Insurance is a fundamental aspect of financial planning that provides individuals, families, and businesses with a safety net in the face of unexpected events. It plays a crucial role in risk management and offers peace of mind by providing financial protection when it’s needed the most.
In this discussion, we’ll explore the four key principles behind buying insurance, shedding light on why it’s essential and how it can safeguard your financial well-being. Whether it’s protecting your health, securing your assets, or ensuring your loved ones’ future, understanding these principles will empower you to make informed decisions when it comes to choosing the right insurance coverage.
Insurance Principle 1: The Expense that Shapes Financial Security
For many of us, the topic of insurance rarely sparks enthusiastic conversation, and it might even trigger negative sentiments, depending on our perceptions of insurance. Nevertheless, it is a critical subject, as it forms the bedrock of our financial plans. Mishandling insurance can potentially lead to future financial challenges. In this original MoneyOwl series on insurance planning, we present 12 fundamental principles of insurance, derived from our extensive experience providing financial guidance to our clients.
When we acquire the latest mobile phone, we part with money in return for the device.
When we visit a hair salon, we exchange money for the services rendered.
What about insurance? What is the reason we pay our insurance company?
Certainly, it’s not for the stack of documents filled with terminology that perplexes us.
In its purest essence, we pay a modest sum of money in exchange for a substantially larger lump sum payout in the event of a rare occurrence such as death, disability, or illness. For instance, a 25-year-old pays $1 per day in exchange for a $1 million death benefit.
Although the probability of these events occurring is typically quite low, their impact on our lives can be profoundly severe. From a purely mathematical standpoint, that same 25-year-old would have relinquished a potential $2 million in earnings if they were to permanently lose their ability to work.
Most of us lack the financial resources to immediately replace our income many times over if we become unable to work. Thus, we entrust insurance companies to assume this risk on our behalf. In a more abstract sense, we pay them to provide us with a safety net, one we hope to never need.
Given that insurance is an expense—a sum you pay for the security net—it makes sense, especially for cost-conscious Singaporeans, to seek the lowest possible expenditure for the highest attainable coverage.
Insurance Principle 2: Insurance Primarily Provides Protection
If you were to input your life insurance premiums into a budget worksheet, how would you categorize them – as an expense, savings, or investment?
Perhaps, if your insurance plan has a cash value component, you might perceive it as a form of savings. Alternatively, if your insurance plan invests in unit trusts, you might regard it as an investment.
Rarely would one categorize insurance as an expense, since this implies paying for a product that is intangible, hoping never to use it, and acknowledging that the expenditure won’t be recovered if nothing adverse happens.
We tend to view insurance as a means to enhance our wealth. This inclination aligns with the way the insurance industry has repositioned itself for better marketability.
According to the Life Insurance Association Singapore (LIA), 48% of new insurance sales in Q1 2020 were attributed to products with cash values, while investment-linked policies comprised an additional 20% of the market. These policies attract attention because they offer the potential for wealth accumulation by channeling a significant portion of your premiums into the insurer’s participating fund or unit trusts.
We firmly believe that the primary purpose of insurance is protection, with wealth accumulation considered a secondary objective at most.
Just as we wouldn’t order bubble tea with cheese toppings to satisfy our cheese cravings, an insurance policy is rarely the most cost-effective means of growing your wealth.
Insurance is essentially designed to safeguard you and your loved ones against unforeseen events that could disrupt your ability to work. Don’t compromise the core benefit of insurance by fixating on the idea of receiving money back.
When we blend our aspirations for wealth accumulation with the fundamental aim of protection, we typically end up spending more on insurance, acquiring less coverage than necessary. It’s akin to buying an umbrella that’s too small to shield you from the rain because you paid a premium for the option to receive a refund in case you don’t use it. This approach seems counterproductive, doesn’t it?
Insurance Principle 3 – Insurance as the Foundation for Wealth Building
“Why should I pay for protection against something unlikely to happen, with no possibility of a refund? Isn’t it wiser to embrace the risk and maintain full control of my finances, rather than relying on someone else’s terms and conditions?”
This perspective often leads some individuals to believe that purchasing life insurance is unnecessary. They intend to rely on their savings and investments to navigate any potential setbacks, and if nothing adverse occurs, they consider it a victory, having spent nothing on insurance.
Interestingly, insurance and investments are two complementary facets of the same strategy for building wealth. In your 20s, your human capital (i.e., the present value of your future earnings) is at its peak, while your financial capital (referring to your savings and investments) is relatively modest, given that you’ve just initiated your earning journey.
If, suddenly, you lose your ability to earn, you may experience a significant reduction in your overall wealth, which you cannot readily replace. Regardless of your investment prowess, potential returns from saving on insurance premiums cannot surpass the lump-sum benefits provided by insurance payouts.
Moreover, most investments require time to compound and experience exponential growth, especially when enduring short-term market fluctuations. Prematurely liquidating your investments could lead to capital loss, which compounds your financial troubles during times of need.
Conversely, in your 50s to 60s, you will likely have accumulated substantial financial capital, while your human capital has dwindled. At this stage, it might be more cost-effective to rely on your investments to cushion any potential setbacks rather than investing in costly insurance policies. When your wealth can comfortably replace your future income, self-insurance becomes a viable option, and life insurance becomes less essential.
We advocate for our clients to secure adequate coverage before embarking on their journey to accumulate wealth. A well-structured insurance plan safeguards your pursuit of financial success, acting as a safety net. It’s akin to having a spare tire in your car; in the event of a flat tire, your journey continues with minimal disruption.
Don’t wait until you’re stranded with a flat tire before searching for a replacement. Initiate your insurance journey with us today!
Insurance Principle 4 – Determine the Right Type of Coverage
Discover the type of insurance coverage you require and the essential questions to consider when selecting the most suitable insurance plan for your needs.
One of the fundamental questions to address when evaluating the appropriate insurance plan for your situation is, “What type of insurance coverage do I need?” Not all insurance options serve the same purpose. To identify the common types of insurance, we must first consider the objectives of coverage.
- To Handle Extensive Medical Expenses (Health Insurance)In Singapore, it’s often said, “It’s better to die in Singapore than to fall sick.” Falling ill in Singapore can incur substantial costs, involving extended hospital stays, treatments, and medications. When considering your treatment preferences and the peace of mind for your loved ones, ensuring adequate health insurance becomes a top priority.
Health insurance in Singapore is available in various forms, such as hospitalization, critical illness, and long-term care plans. Hospitalization plans, including our national healthcare insurance, can be complemented by Integrated Shield Plans offered by private insurers. These plans primarily operate on a reimbursement basis, meaning you can’t claim more than the actual medical expenses incurred.
However, there are specific medical expenses that aren’t covered by conventional health insurance plans, such as alternative treatments, traditional Chinese medicine, and ancillary medical costs. Critical illness plans address these gaps by providing a lump sum benefit that can be utilized at your discretion. Severe disability and long-term care plans, like CareShield Life and ElderShield, along with their respective supplements, provide monthly benefits to offer flexibility in utilizing the funds for medication, hiring assistance, or covering community care services.
- To Provide for Loved Ones in Case of My Absence (Life Insurance)Life insurance is essential to ensure that your financial dependents are protected in the event of an untimely death or total and permanent disability. Cost-effective term insurance is well-suited for this purpose, covering you until your retirement or until your financial dependents no longer rely on your support, whichever occurs later.
While whole life insurance can serve the same purpose, it tends to be more expensive due to its extended coverage period and additional savings component. This may not be the most cost-effective method for wealth accumulation.
- To Replace Lost Income in Case of Inability to Work (Lifestyle Insurance)Disability or illness that prevents you from working can significantly impact your financial stability. Lifestyle insurance is designed to replace your income during your recovery period, ensuring that your financial plans remain unaffected by changes in your income or temporary work absences.
Occupational disability plans provide a monthly benefit, aiming to replace up to 75% of your income if you are unable to perform your current job duties. Critical illness plans, on the other hand, offer a lump sum payout that you can use at your discretion to supplement your income while focusing on treatment and recovery.
These are just a few of the more common insurance types intended for protection purposes. Naturally, other insurance types are designed to help you save and plan for your retirement. However, as these plans primarily focus on wealth growth, they are typically more expensive when used for protection needs.