". A peril is the proximate or actual cause of a loss eg. Fire, tornado, earthquake, burglary, collision etc. A hazard is acondition that creates or increases the likelihood of a loss occurring and /or the severity of damages that result from a peril. But first, let us understand the terms - Risk and Insurance. Risk can be defined as the possibility of loss, uncertainty or a variation of actual from expected results. Risks to a person could be premature death, prolonged illness, disability, the inability to work and the need for long-term care. While these risks could be low in frequency, they are potentially catastrophic in severity. Individuals must take steps for mitigating the impact of such risks by selecting and implementing appropriate insurance coverage.
Insurance Coverage
Proper insurance coverage is essential to an individual's financial plan. Most people do not have the right amount of insurance coverage and, therefore, are either over insured or underinsured. For most
individuals, basic insurance needs can be covered with life insurance, health insurance, disability insurance, homeowners or renters insurance, automobile insurance and personal liability insurance.
Individuals and businesses may respond to pure risk exposures in one or more ways:
a) Risk avoidance-it is simply the avoidance of any
chance of a loss.
b) Risk reduction-consists of activities that reduce the frequency or severity of losses.
c) Risk retention-when an individual is exposed to risk and decides to bear part or all financial burdens if
a loss occurs.
d) Risk transfer-involves shifting the probability of loss to another party, such as insurance company, by
purchasing insurance.
Nature and Functions of Insurance
Many people mistake insurance with investment. However insurance is primarily a risk aversion
product and not an investment opportunity. Insurance is a valuable tool for protecting the individual
against fortuitous accidental losses because it allows for the transfer of losses and for the sharing of losses with others. Thus the insured transfers the risk to insurance company and pays the insurer company a premium to accept such risk.
Insurance has two fundamental characteristics:
1) Transferring or shifting risk from one individual to a group;
2) Sharing of losses, on some equitable basis, by all members of the group.
Cooperation and sharing are essential to the insurance process. From an individual's point of view, insurance is an economic device whereby the individual substitutes a small certain cost (the premium) for a large uncertain financial loss (the contingency insured against) that would exist if it were not for the insurance.
The primary function of insurance is the creation of the counterpart of risk, which is security. Insurance does not decrease the uncertainty felt by the individual as to whether the event will actually occur. Nor does it alter the probability of occurrence. What it does is to reduce the probability of financial loss connected with the event.
Why insurance is a Must
Insurance plans have always been, and will remain, an essential feature of every Financial Plan and more so because of the following developments:
Increase in the number of nuclear families: An accelerating trend of a higher proportion of nuclear
families in the total number of house holds vis-à-vis joint families increases the need for insurance as the dependency ratio increases significantly.
Increase in Debt: Low interest rates have fostered a further increase in household debt, mainly in the form of mortgage loans. As the proportion of leverage increases and lenders stipulate that the loans availed of be covered under insurance, there is a greater need for term insurance.
Increase in Health Cost: With health spends inflating faster than the headline inflation, there is
a greater need for health protection.
Absence of social security increases need for risk cover: In other developed economies (like Singapore, UK, etc), there is an adequate social security system in place, which lowers the need for insurance. In comparison, India does not offer a social security system, as a result of which the populace has to rely on external agencies to provide the much required risk cover.
Providing financial support to the dependants: Life insurance is a fundamental element in a comprehensive financial plan for most individuals, particularly those with dependants. The purchase of life insurance is one of the most effective methods of protecting against the consequences of untimely death. After a family suffers the loss of a loved one, it usually encounters an unsettling and emotionally stressful readjustment period. Life insurance proceeds to the family members or heirs can provide for the family's financial support during such a period of readjustment.
Need for General Insurance: A home and automobiles can represent a substantial portion of a person's assets. Thus, insurance on each is a significant concern in Financial Planning. Government requires automobile insurance by compelling motorists to be "financially responsible" for damage to or loss of the insured's vehicle, injury to the insured or family members, legal liability for injuries and damages to other persons. In addition to these statutory requirements, automobile insurance is also purchased because the automobiles are financed, and the lender requires the borrower to carry coverage for direct physical damage on the vehicle. Liability insurance provides the insured with financial protection against lawsuits and other claims for damages that result from the insured's actions.
Risk Management Plan
The risk management is a vital component of the Financial Planning process. It must reflect the chosen response to risk. Once executed and various insurance covers are bought it should be periodically evaluated and reviewed on account of two reasons. One that external influences change over time and risk exposure can change as well. Secondly, errors in judgment may occur, and periodic review allows the risk manager to discover such errors and review the risk management plan as necessary.
While drawing up the Financial Plan it is important to realize that Insurance is about taking a cover for the unknown future events that could bring with them varying financial liabilities. It is also about providing financial support for the family and other loved ones, protecting their lifestyle once you are not around. No wonder paying insurance premiums is a small price for the benefits it brings along in times of need.
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