The billion-shilling question: Why should one buy insurance?
Life is highly unpredictable and uncertain. No one knows for sure what will happen not only tomorrow but in the next moment. As it were, most of us want to be in a situation where whatever troubles, and adversities may appear in our lives, our families, our businesses, still our valuable belongings remain safe.
As much as we want that, however, disaster, of whatever form – whether man-made accident or a result of natural calamity would appear as a challenge before our existence. And this is true up to the point when insurance plays a major role in our lives.
So, what is insurance? Insurance is a means of protection from unforeseen losses and contingencies. It is a risk management mechanism, primarily used to hedge the risk of a contingent or uncertain loss. Insurance is a contractual agreement between parties where one party (the insurer) promises to protect another party (the insured) from sufferings in case of damages and losses. That way, sharing of risks is an important function played by insurance. It means pooling the risk of one person among a larger number of persons.
Why do we need insurance? Insurance is a way of managing unexpected and unavoidable risks. When one buys insurance for some things (either an asset, a business, or health, etc) they transfer the cost of a potential loss to the insurer in an exchange for a fee, commonly known as premium. Normally insurers (insurance companies) invest these premium funds in secure financial instruments and other asset classes (i.e. Treasury bonds and bills, shares in publicly listed companies, bank fixed deposits, real estate properties, etc) so they can grow and be able to pay the insured when there is a claim, while at the same time covering their operations and administration costs to ensure sustainability of their operations.
Because of that, insurance benefits individuals, organizations, and society in more ways. Let us touch on some of the benefits of insurance, some of which are obvious while others may not.
The obvious and most important benefit of insurance is the payment for the losses. As it were, an insurance policy is a contract used to indemnify individuals and organizations for covered losses.
The second benefit of insurance is managing cash flow uncertainty. Insurance provides payment for covered losses when they occur. Therefore, the uncertainty of paying for losses out-of-pocket is significantly reduced when one has covered those losses by buying an insurance policy.
Another common benefit of insurance is compliance with legal requirements. There are legal requirements that for the greater good of a society some assets are mandatorily insured, partly to protect owners of those assets but also others within the society (also known as third parties). Insurance meets statutory and contractual requirements as well as provides evidence of financial resources.
Another very important benefit of insurance is promoting risk control. Insurance policies provide incentives to implement a loss control program for individuals and businesses because of policy requirements and premium savings incentives.
The other benefit of insurance is in the efficient use of the insured's resources. Insurance makes it unnecessary for one to set aside a large amount of money to pay for the financial consequences of the risk exposures that can be insured. This allows that money to be used more efficiently.
Another important benefit of insurance is the support for the insured's credit and or borrowing. Insurance facilitates issuance of loans to individuals and organizations by guaranteeing that the lender (a financial institution) will be paid if the collateral for the loan is destroyed or damaged by an insured event. This reduces the lender's uncertainty of default by the party borrowing funds and hence making it easier for the lender to lend with an understanding that some levels of risks have been mitigated through the insurance mechanism.
The other benefit of insurance is that it provides sources of investment funds within the economy. As indicated earlier Insurance companies collect premiums up front, they then invest these premiums in a variety of investment vehicles and pay claims if they occur. When premium funds are invested in either Treasury bonds, Fixed Deposits, Shares, etc – these mobilised funds are used for productive investment activities within the economy – that way insurance is a mechanism to mobilise financial resources which is then intermediate into productive sectors of the economy.
The last benefit of insurance is that it helps in reducing a social burden. Insurance helps reduce the burden of uncompensated accident victims and the uncertainty of society.
Therefore, in analysing and justifying your purchase of insurance it is always good to understand how beneficial and critical it is – the role of insurance.
