Chapter 01 · Insurance in a financial plan
Insurance pays for a loss you cannot fund
Insurance is a way to move a loss you cannot pay for onto a balance sheet that can. It is a poor way to save, and a poor way to invest. This chapter draws that line before any product is named.
Which losses qualify
A loss qualifies for insurance when it is large, uncertain, and damaging enough that your other plans would not survive it. A fire in the only house, a long hospital stay, an early death that removes the income other people live on. A loss does not qualify when it is small enough to pay from the emergency fund, or when it is certain. You do not insure the cost of food. You already know it will happen, and the insurer, who also knows, would charge you the cost plus a margin.
The premium is the price of transferring the large uncertain loss. On average, across all customers, the insurer must collect more than it pays out, because it has costs and a profit. That is not a scandal. It is why a customer who buys insurance for small, frequent costs will lose on the exchange. The right customer is the one who cannot survive being the unlucky case, and who is willing to lose a modest premium in the lucky case.
Saving and insuring are different jobs
A savings product collects your money, invests it, and returns it later with a return that depends on the assets. An insurance product collects a premium and pays a claim if the event happens. A product that promises both is doing two jobs with one premium, and the part that is actually insurance is often a thin slice. You can see the slice by asking a rude question: if the event never happens, how much of my premium comes back, and after what charges? If most of it is designed to come back, you bought a savings plan with an insurance label, and you should compare its charges with a fund you can buy separately.
A household balance sheet test
| Event | Could the household pay without selling the long-term investments or changing house? | The fitting tool |
|---|---|---|
| A laptop dies | Yes | No insurance. Replace it from cash. |
| Two months of lost income | Yes, if the emergency fund is real | The emergency fund, not a policy. |
| A hospital bill of several lakh | Often no | Health cover, read for exclusions. |
| The earning adult dies, and others depend on that income | No | Life cover of a size that replaces the income, not a size that feels like a round number. |
What to remember
- Insure the loss that would wreck the plan. Pay the small losses yourself.
- The insurer’s margin means insurance is a bad deal for small, likely costs and a sensible deal for large, unlikely ones.
- If most of the premium is designed to come back, you are saving, and the charges should be compared with a fund.
- The size of the cover is set by the loss, not by a convenient premium.