What is Insurance?
Insurance is one of four ways "Risk" can be managed. You may not realise or even know it, but this is how we, as individuals, handle all the risks to our health and welfare throughout life, enabling us to make informed decisions about how we manage potential threats to our health and well-being.
Essentially, either consciously or unconsciously, we all choose to one of the four options (or sometimes a combination of the four) below:
1. We Accept the Risk
This is where you acknowledge the existence of a risk and decide to accept the consequences if it occurs. This is often chosen when the costs of mitigating the risk are higher than the potential loss.
An example might be a young parent who already has a basic life insurance policy through their Super. They know that if they were to pass away unexpectedly, their family would face financial challenges. However, they decide not to buy additional coverage for the following reasons:
- Financial Priorities: They feel their budget is tight and would rather allocate funds to other essential expenses, such as saving for a house or paying off student loans.
- Belief in Low Risk: They perceive themselves to be in good health and believe that the likelihood of an untimely death is low, especially given their age and lifestyle.
By opting not to increase their life insurance coverage, they consciously accept the risk that their existing policy may not provide enough financial support for their dependents should something happen to them.
2. Avoid the Risk
Avoiding a risk means taking steps to eliminate it entirely. This can involve changing plans, processes, or strategies to sidestep potential threats. This strategy is employed when the potential impact of a risk is deemed too great. For example, you might avoid entering a high-risk location such a war zone that could result in significant harm or injury.
An example of this could be that you are planning to buy your first home. You understand that if one partner were to pass away unexpectedly, the surviving partner might struggle to make mortgage payments, leading to financial instability. To avoid this risk, you take the following steps:
- Delay Home Purchase: Instead of rushing into buying a house, you decide to wait until they have purchased sufficient life insurance for both partners.
- Research and Purchase Coverage: You visit us, your financial adviser, and we research and select a life insurance policy that offers adequate coverage to protect your financial situation.
By postponing their home purchase until they have appropriate life insurance in place, they are effectively avoiding the risk of financial hardship that could arise from one partner’s untimely death. This proactive approach helps ensure that their financial obligations are manageable, even in the worst-case scenario.
3. Reduce or mitigate the Risk
This strategy focuses on implementing measures to lower the likelihood or impact of a risk. This could involve implementing safety procedures when you do something, such as wearing a helmet on a motorbike or a seatbelt in a car. For example, not smoking, eating healthily, and keeping fit will lessen the risk of bad health outcomes or long-term illness.
One example of reducing risk is the use of income protection insurance alongside life insurance.
Income protection helps mitigate the risk of losing your income due to illness or injury. If a person cannot work for an extended period, income protection would provide a regular benefit to replace a portion of their salary. This reduces the financial risk to the family by maintaining cash flow for essential expenses, such as mortgage repayments, living costs, and children's education, ensuring financial security even without the primary income earner's contribution.
By combining life insurance and income protection, you effectively reduce the financial risk of premature death or prolonged inability to work, securing your family's financial future.
4. Transfer the Risk
Transferring risk involves shifting the responsibility or impact of a risk to a third party. This can be done through various means, such as purchasing insurance. For example, you may buy Life insurance to cover you if you pass away from illness, accident, or injury, effectively transferring the financial risk to the insurer.
Insurance is a financial arrangement that protects against potential future losses or damages. It works by allowing individuals to pay regular premiums to an insurance company. In return, the insurer agrees to cover you from certain risks and compensate the policyholder in the event of a loss, such as Illness, Injury or death.
Here are the key components of how insurance works:
Risk Management: Insurance helps manage the risk of financial loss by spreading it across a large group of people. When individuals pay premiums, they contribute to a pool of funds that the insurer uses to pay for claims.
Premiums are the regular payments made by you, the policyholder, to maintain your cover. Premiums are typically based on factors such as your age, health, the level of risk, amount of coverage, and previous claims history.
Coverage is the specific risks or events that the insurance policy will protect against, such as life cover, Trauma Cover, etc. Different types of insurance provide coverage for various needs, such as different health events and the severity of those events, ranging from a few weeks off work to partial disability to permanent disability or death.
Claims refer to when a covered event occurs. The policyholder can file a claim with the insurance company. The insurer will then assess the claim and, if approved, provide compensation according to the policy terms.
Exclusions or Loadings: These are specific conditions or circumstances that are not covered by the insurance policy. Ladings are where you are asked to pay a higher rate due to a particular issue, such as being overweight or having a particular condition. It’s important for policyholders to understand these exclusions to avoid surprises when filing a claim.
In summary, insurance serves as a financial safety net, offering protection and peace of mind by helping individuals recover from unforeseen events without incurring overwhelming costs.