The purpose of insurance is protection against financial disaster. In this regard, there are usually 3 areas where disaster can strike:
1. Loss of income. Not many people realize that their greatest financial asset is their ability to earn money. A disability, whether physiological (e.g. loss of one hand) or psychological (e.g. mental illness), results in an inability to perform productively. This means that you will either lose your high-paying job or become unable to operate your business effectively. Either way your income falls.
2. Loss of health. A major illness or accidental trauma can run up hundreds of thousands of dollars in medical bills, in addition to the loss of income during hospitalization.
3. Loss of life. This is actually a variation of a loss of income, since it’s not the life itself but the income associated with the lifespan that can be valued in monetary terms. However insurers distinguish between loss of life and loss of income since you can be alive and kicking but totally unable to earn your previous level of income.
Comparing your lifetime earnings and the typical rates quoted by an insurer, there is no excuse for not insuring your ability to work. A disability income policy will pay a percentage, usually 75% of your last drawn pay, should you become unable to work. If you suffer a pay cut it pays a percentage of the pay cut. A typical 25 year old fellow in Singapore earning say $30,000 annually would likely earn at least $900,000 over the next 30 years, excepting increments and bonuses. Yet the cost of providing 75% replacement income ($650,000) is $400 or less annually. It is the most cost-effective coverage you can buy – ‘leverage’ is over 1,500 times.
The average person gets sick 4-5 days a year, but that’s small things like a cough, cold or the flu. 1 in 3 men will suffer a heart attack, stroke or cancer before age 65. For women, it’s 1 in 5. There are other alarming medical statistics freely available that demonstrate that the likelihood of living out a full life without a major medical incident is rather low. The local Medishield and its variants offer extremely limited coverage – there are dollar caps on every item, plus a significant deductible. At a minimum, all locals should move to IncomeShield (best of the Shield variants), but it’s not enough.
A third-party hospital and surgical plan offers better coverage (no deductible, much higher dollar caps). Premiums are in the mid-hundreds to low-thousands per year, meaning you’ll likely spend $20,000 over a lifetime. But one medical claim alone can hit $20,000, and a major operation like an organ transplant can cost $200,000. So one claim, and you’ve recovered your premium costs. Of course, ideally you don’t want to have to claim at all! Insurance is one bet you always want to lose. Critical illness plans (which pay a lump sum on diagnosis) are a nice-to-have option, although their coverage overlaps with health and surgical plans (which work via reimbursement).
Loss of life is actually only an issue for those with dependents (young children, aged parents etc). For those without dependents, life insurance is actually a waste of money, because nobody suffers a financial loss if you die. All you need is enough coverage to pay for funeral expenses – and most locals are covered in this respect by the Dependants’ Protection Scheme (automatically paid from CPF unless you opt out). But for those with dependents, it is prudent to have sufficient coverage to cover the loss of income – disability coverage usually doesn’t pay much on death.
In financial terms, when facing a risk, one should, in order of preference:
1. Avoid it.
2. Minimise it.
3. Transfer it.
4. Absorb it.
As far as health/life is concerned, you can’t avoid getting sick. You can minimise the risk by maintaining a healthy lifestyle. You can transfer the risk of major bills to an insurer. You can absorb the risk of small bills from seeing your general practitioner.
Where income-earning ability is concerned, you can’t avoid getting injured or dying in an accident. You can minimise the risk of death or injury by choosing a less hazardous occupation. You can transfer the risk of consequent financial loss to an insurer. You can’t absorb the loss of income by saving enough money during good times.
Everyone but the extremely rich should have medical insurance to pay for bills and disability insurance to replace lost income. Only those with dependents should bother about life insurance.
Investment is a game of greed where you give up small known losses (in inflation and opportunity cost) in order to get large unknown gains. Insurance is a game of fear where you give up small known losses (in premiums) in order to avoid large unknown losses. Fear and greed are distinct; do not mix the two. Yet both are vital to any financial plan and must be adequately addressed.