What is insurance and what type of insurance you should aim to take?



What is insurance and what type of insurance you should aim to take?

What is Insurance and what is the purpose to have one?

Insurance is a contract between an individual or a company and an insurance company to make good the losses incurred if any in case of death of the policyholder or damage/destruction of the property of the policyholder. The policyholder needs to pay a small amount of premium for the promise of the insurer. What makes this kind of contract possible for an insurance company is the contingency of the event covered under the insurance policy.

Since only a few policyholders end up claiming the insurance, the insurance company is at a profit and it's a win-win situation for both the insurance company as well as the policyholder. One thing which is of concern is that the discretion to provide with the insurance solely lies with the insurance company. Usually, applicants who carry a high risk of the contingency being occurred are not given insurance.

Before we start discussing types of insurances, one should keep in mind that insurance schemes are advised to be taken in order to cover losses against some unwanted contingencies and not to be used for an investment perspective. SIP is a much better option when it comes to saving up for a future event be it your child's marriage, buying a house or growing your retirement corpus.

What are the different types of Insurance?
  • Life Insurance: As the name suggests life insurance covers the life of the policyholder. In case of the untimely death of the policyholder, the nominee or the family of the policyholder is compensated with a lump sum amount so as to carry out their lifestyle in absence of the bread earner of the family. This arrangement is the most recommended insurance type and one must have at least one life insurance policy.
  • Health Insurance: Illness doesn't take an appointment and then come. To cover expensive illness treatments which can occur at any point of time one must have a health insurance policy. Since the health insurance policy gives a cover to a limit of a few lakhs, one can also take health insurance against some specific diseases. The premium towards health insurance would cover the treatment, the hospitalization cost, and the medication cost.
  • Car Insurance: One of the most common among all types is car insurance, which is not optional but compulsory to have. The premium paid towards car insurance could be used for repair of car parts which were damaged during an accident or towards a third party where you need to pay towards the damages caused. There is also variation in the car insurance policies wherein a car owner could either take generic insurance or a zero debt insurance which includes complete coverage without factoring in any depreciation on the value of the car. Zero debt insurance usually has a slightly higher premium.
  • Home Insurance: A home insurance covers your house against all sorts of damages such as fire, lightning, earthquake or any other natural calamity for that matters.
  • Education Insurance: Education has become really expensive these days, especially higher education. To meet your child's future education expenses insurance companies promote various schemes to save for your child's education but it is usually not advised to take such kind of policy and here's why. The Insurance company uses your money and invests in various asset classes in order to get a return from the same. Once the returns are generated a percentage of the same are kept by the insurer and a percentage is set out for giving commission to the agent from whom you might have taken the insurance policy. At last the remaining amount is given to you after a couple of years. So to maximize your returns it would have been much better if you could have invested in an equity fund. The risk is also decreased because education insurance is usually taken for longer periods of time.
In nutshell go for insurances which take very low premiums and cover large risks but don't use insurance for accumulating a lump sum amount of money in the future. If you will buy insurances that pay a lump sum amount in future, you will notice that you are earning a compounded annual growth rate(CAGR) of only 6%.

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Thanks for reading!
Please comment on any financial query you had like me to address. I will try to post something worthwhile. 

Coming up Next: What are the sections under which a salaried employee can claim tax benefits?


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