The Complete Guide to Buying Insurance

Welcome to the complete guide to buying insurance. In this article, I will share with you all the basics of insurance, which are important for you to know before you buy any insurance plan for yourself.

Dear friends, I am launching this masterclass series called 'The Complete Guide to Buying Insurance'. In which I will cover all those minute details of insurance with you in my own 6 articles, all that you need to know to buy any insurance plan. I am not an insurance expert, so I associated with a knowledge partner with Policybazzar for this series. I spent a lot of time with their terms and tried to understand all the things that I guess, even I did not know. I am just a medium, and whatever I have learned from Policybazzar, I will share all of it with you today in this 6 part of series.

The Complete Guide to Buying Insurance
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In this first part, we will cover the basics of insurance. Many legal terms are used in insurances, go it is important to know them, How do things change? What is a risk profile? What is premium? Why does it change? All of those things are important for you, irrespective of which insurance you are buying.

In the second part, we will focus on life insurance, which according to me is the most vital insurance, and before you make any investment, it is very important for you to have the right insurance plan. Which one should it be?

In the third part, we will talk about health insurance, specifically for your parents. When it comes to parents, health insurance goes to a different degree, why? Because they are aged, maybe their ailments are increasing, their risk profile is very different so, the terms and conditions in their insurance plan should mostly be different from your insurance plan. How and why? we will get to know it all in that part.

In the fourth part, we will talk about health insurance focused on you and your family. Since you are young, you have lesser dependents or even if you have dependents, then they are your kids or spouse, and that will be very different from buying health insurance for your parents. So, what should be the terms and conditions in it? That is also important to know.

In the fifth part, we will talk about insurance against loans. You are taking a home loan, education loan, then you can take insurance for that also. Like I took insurance for my education loan as well as a home loan. Why did I take it? On what terms? And which other things are important to know to take this insurance, we will get to know in that part.

And finally, Vehicle insurance. It is mandatory whenever you buy a car or a bike, but we never to understand it, number 1, that what are the things in it which are important to know, and if God forbid if an accident happens to you, then what should you expect? In these 6 parts, as you have figured, we will cover everything that there is to know about insurance and after that, you will know everything that there is to know about buying insurance. All right, let's start the first part today.


Basics of Insurance

What are the fundamentals of insurance? first let's try to understand insurance, that what is this product? It is a beautiful product, a valuable product and if used properly then you can have adequate protection for yourself. This means that you give an amount to a company, which is called the insurance company, half-yearly, quarterly, or monthly. And why do you give this amount? Because you want protection. Protection against something that you can't plan and predict. So, insurance has a basic formula, that is 'X' happens, and 'X' keeps changing depending on the kind of insurance you are buying, then give me financial protection. If 'X' happens, give me financial protection. For example, if I am hospitalized, I get a disease because of which I have to stay in a hospital, then give me financial protection, meaning I need aid to bear the hospital's expense. If death happens, if I die, then give my family financial protection, meaning if I as an earning member die, then my dependents who relied on my income, give financial protection to them. This is the basic definition of insurance. Because, usually the amount that you have to give for this protection, that dramatically lowers then the actual amount you are paid when it is 'X'. I will say that once more with an example, many of us must be having health insurance, even if not, then hopefully after that series, you will definitely take it, I will give my example when I started health insurance, which was about 15 years back when I was 20 years old, around that time I took a cover of 5 lakhs, for my parents and my self and my sister. I was unmarried at that time, there were just the four of us, and I took a 5 lakhs cover. As for as I can remember, according to me for that 5 lakh cover, I used to Rs 15,000 annually and that covers the entire family. this means that God forbid if something happens to any one of us and we have to be hospitalized because of that, then the insurance will pay the hospital bill. But I have paid only Rs 15,000 for that, for one year, yes it could happen after 2-3 years, but it will take many years to cover Rs 5 lakh, right? But still, the insurance company is giving me a 5 lakh cover for just a premium of Rs 15,000, how does it work? To understand this, first, let's understand the definitions.


What is a policy/insurance?

First, the contract that you do with your insurance company, that if 'X' happens, then give me financial protection, that contract is called policy. In short, life insurance is a contract between an insurer and a policy owner. A life insurance policy guarantees that the insurer will pay an amount to the nominee if something happens to the insured during the period the insurance is in force. There are two fundamental things in this policy.

1. Premium

One is premium. Premium is that amount which you give to the insurance company. It could be monthly, quarterly, half-yearly, or annually. This is the amount you give to get the financial protection, that the insurance company promises you. Another important thing is cover. Cover means financial protection. To what limit, what scale, what amount, will you get this financial protection, it's called a cover, meaning how much covered, are you? So, let's talk about the same health insurance. At the age of 20, when I took a cover of 5 lakhs, meaning if, in my family, anybody gets hospitalization, then the insurance company will bear the hospital bill up to 5 lakhs on my behalf, and for that, I gave a premium of Rs 15,000. This is how it works. Now the biggest question that most people have is, 'this is a fraud!' How can you get something worth 5 lakh in Rs 15,000? This is not possible. I am not going to do this, and that is why, In India, very few percent of people actually have insurance, whether life or health. And it is because you are asking protection for something which has not to get happened to you, and more often than not, you want that it should never so you are actually paying someone for something that you do not want. 

2. Cover

And second, you are paying such a small amount for such a big cover, that it almost sounds fake. How is this possible? How does this work? So, for that, it is important to understand that what is business model of insurance companies. Since I am a stock investor so I am interested in business models, and I love to understand them.


How does Insurance work?

Suppose, there is a town and 100 people live in it. All of those 100 people have health insurance and let's assume the insurance is for Rs 3 lakh for all those 100 people. And suppose these 100 people have paid Rs 10,000 annually for that insurance of Rs 3 lakhs. So how much money does the insurance company get in a year? (Rs 10,000*100) which is Rs10,00,000. They have given the insurance of Rs 3 lakh, Now the insurance company has done a calculation at their end that, How many people get hospitalized in one year? Now, I don't actually know this number, but if I Predict, of course, I am not an insurance company, an insurance company has all the data, they collect all the data from all the hospitals, medical fraternities, and use it. They figure that 2% of the population gets hospitalized in a year, so 2 out of 100 people get hospitalized in a year. The company got a premium of Rs 10 lakh in a year but at the end of the year, out of 100, on average 2 people get hospitalized, which means, what was the expense on them? Even if we take maximum, though the hospital bill doesn't need to be equal to be cover, it could be less also, but even if we take the maximum, then for 2 people having a cover of Rs 3 lakhs, which means insurance company had to pay Rs 6 lakhs to the hospital and at the end of it, that year, they made Rs 4 lakhs 'profit'. This is not the actual profit because there are many other things as well in it but at the premium level, they made a profit, and that is how it works. 


How is an insurance premium decided?

What they do is something called "Risk pooling. Insurance companies pool the risk,  They try to understand that, there is a group, and the characteristics or features of that group are more or less the same, which means broadly even their risk profile would be the same. For example, in health insurance, if you smoke but everything else is fine, then your grouping would be with all the smokers who have everything else in order. So, it is assumed that this group, which actually smokes, but has no other medical condition, will have more or less the same risk behavior, meaning the rate of their hospitalization will be more or less the same, rate of their critical illness will be more or less same, the possibility of their death will be more or less the same, and that is how the insurance company actually goes about creating common risk group and through that they decide the premium. This is why the premium changes according to who you are and where you are. Since I took insurance at the age of 20, which is quite young, hence I got it cheap. If today at the age of 35, I take an insurance plan with the same cover then I will not get it at the same premium. I will have to pay more premium, why? Because the risk of me dying so young is far lesser. If I have taken the same insurance at the age of 35, then naturally risk has changed, the risk of someone dying in the next 20 years when they are 35, is far higher than the risk of someone dying in the next 20 years when they are 25, and that is how the insurance companies price their product and that is why your premium, the amount that you pay for covering the financial protection varies according to your age, your profile, your medical conditions, your characteristics, your features. In the west, countries like the US, where insurance is highly developed, it is on a different level. If you take insurance for a vehicle, then they look at your past driving profile. In which area do you live? Where and how do you go every day? How much do you travel in your car? All of those inputs go into determining that what will be your probability for a car accident. And obviously, if I drive really fast, and I am not assuming or being judgemental, but just to give you an example, I am very young, I have a fast car or a sports car, I have kilometers every day, I have had 4-5 accidents previously, then it is quite likely that the probability of me having an accident is higher, as against a 35-year-old man, who drives 10-20 kilometers every day, has a simple small hatchback or sedan car, never had an accident, so his risk profile for car insurance would be very different. That's the detail that goes into buying insurance. So, this is very important to understand before we go into any analysis of an insurance product, whether you are buying life insurance, health insurance, insurance for a home loan, education loan insurance, vehicle insurance, for parents, for yourself, for your family, whatever the case is, it is very important to understand how does the insurance work.

Summary

What is a policy, what is a cover, what is a premium, and how is it that you can take such a big cover in such a small amount? Once you have understood this, then is the next step for us to cover, how do you go about assessing different insurance products. I hope this article was useful and this was a good start to cover our insurance journey. This is "The Complete Guide to Buying Insurance". In the next part, we will cover life insurance, the most important insurance according to me, every person should take it as soon as possible. but what is term insurance? What are different other forms of life insurance? What is a capital guaranteed plan, pension plan, retirement plan, death plus plan? What are all these things? How to buy? How to evaluate? we will get to know all of these in the next part.

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