Understanding insurance: It’s all about risk management

Do you really understand why you need insurance?

I don’t want to say that all insurance agents are unscrupulous and money-minded, because I have a few friends who work as insurance agents and are really good at their job.

The sad reality is that insurers are dishing out very attractive commissions for insurance products that are designed to make you part with more money than what you have to. They make their products more complicated by integrating elements of investment to charge a higher premium and grow their corporate revenue.

For a insurance agent who’s basically an insurer’s sales person, it’s very hard to not focus on selling the more profitable products.

You have to look out for yourself because nobody is doing it for you.

Insurance is all about risk management

Opposed to what many insurance agents are telling you, insurance is actually all about mitigating risk.

You just bought your home and did a nice renovation. Losing your home and belongings to fire or theft could mean losing everything. In order to mitigate that risk, you buy a home insurance to reimburse you for your losses.

That in my opinion, is what insurance is truly meant to do.

What you need to understand about risk

Start by determining the probability and impact of your risk.

TL;DR? Here’s a risk matrix to help you understand risk management in a nutshell.

Avoid risks that have high impact and high probability

If a risk has a high impact to your life and a high probability of occurring, the best way to eliminate this risk is to not participate in the particular activity or own the particular property.

The high impact could cost you everything you worked for (or your life) and the high probability of occurring means that insurers will charge you an arm and a leg just to protect you from the risk.

Reduce the probability of the risk occurring

Obviously we can’t avoid all forms of risks or we’ll never leave our home or cross the street. If the impact of the risk is not devastating, we can try to manage the risk by reducing the chance of it happening.

In most cases, reducing risk is just a matter of using common sense and doing things you know you should have done.

• Servicing your air conditioning to prevent water leakage
• Not drinking and driving to reduce the risk of getting into a car accident
• Not showing off your cash and jewelry in public to reduce the risk of getting robbed

If you can reduce the chance of a risk occurring, you may opt not to get any insurance to protect yourself against it.

Accept that there are some risks you have to take

There are some risks that have a low probability of occurring and low impact on your life should they occur. For these risks do you even need insurance coverage?

In some cases, the answer could be no.

Here’s an example.

You buy a standing fan from Courts for $39 and the cashier tries to sell you their in-house warranty that offers a longer and more comprehensive coverage for $10 (this is a fictitious amount). Personally, I would be willing to accept the risk of the fan breaking down and will either pay out of my own pocket for the repairs or purchase a new standing fan when that happens.

The amount of risks you are willing to accept depends largely on your risk appetite.

For me, I don’t always buy travel insurance for short holiday trips because I am willing to accept the risks involved. You may not want to accept these risks.

Transfer some risks to other parties

For risks that do not have a high probability of occurring but can make a large impact to your life when that happens, you would want to consider transferring these risks from you to another party.

Buying insurance is the most common method of risk transfer.

Insurance allows you to pay a predetermined fee (premium) and in return, the insurer takes over the risks from you. Should the risk occur, the insurer will absorb the losses that you would otherwise have to pay out of pocket.

Insurance makes the most sense when the impact of the risk is large but the cost to transfer the risk is low in perspective.

Here are a few examples:

• Transferring the risk of having to rebuild your $500,000 home after a fire to an insurer by buying a home insurance for $200 per year
• Buying a term life insurance to transfer the risk of leaving your family with debts when you pass away
• Purchasing a health insurance to transfer the risk of incurring hefty hospitalization fees, should you be struck with a major illness

Making your insurance purchasing decisions after understanding risks

You now understand what risk management is all about.

It’s time for you to decide what are the personal risks that you are undertaking today and how you should manage them.

If the insurance product that you are considering to purchase does not transfer away an adequate amount of personal risk for a low cost, then you don’t really need them.

If your insurance agent is talking to you about project returns and profits for purchasing an insurance product, instead of how the product can protect you from certain personal risks, walk away.

Do you agree with my view in this article? I’d love to hear your thoughts in the comment section below.

3 things I learnt about myself from Seedly’s recent event

Seedly is probably the only company that is able to organize a finance event in Singapore that managed to get people in their 20-30s to show up for a 6-hour long event, and make them pay $30 to attend.

On a lovely Saturday morning, I joined the bunch of lovely folks from Seedly at their exclusive meetup, Coffee Meets Investing. It’s a one-day meetup that discusses about a variety of topics around personal finance and investments.

Decide how much insurance coverage is sufficient for you

The recommendations made by Kenneth from Seedly on insurance planning was very similar to my low-cost insurance planning strategy. Making insurance decisions based on your income, spendings and liabilities made a lot of sense to me.

Kenneth also shared how I should choose insurance products and have meaningful decisions with my insurance agent. It’s a very sensible way in making insurance choices. The product(s) has to provide sufficient coverage, cost the lowest among its competitors and purchased for the right reasons.

I still make wrong investment decisions, even on hindsight

You know how people say hindsight is always 20/20?

Wrong!

Tai Zi from AutoWealth conducted a quiz where all the questions on investment decisions revolve around both recent and historical events. You’d think that with full information about market performances, everyone should get almost full marks right?

That wasn’t the case. Not even close!

Looking at the scoreboard, many participants were getting many of the questions wrong just like me.

The truth about making investment decisions by anticipating the results from political and economic events are really hard. Even economists don’t always get it right.

The exercise made me feel better about my investment decision to invest through AutoWealth since the start of 2018. By keeping investment simple and automated, I do not have to make any investment decisions (pretty sure I’d get it wrong anyway) at all. 🙂

Stock picking techniques did not excite me at all

Seedly invited a few folks to talk about investments, specifically on Dividend Investing by Chua I-Min and Factor-based Investing by Alvin Chow.

I think the topics are very interesting to the audience, but not to me.

Let’s talk about investing for dividends or income. I didn’t think it’s applicable at my current life stage because I’m still gainfully employed, working my way to financial independence. I don’t depend on my investments for income (yet) so I would much rather invest for capital appreciation instead.

When I’m ready to retire, I will then reduce my asset allocation to focus more on investing for income.

I’ve listened to Alvin Chow talk about Factor-based Investing before and I’ve read articles from quite a number of finance bloggers about the topic. It was just too complicated for me and I prefer to spend time NOT analyzing annual reports from companies.

Seedly helped me understand what I like and dislike about finance

I’m really thankful that Seedly took the time and effort to organize such a comprehensive event that covers the various topics around personal finance and investing without the hard-sell that usually comes with such events.

Over time, I can tell that I don’t like to spend a lot of time on identify individual stocks for investment. Instead, I’d very much prefer to keep them as simple as possible, and automate the entire wealth accumulation process.

Personal finance on the other hand, is something I’m more passionate about and I’ll try to write more about my thoughts on this topic more often in this blog.

Did you attend Seedly’s Coffee Meets Investing meetup? What are your thoughts about the event?

How I keep my insurance expenses low

I must admit that insurance is one of the things that I have been very slack at managing over the past few years. In my first few years of work, I bought an investment-linked policy from a friend who was an insurance agent in Prudential. When my father passed away, I realised that the hospital bills were very hefty. Not to mention the costs involved in organising a funeral.

Last month, I checked my investment-linked policy and found that after so many years, the policy was incurring a loss. Having concluded that insurers are not good good investors, I decided to surrender the policy and switch to term insurance instead while I build an investment portfolio for myself.

After all, the only one who cares about your money, is YOU.

My insurance philosophy

Insurance companies are not non-profit organisations. They need to stay profitable and keep their shareholders happy. Like-wise, insurance agents are faced with a conflict where the insurance plan that pays the highest commission, may not necessary be the best insurance plan for their clients. I spent a few weeks meeting insurance agents from different insurance companies to understand the types of insurance plans they offer and their benefits (I had to determine the weaknesses myself because no salesman would tell you the flaws of their products).

Self-insurance is a method of managing risk by setting aside a pool of money to be used if an unexpected loss occurs. Theoretically, one can self-insure against any type of loss. However, in practice, most people choose to buy insurance against potentially large, infrequent losses.

I decided to adopt a self-insured approach by maintaining an adequate self-insurance reserve fund. The self-insurance reserve fund is essentially a stash of cash that’s set aside for me to absorb some of the risks from the insurance company in exchange for paying lesser premiums. For example, this fund can come in handy when I need to pay for doctor visits and minor medical procedures. I don’t foresee the need to tap into the reserve fund anytime soon because my employer has a corporate medical and dental insurance for all employees so I can always use the corporate medical card to see the doctor.

To start the reserve fund going, I will be injecting the money that I get for surrendering my investment-linked policy so that it has a substantial amount to start with. I intend to add $128 (just a magic number that I came up with) every month so it could grow into something substantial when I retire and when there’s a high likelihood that I may need to tap into the reserve fund.

I still intend to take up health and life insurance plans to let the insurance company absorb the risks of a major illness or life-changing accident which could easily cost a six figure sum and wipe out my savings in an instant. I make it a point to avoid insurance plans that are packaged with savings and investment elements because these plans tend to charge higher premiums (and higher commissions for insurance agents) and produce below-average results. My investment-linked policy is an excellent example.

What’s my biggest worry?

My family. As the main breadwinner in the family, most of our liabilities lie with me. If something were to happen to me, my family will then have to shoulder my liabilities. What if I don’t die? That will make matters worse as they would then have to manage the cost of taking care of me.

How much do I insure myself?

My previous investment-linked policy costed me $128 per month and I was very comfortable with paying this amount monthly. However, the sum assured was only $100,000. I felt that the figure is very inadequate at this time in my life when I am busting my ass in the corporate rat race.

Here is a structure of my insurance portfolio built based on a time x income scenario:

• Death/Total Permanent Disability – 7.5 years of annual income
• Critical Illnesses (CI) – 5.5 years of annual income
• Early Stage of CI – 1 year of annual income
• Accidental Death – 5 years of annual income

After building my insurance portfolio structure, I went out and spoke to a few insurance agents for quotes. Eventually, I settled down on these options.

Death/Total Permanent Disability

• SAF Group Term insurance for $300,000 sum assured – $38.40 per month
• NTUC Income i-Term insurance for $200,000 sum assured – $24.70 per month

Critical Illnesses (CI)

• SAF Group Term Living Care insurance for $300,000 sum assured – $30 per month

Early Stage of CI

• SAF Group Term Living Care Plus insurance for $100,000 sum assured – $10 per month

Accidental Death

• SAF Group Term Personal Accident insurance for $300,000 sum assured – $13.38 per month

Despite getting an increased coverage, my total insurance expense is reduced to $116.48. On the whole, I am very satisfied with this outcome.

It’s not over yet

Insurance is planned for the long term and I will have to re-examine my insurance portfolio periodically to see if any changes to their policies are necessary. The critical timing that I must re-examine my insurance portfolio is at 65 years old because that is when my SAF Group Term insurance premiums will skyrocket every year thereafter.