The insurance trap

When a young person starts earning, the first step into financial adulthood is to get insured. However, to do this correctly, one needs to understand what insurance really is and how much one actually needs.

Let's look at the dictionary definition of insurance: an arrangement by which a company or the state undertakes to provide a guarantee of compensation for specified loss, damage, illness, or death in return for payment of a specified premium. For life insurance, this can be simplified: an arrangement by which a company will compensate your survivors if you die in return for payment of a specified premium.

This is the only definition of insurance. Any product or service that does not fit this is not insurance, even if it is being sold by an insurance company. Keep in mind that much of what insurance agents try to sell you is not insurance.

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How much should you be insured for? There are a variety of ways to arrive at the answer, but a starting point could be 10 years' worth of your current income. This will obviously vary according to other family members' income, assets, house, etc., but rarely would an amount less than 10 years' income suffice. If you don't believe me, quickly make a rough estimate of what your family's budget would be if you were to die soon. Believe me, 10 years of income will turn out to be barely adequate unless you are otherwise wealthy.

So here's the most important question: Do you have enough insurance? The answer is no. How can I be so sure? Because that's the correct answer for a vast majority of Indians, and so statistically speaking, this is likely to be your answer, too. The strange thing is, in my experience, most people know how much premium they pay to insurance companies, but do not know what their family will get if they were to drop dead at this instance.

Actually, it's not that strange because the life insurance business is optimised around taking money and, indeed, measures its success not by how much its customers are insured for, but how much money the customers pay. It does so by ensuring that a vast majority of products are not insurance but expensive and opaque investment products that have a small smattering of real insurance as a statutory requirement.

By the way, this trickery is official. Even the insurance regulator (IRDA), which is supposed to protect your interests, measures the industry's growth success by how much money the industry takes from customers rather than how much insurance they have delivered and to how many people.

The IRDA annual report, or any other published data in this country, does not reveal the actual extent to which people are insured. IRDA uses something called 'insurance density', which is the per capita premium customers are charged as well as the premium as the ratio of GDP. This is not a joke, although it ought to be.

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These numbers do not tell us how much insurance coverage is delivered, only how much money the industry has extracted from people. The real questions are: When a customer dies, how much money does his family get? How many customers receive the full amount of coverage? What is the ratio of the total premium collected to the cover provided? Shockingly, this information either doesn't exist (meaning IRDA has not bothered to collate it), or it's a secret.

This attitude of the regulator is perfectly reflected in the behaviour of whoever sells you insurance. However, the various ways in which agents will try and befuddle you will make too long a story. You should just focus on getting 10 years' income worth of insurance. If you do this, you will get only the right kind of insurance product, which is term insurance. The reason for this is that in other kinds of insurance products, getting 10 years' worth of life cover will cost you your entire income.

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The basic principle of buying insurance is to keep insurance and investment separate and buy only pure insurance (term insurance). In India, insurance sellers have encouraged an investing culture where people are averse to buying term insurance because 'you get back nothing'. Agents do this because they earn far higher commissions for other kinds of products.

It's not possible to be charitable or even polite while commenting honestly about this existing system, so I won't even try: this system exists because the regulator is asleep, agents are conniving and manipulative, and customers are foolish. The system won't change, so it's up to you to learn how to actually buy insurance. Don't get fooled.

Also read: An unrepentant industry

This article was first published on May 30, 2018.