10 November, 2009

Living life & loving it

Insurance helps you to enjoy life, without worry

The spotlight was on Harish. He was to pour his heart out about the tribulations of a widower, in this play he was acting. Instead he forgot his lines and was currently blinking. Understanding his plight, Bikram was now prompting from behind the screens, “O God, how will I bring up my daughters…”. Harish clutched the lines like a drowning man a lifeboat and launched forth on his soliloquy. And what a hit it turned out to be.

Bikram turned out to be a life saver for Harish. The director had envisaged the possibility of actors going blank before an audience and had a backup ready to support when there was a snag. That ensured that the program was a hit instead of a rout, it could have well turned into. That in a nutshell, is risk management.

Risks abound around us. Also, what one perceives as risk, may be par for the course for another. Risk is hence relative. It is a risk to drive a vehicle, to keep valuables at home, pass on to the nether worlds without paying the home loan in this world, be exposed to ruinous medical expenses…

Some of these risks may be retained… risks that are small & frequent, risks that no one will cover or cannot be passed on. Some may have to passed on. There are always others who are willing to assume your risk, for a consideration.

Many big businesses have sprung up to assume various types of risk… for a fee. Life Insurance, medical insurance, property insurance, accident insurance, professional indemnity etc. are available today for those who want to derisk and are willing to pay for it.

Insurance companies pool the risks and pay those suffering losses, from the funds ( premium ) collected. They aggregate similar risk profiles into pools. The people in the pool pay premiums and collectively share the risks.

To illustrate, let us take a pool of 1 Lakh people with similar risk profiles. Let us also assume that they contribute Rs.3000/-pa per 10 Lakhs of life-risk cover. If the overall Sum insured of people in the pool is Rs.50 Crores, the premium collected would amount to Rs.15 Lakhs. When someone in the pool now passes away, the insurer would compensate the insured person’s family based on the cover taken. Let us say A, from this pool, who has an insurance cover of Rs.10 Lakhs, passes away. The compensation would be paid from the premium collected. In the above example, A’s family was compensated to the extent of Rs.10 Lakhs and the financial shock to the family gets cushioned to that extent.

If there is just one claim in the year, then the premium collected would cover it. However, if there are 5 such claims from the pool, the insurer would have to pay Rs.50 Lakhs, though they have collected only Rs.15 Lakhs as premium. This means losses for the insurer. Hence, an insurer needs to assess the people coming into the pool and charge a premium that will enable them to pay any claims and run the operation successfully, from year to year. Insurance companies have actuaries, who decide the parameters that define the pool & the premiums to be paid based on past experience. This is constantly monitored and appropriate corrective measures are taken to ensure that the business remains viable. Other insurance businesses function in a similar manner.

Risk mitigation is a very important function that allows individuals & businesses to protect themselves from paralyzing shocks, that has the potential to derail them. Insurance, hence plays a very important role of risk reduction and orderly functioning of businesses, lesser disruptions & event driven bankruptcies and ensures peaceful progression in society.

There are many risk reduction mechanisms at work, in all areas. When a backup is taken from a computer at the end of the day, that is insurance at work. When a stock exchange has a hot, standby server to take over when the current server fails, that’s risk containment at work again. Rockets & other spacecraft routinely have built in redundancies of critical parts, upto level 5. That means, if part 1 fails, part 2 takes over and so on till part 5. That’s extreme insurance, ofcourse. But, space travel is not your usual drive to the club, either.

Businesses recruit more than they require to cushion themselves from unavailability of talent in future. IT firms typically have a certain percentage on the bench, as a cushion. BPOs have their centres in different geographies. Many companies stockpile raw material if they sense there is an impending deficit. US has a huge crude oil buffer. China has recently stockpiled raw materials like Copper, Nickel. All these are great derisking strategies.

There are various risk reduction mechanisms functioning from time immemorial. Insurance is hardly new. A patriarch in olden days had many wives to ensure continuation of his lineage. In fact, sons were thought to be the insurance of choice for old age needs. They used to have huge granaries to stock food grains – an insurance against hunger for the rest of the year. Every village had many ponds to collect rainwater – call it prudence or insurance against water shortage. People used to buy gold ornaments and pass it down the generations – ensuring wealth, prestige and a cushion against penury. The kings married from neighbouring kingdoms, to ensure friendly neighbourhoods as also to have trusted allies to ward off other invasions.

If by all these you conclude that insurance is the sole preserve of human beings, you couldn’t be more wrong.

The birds & bees seem to have been doing that for eons. An adult female cod fish spawns on a gigantic scale – they lay about 4 – 6 million eggs so that after the inevitable attrition, there are still enough to hold the banner high. Beavers build dams on streams to ensure that they don’t lack water in summer. Camels store water inside their body, in a spare pouch. Ants toil and store enough for a rainy day. Even plants have mastered it. They have such excellent seed dispersal mechanisms to ensure the survival of the species, that our commandos could well study & emulate!

What do you think of our own body? It has such excellent mechanisms - like storing fat and living off it when body does not get food, an amazing tolerance built in that you will feel normal even if the heart is functioning at 30% levels. I’m told it is something similar with kidneys too. God believes in insurance.

Still people keep asking, “Do I need Insurance?”

Published in Money Mantra in Nov 2009 issue

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