In my first post, we saw that there are only 4 possible ways that a person can spend money. Also that out of these 4, spending to achieve your goals is the most important. We called that Quadrant 4 expenses. You can find the full article here.
In my second post, we discussed how money can grow out of thin air which will eventually fund your goal based spending. Those who missed out can read it here.
Now, you know what is important. You also know how to create the cash flow required to fund what is important. You are about to start a long journey called investing.
Wait a minute!! Have you got your safety net in place?
If no, that’s the first thing that you should be doing before you even think of investing.
It will not be out of place to compare investing to Trapeze in circus. Both involve years of preparation, practice, timing, mastery over your fears, taking calculated risks and so on.
Have you ever thought of what the safety net means to the Trapeze artist? Of course, it protects him in case of a fall. But more importantly, it removes fear out of the equation. He will not be able to perform with fear at the back of his mind. The fear of uncertainty – What if a snatch doesn’t happen? What if the bar misses the timing?
It is a proven psychological fact that if one obsesses over something whether positive or negative, it materializes. Hence, it is in our interest that we obsess over positive aspects rather than negative thoughts.
The same concept applies to life generally and more specifically to our subject – Personal Financial Planning.
It’s not worth living in constant fear of uncertainties. If we have to live to our full potential we have to remove the fear element out of the equation.
This is done by replacing Known Uncertainties with Known Certainties. And there is only one product in this world which can do that for you. That is called Insurance.
From a personal finance perspective, I would classify Insurable Uncertainties or Risks into the following three broad categories:
- Personal Risk – This applies to the life, health and functionality of you and your family members
- Asset risk – This applies to your major physical assets like home or car
- Income risk – This applies to your source of income
Let us see why these become important in your overall financial planning.
Personal Risk
If you need to cover your personal risks comprehensively, you should ensure that the following three scenarios are taken care:
Scenario 1:
I know the exact amount which I need for each of my financial goals and I know the year in which the amount should be ready. Because it involves major goals like the education/marriage of my children and my retirement, the amounts are big which will take years to build. With my experience, skills, qualifications and hard work, I am 100% sure that I will have the required amount in my bank as and when the time comes.
That is – IF I AM ALIVE.
If I die this very minute, will my children get the same education which I wanted them to? Will they get married off in the same way I wished? Will my spouse be able to put food on the table for the family?
These questions are answered by Life Insurance.
I can see the smile on your face and I can read your mind – “Big deal. I already have Life Insurance”.
Almost everyone has been sold some or the other life insurance product thanks to the numerous Life Insurance Agents.
But I can bet that very few among you have ADEQUATE life insurance which will ensure that your goals or in other words, your dreams will be met the way you wanted if you are not around.
My bet is based on pure mathematics rather than any prophetic skills. Majority of the life insurance products sold currently are ULIPs, money back or endowment policies. These policies are mainly sold as investment and not as insurance. Hence the advisors tend to keep the insurance cover to the bare minimum stipulated by the regulator (IRDA).
The minimum insurance cover stipulated by IRDA in ULIPS, Money back or endowment policies is 10 times of the annual premium which you pay. This means if you need an insurance cover of Rs.1 crore you should be paying a premium of Rs.10 lacs per year.
Most of you who are reading this blog would need an insurance cover upwards of Rs.1 crore to effectively cover your goals. But how many can afford to pay a premium of Rs.10 lacs per year?
The solution to the above is called “Term Life insurance “which very few advisors promote to their clients. A 40 year old can get a cover of Rs.1 crore for a premium of less than Rs.18000/- per year which works out to approximately Rs.50/- per day. Costs less than half a packet of cigarette.
Scenario 2:
Unlike Scenario 1, I am very much alive and am slowly but steadily building my Quadrant 4, ie, my goal based fund.
One fine morning, I collapse and is taken to hospital. Doctors diagnose that I have coronary blocks and advised a By-pass surgery costing around Rs.3-3.5 lacs. Where do I get the money for this?
The whole family gets tensed up. Eventually, the money is taken out from my Quadrant 4. The money which I had put aside for my retirement now gets pulled out to meet this emergency.
This is where Health Insurance comes into picture. If only I had health insurance, my retirement fund in my Quadrant 4 would have been protected.
Similar to term life insurance, this doesn’t cost much. A family floater plan providing a cover of Rs.5 lacs for both parents in the age group of 36-45 and 2 children costs less than Rs.18000/-per annum. Again less than Rs.50/- per day.
If you really need to understand the value of a life insurance or a health insurance policy, ask the young father who had just undergone a heart attack and realized that he has missed to take health insurance to cover the treatment costs as well as life insurance to protect the future of his kids. No one is going to give him insurance now.
Forget heart attack, even if you have been diagnosed with the common diabetics, you will find getting insurance nearly impossible or exorbitant. Hence, if currently you are underinsured for Life or Health and if currently you are lucky to be healthy, don’t waste a day. Get insurance TODAY.
Scenario 3:
Let’s assume that I have taken adequate Term Life insurance to cover scenario 1. I have also taken health insurance to cover Scenario 2.
I meet with an accident. I was hospitalized for couple of weeks. Hospital bill came to Rs.1 lac which my health insurer promptly paid. I was discharged but my doctors told me that I will be paralyzed for life.
This puts me in a fix. I am very much alive and hence my life insurer will not pay me money. My hospital treatment is over and my health insurer has discharged their obligation. There is a glaring gap here.
This void is filled by a personal accident policy.
A personal accident policy in addition to covering accidental death also covers permanent total or partial disability. A cover of Rs.25 lacs costs less than Rs.4500/- per annum. Rs.12 per day.
Very few people have comprehensively and adequately protected themselves against all the three scenarios which I have mentioned above. Don’t think that this negligence applies only to non-finance professionals. I have worked in financial services industry for 17 years and the story is not different even for professionals working in the industry.
Asset Risk
Asset risk applies to your major physical assets like your house or car.
You have spent most of your life’s earnings into buying or building your house. If something happens to that house, maybe due to an earthquake maybe due to a flood, can you afford to re-build that house a second time? If yes, will the money again come out of Quadrant 4 which should have funded your goals like retirement?
Take the example of Chennai floods in year 2016. A lot of my friends had to leave their houses for months, stay in rented alternative accommodation, clean up for days after the water receded, repair the plumbing, electrical fittings etc. In addition to the hardships caused, these would have hit their Quadrant 4 by anywhere between Rs.50000/- to Rs.1 lac. All of which should have ideally been footed by a home insurance policy. If only they had taken it.
A home insurance policy also covers contents including electrical appliances and valuables. This means your 48” Television destroyed in lightning or your necklace which gets stolen will not hit your purse but that of the insurance company’s purse.
Do you want to know the cost? Buildings cover for a 1500 sq ft house comes at approximately Rs.2500/-per year. Add to this, Contents cover of Rs.5 lacs (including jewellery cover for Rs.1.25 lacs) and the premium becomes approximately Rs.7000/- per year.
Car insurance is anyways mandatory and hence you have to take it whether you like it or not. Irony is that people who wouldn’t mind paying a premium of Rs.25000/- to insure their Rs.9 lac car are reluctant to pay a premium of Rs.18000/- to protect their family’s future by taking a term life insurance for Rs.1 crore!!
Income Risk
“Lionel Messi insures both his legs for 550mn euros”. Hope you got the idea of income risk.
This protects your source of income. Mainly applies to people who are businessmen or self employed professionals like doctors etc.
Example – For a shop keeper, his shop is his source of income. If his shop gets destroyed in a fire, his income stops which ultimately devastates his Quadrant 4. If he has failed to insure his shop, he has only himself to blame.
Let’s take the example of a doctor. We are seeing more and more instances of patients and patient’s relatives accusing doctors of professional negligence. When such an incident happens, the public, the media, people in power all take a stand against the doctors irrespective of the facts. Even one such incident can impact the income and Quadrant 4 of a doctor severely. Taking a professional indemnity policy protects the doctors against this risk. In addition to covering the financial liability, a professional indemnity policy also brings in the expertise of the insurer in handling such cases. Cost – Approximately Rs.18000/- per year for a Rs.1 crore cover.
End Note
Let me take you back to a statement which I mentioned at the beginning of this article. In order to remove the element of fear, replace the Known Uncertainties with Known Certainties. Let’s map the scenarios under Personal Risk to this statement. The Known Uncertainties were possible death, disease and disability and the possible outcome was non achievement of financial goals for me and my family. Now we have replaced that with a Known Certainty that COME WHAT MAY, the goals will be achieved for my family – WITH ME OR WITHOUT ME. And at what cost? Rs.112/- per day!!
In short, when you take insurance it does not protect your life, health, home or profession. It actually protects your dreams irrespective of what happens to your life, health, home or profession. It protects your Goals. It protects your Quadrant 4. I wouldn’t mind starving for a couple of days. But I wouldn’t dare to miss the premiums on my life or health insurance even for a day. And for that same reason, I classify these premiums as Quadrant 1 expenses, the most urgent and important expenses.
Because performing a Trapeze without the safety net is not bravado but sheer foolishness.