More about reducing coverage

When we buy life insurance, there is one important reason why most of us should go for reducing coverage: most of us have limited budget in paying for insurance, reducing coverage gives us higher value of protection as compare to level coverage, at least for the first few years. This makes all the difference if anything happen to us now.

We begin with a simple example. You and your insurance agent calculated that you will need a coverage of RM400,000. But you can only afford to pay for premium of either
a. RM300,000 protection in a reducing coverage term life, or
b. RM200,000 level coverage protection term life, or
c. RM100,000 level coverage protection with RM100,000 savings/ investment (full life/ investment linked)

The logical choice is to buy the term life insurance RM300,000. Anything happen to you now or the next three years, you and/or family will get RM300,000 or close to RM300,000.

What about ten years later when your coverage reduces half to RM150,000?

Risk management is a process to review periodically. Just three years later your financial position would have changed, i.e. you have a higher salary, you have more kids, you have saved more money, you have more investment, you have more ownership in your home, etc. You can decide three years later whether to increase your coverage or to reduce your coverage. You can decide then whether to dump your current policies and buy a completely new plan for your entire protection need or just to buy new policies to top up your current coverage.

Just like corporate risk management, personal risk management requires periodic review. Personal risk management is something you can never do once and say enough.

Using the above method you are going to pay higher insurance premiums through out your life time. Some of the plan you add in your older age may be more expensive. However, you and your family protection are maximized based on your limited budget. You increase your insurance premium and protection when your financial situation improves and when your family grows.

If there is no financial constraint that you are rich enough to buy sufficient protection at level coverage, then you should buy level coverage. However, most of us probably cannot afford the premiums. (Insurance agent would say, "Therefore you should buy more now...since it will be more expensive in the future..." They are blind to say such things. Driven by peers pressure, targets to acheive and group commitments, most insurance agents refuse to recognise our financial limitation.)

Read more about reducing your life insurance premium without compromising protection.

Gambling with your insurance plan?

There is a fine line between hedging your risk or gambling with the hedging instruments. Insurance is for us to hedge against our financial loss upon the occurrence of an event. It is not meant to be used so that we are financially better after the event and the subsequent insurance claim.

When an event strikes, if our financial loss is covered by insurance, this is called proper hedging of risk. However, if not only our loss is covered but we are financially better off from our insurance claims after the occurrence of an event, we are gambling.

If we buy insurance more than what we need, the premium that we pay for just cover our loss is for the purpose of hedging, the extra premium we pay in order to have extra insurance claims is for gambling.

If we buy an insurance plan when we will be financially better off after the strike of an event, the extra premium we pay is just like the money that gamblers pay to 4D, TOTO, Big Sweep, etc. There is no different.

In lottery, you pay the bookie your bet. When the event strikes (you strike lottery) you are financially better. In buying insurance, you pay extra premium (more than actually required to just cover loss) to the insurance company. When the event strikes (though unfavorable), you cover your financial loss (hedging) and have extra money (gambling).

We were usually told (by agents), "Isn't it better if you have extra money after these things happened". Yeah, sure. It is also how gamblers convince themselves, "Isn't it better if I have extra RM3 million if my Big Sweep ticket strike."

This is particularly true in the education fund insurance that you pay for your children future education. Education fund insurance covers child's life. STOP! Why cover child life? Your child has not earned income yet! What financial loss that you are hedging against in the event of your child's death? (Touch wood.) Funeral expenses? It can be minimised, therefore it is not really an issue. So, a family becomes financially better (from the child's life insurance claim) after the death of their child.

This is a unpleasant example, but it illustrates well on the gambling part of insurance. When we pay what we don't need, when we were convinced by insurance agents buying more than covering our actual FINANCIAL loss (not emotional loss, etc.), we are gambling with insurance. No wonder we always feel insurance is expensive.