Risk Management is Important

“If you don’t invest in risk management, it doesn’t matter what business you are in, it’s a risky business.” – Gary Cohn

In investment and trading world we often hear about risk management which means to minimize the risk involved in a trade. When we enter a trade, it can either go in our favor giving us profit or go against us giving us a loss. The maximum loss that we can afford in a trade is our risk in the trade. We are advised by the experienced traders to manage the risk through proper position sizing and by using a stop loss. Professional traders pay more attention on limiting their risk in a trade so as to primarily protect their capital. Whether its trading or life, the risk management acquires fundamental importance. In fact, the risks involved in life, if not taken care of, may lead to irreparable financial damage. However, some of these risks can be managed with the help of safety measures such as Insurance.

The Key is to Transfer the Risk

“The Key to risk management is never putting yourself in a position where you can not live to fight another day.” – Richard S. Fuld. Jr.

The best way to manage unforeseen and unaffordable risks involved in our lives is to transfer those risks, if possible, to someone else. By purchasing an insurance plan/policy, we actually transfer the risk to the insurance company. I used the word ‘purchase’ because transferring the risk would involve some cost. In case of insurance that cost is the fee or premium that we pay, either one time or periodically, to the company. The company collects the premium from the ‘insured’ (the person who purchased the insurance; also called the policy holder) and invests the funds in financial markets. This way the funds invested by the company grow consistently over time. In case of emergency the policy holder can make a claim on his insurance, from the insurance company. The company pays back the sum assured, as promised in the insurance plan, to the policy holder. In this process the onus to meet the risk shifts from the individual policy holder to the insurance company.

The Risks That Make Us Vulnerable

“Our alertness towards the unpredictable makes us less vulnerable.” – JJ Singh

Each one of us is vulnerable to uncertainties in life. An uncertainty could be an unfortunate death in the family; a serious accident; an unforeseen medical emergency; a permanent damage to our property; or damage to our vehicle etc. Also, it does not matter at all if presently we are living a healthy life or if we are young; it also does not matter if we are rich and having numerous sources of income, an emergency situation could get us into an unreasonable financial trouble. A mediocre family may have to spend their entire life-time savings to meet a medical emergency. Recent Covid-19 pandemic has been a recent example. Fortunately, insurance is one of the best ways to cover various risks related to life, health, vehicles and property.

Types of Insurance

There are different set of insurance plans to meet our needs. Broadly they can be classified into following five categories.

Life Insurance

“Among the life insurers, Life Insurance Corporation (LIC) is the sole public sector company.”

Life insurance is to provide financial help to the family in case of unfortunate death of the policy holder. In many cases the policy holder is the sole bread earner in the family. Under these circumstances the family will get a lump sum amount as promised in the policy document, which helps them to rebuild their lives. The family can use this money to fulfil its short term as well as long term needs as per their requirement.

Health Insurance

“Over 500 million people across India were covered under one or the other health insurance schemes in the financial year 2020.”

This type of insurance is to cover the medical expenses in case of any health issue. This plan works in case of a medical emergency, vision care, dental care etc. and may cover hospitalization and treatment expenses. There are various health insurance plans which may also cover your spouse, children and parents besides you as the main policy holder.

Auto Insurance

“Auto insurance is a legal obligation for the owner of the vehicle under Indian Motor Vehicle Act, 1961”

As the number of vehicles are increasing on the roads, we are more prone to accidents and legal requirements. Auto insurance provides cover to the policy holder against any damage to the vehicle in case of an accident or natural calamities. It also covers damage to the third party, through a very popular type that is third-party insurance. The third party means people who have been hurt or faced loss due to an accident with the policy holder. Third party insurances are relatively cheaper. Generally, a ‘full’ vehicle insurance is advised to cover all the other aspects as well including the third party.

Home Insurance

“The Overall insurance penetration in India is about 4% and the contribution of home insurance is much lower.”

People are interested in owning a new house and paying home loans but the above statistics state loud that most of them forget an important aspect of owning a house and that is home insurance. Home insurance plans cover damage to the home in case of an accident and natural calamities. It may also cover expenses involved in repairing any damage caused from fire or water etc., as prescribed in the policy.

Child Insurance

“The gross enrollment ratio, for the relevant age group (18-23 years), in higher education in India is 25%”

Child insurance plans insure the life of the child, with parents as the policy holders. These plans help parents in saving money for the child. The plan generates a lumpsum amount, from the premium paid by the parents, for meeting the future educational needs of the child. The amount is given to the child after reaching certain age as prescribed in the policy. This way parents don’t have to buy educational loans and pay huge interest on them.

Besides a basic life insurance plan, where the family gets a lump sum amount after the death of the policy holder, there are other plans where the premium is paid for a certain period of time. At the time of maturity, the policy holder can opt for receiving the entire amount paid during that time period. This way insurance also encourages saving money over a period of time by paying periodic premiums. In addition to savings and security, an insurance gives us peace of mind by ensuring utmost protection against any crisis.

This article gave you a very basic understanding on insurance. I will elaborate more on this topic in the coming articles.

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