The other day, I met with a tech-enabled wealth management firm. Its platform allows an individual to track his or her financial assets and liabilities. The platform can extrapolate past track record to show potential wealth accumulation at a later date. This enables a user to adjust current savings and expenses to achieve financial goals.
I liked the platform for its ease of use. Many individuals, whose finances are in disarray, will benefit. The thing I struggled with was the manner of projections. The projections were a straight line. I pointed this out to the wealth manager and suggested a third dimension, risk. Especially those risks that can disrupt income or destroy assets. A few of these risks could be hedged with insurance.
I don’t want to be a harbinger of doomsday. But you would agree that bad things do happen, even to good people. Now, one should always hope for the best and work towards a bright future.
However, optimism should not be a substitute for preparedness against bad luck. There are some risks that are difficult to hedge, for example, a recession. Then there are a few that you can prepare for. If a risk can be outsourced, why shouldn’t it be? Good investment managers generally worry about the price of risk. They adjust the variables to optimise the risk-reward situation. Seldom does a sound investment manager ascribes zero probability to possible risks.
Ironically, during financial planning, much attention goes to factors that seem probable but un-addressable. And, less attention to risks that seem remote but addressable.
Residential homes are a good example. Coffee conversations revolve around price trajectory, construction quality and level of supply and demand in the market. Generally, people do not plan for a cylinder blast in the neighbour’s kitchen or an earthquake.
Considering that a city like Delhi gets about 63 fire calls and two earthquake tremors every day, you cannot avoid these situations. But, if you have a fire insurance for your home, you can ease the financial stress caused due to such an incident. You do not even need to buy insurance for the full value of the house, but only the reconstruction cost.
A 2,500 sq. ft mid-luxury house with an average construction cost of Rupees 4,000 per sq. ft will have a sum assured of Rs 1 crore. The annual premium for basic fire insurance for Rs 1 crore sum assured is less than Rs 4,000, excluding taxes. If you take a ten-year policy, premium would be less than Rs 15,000, excluding taxes.
Personal accident insurance is another example. A cousin was recently returning back home with her children after receiving them from the school bus. A car in the reverse mode rolled over her feet. Her ankle was fractured for which she had to undergo surgery. She was confined to six weeks of bed rest post-surgery. Apart from hospitalization expenses, which were covered under her health insurance, she suffered several out-of-pocket expenses.
She missed her work, got additional attendant help, and bought a few equipments to support her movements. A personal accident policy would have covered this expenditure. Depending on the disability type, permanent or temporary, and extent, partial or total, the plan pays a lumpsum. Rs 25 lakh coverage for personal accident insurance cost about Rs 3,000, excluding taxes.
Even if you consider the part-mandatory motor insurance, it is substantially underinsured or uninsured. Motor insurance has two components, own damage and third-party liability. The latter is mandatory.
Own damage covers loss to your car by accident or theft. The third party covers legal compensation payable to the third party due to damage caused by your car.
Estimates suggest that between 25 percent to 40 percent of vehicles on the road are plying without the mandatory third party liability insurance. The number of vehicles without own damage insurance is likely to be higher. A large proportion of people who have own damage motor insurance are not aware of a few critical add-ons. For example, zero depreciation is a highly recommended cover.
While settling claims of repairs, insurers deduct depreciation for the period for which the parts have been used. This leads to major deductions for plastic parts. A zero-depreciation add-on ensures that such a deduction is not made. Zero depreciation costs about Rs 4000 for a car worth rupees five lakhs.
Fred Rogers, a distinguished US TV presenter, once defended budget allocation for his program before a US Senate committee. In his case, he described how his program helped viewers develop emotional abilities. He emphasized the need for individuals to have “the good feeling of control” when things don’t go as per plan. This control comes from the assurance that one can start over. That speech gave goosebumps to the senator and earned him $20 million approval. Insurance can be that reset button that gives financial resilience when things go wrong.
I had used these examples to illustrate my point to the wealth management firm but was rebutted with a more practical difficulty. Several clients see these insurances as an avoidable expense. And, a push from the wealth manager is often perceived negatively and driven by vested interest. That is unfortunate because not buying these low-cost insurances is really the client’s loss.