Saturday 7 December 2013

Doing Your Own Insurance Planning

I guess most people are familiar with the concept of insurance planning. Whenever you buy an insurance policy, the insurance agent will first carry out insurance planning to determine your needs. She will ask you some questions related to your monthly income, expenses, amount of assets, liabilities, etc. before proposing a suitable insurance policy. Since this is such an important step to determining your insurance needs, why not do your own insurance planning? 

Benefits of Insurance Planning

There are several benefits to doing your own insurance planning. Firstly, the results are likely to be more accurate. During the discussion with the insurance agent, unless you come prepared, you will be hard-pressed to estimate how much your expenses, assets and liabilities are. Some are also not comfortable disclosing the actual income or assets for whatever reasons. But in the comfort of your home and away from all the strangers, you have all the time to find out all these figures accurately. There is also the advantage of updating the insurance plan as regularly as you wish, without the need to seek another review session with the insurance agent.

The second benefit of insurance planning is knowing how your insurance needs vary with time and the age that you no longer need any insurance. This is important for those who prefer to buy term insurance and invest the rest of the money over life insurance. By knowing when the coverage is no longer needed, you can save more money for investment.

The third benefit is you can carry out sensitivity analysis to find out which parameter affects the insurance needs the most. For example, the disability income insurance that I have comes with an option for a 2.5% escalation in benefits every year. Is it better to increase the coverage by another $1,000 per month or opt for the 2.5% escalation? Sensitivity analysis tells me that it is better to increase the coverage than to have the escalation. Similarly, sensitivity analysis also tells me when can I retire given the expected income, expenses, assets and liabilities. Finally, sensitivity analysis tells me which of these parameters are my best friend and worst enemy.

Worst Enemy: Interest Rate

Here, interest rate refers to inflation. Inflation is the worst enemy because all expenses go up, thus increasing the insurance needs. Inflation on medical costs and education is likely to be higher than general inflation. Through insurance planning, I have realised that if a potential liability costs $10,000 today, we should really be covering for 3-4 times that amount (depending on the expected inflation rate), because if and when the liability were to happen in 20-30 years down the road, inflation is going to increase it by 3-4 times.

Best Friend: Interest Rate Too!

If inflation were the worst enemy, investment rate of return would be the best friend. If we could grow our wealth at a higher rate of return than inflation, then our wealth could keep pace with the expenses. The insurance needs will also be much more manageable. After all, when we pay insurance premiums to the insurance companies, they also invest the money to make sure that it grows sufficiently large to cover the sum assured when the liability happens. Insurance is not just about risk pooling but also about investment!

Notwithstanding the above, in my last blog post, I have highlighted that it might be difficult to invest at a high rate of returns when one is not in the best of health. This then becomes a double whammy, because one is unable to generate high returns while at the same time the insurance needs go up. Thus, health is all important and is the capital to generate wealth.

Conclusion

In conclusion, insurance planning is an important step in identifying one's insurance needs. It provides insights into how the insurance needs vary with time and the key parameters that significantly affect the coverage needed. Given its importance, why not do it yourself?

2 words of caution are needed, though. Firstly, the model to determine the insurance needs must be correct, otherwise, it will result in either under-coverage or over-coverage. Secondly, like all models, it is rubbish-in, rubbish-out. Not only the model must be correct, the inputs must also be accurate too! Nevertheless, given its importance, it is worth investing the time in building and fine-tuning the model and establishing accurate input parameters.


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6 comments:

  1. Hi, care to explain what sensitivity analysis is all about and how it's done? I'm interested to know, thanks!

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    Replies
    1. Hi La Papillion,

      It is to vary the value for each parameter and see how it affects the outcome. You can vary different parameters and from this exercise, you can tell which parameters have the greatest impact. You can also use the table function in Excel to do this.

      Rgds,
      Chin Wai

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  2. I totally agree with doing your own insurance planning. For me I do it for my family including my parents. To me insurance is like a portfolio hedge against disaster, simply to says nowadays a big hospitalization bill could potentially wipe out your lifelong savings. Make sure you insured what you need and not what the insurance agent wants to sell you! Word of cautious!

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    Replies
    1. Hi sgftfund,

      I agree with you. Ultimately, we need to be responsible for our own insurance coverage.

      Rgds,
      Chin Wai

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    2. Chin Wai - Do you also advocate buying term policy for life and invest the rest kinda of mindset?

      As people around my age are mostly having their first babies and insurance agent started to crowd around them to sell "Education Endowment Plans" to prepare their kids for future education.

      Insurance agents might hate me though! LOl...I am telling them to build their own 15/20 yrs Endowment plans instead thru the use of unit trust or shares builder plans which we can easily DIY nowadays. I will be writing up something on this as my son is going to be born in Jan and I will be doing what I preached!

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    3. Hi sgftfund, Endowment plans can be useful as a form of forced savings for those who needs a reason to save. But for those who are already saving regularly, buying term and investing the rest seems the better option as it is more transparent.

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