Insurance tends to be unloved, but it is vital to any household, company or project — reason why it is included on the Euroconsumers Invest's Money Framework Roadmap.
Most people tend to underwrite compulsory insurance with minimum legal amounts, but paying less for a Basic plan now can be a problem afterwards. It's human to believe that bad luck only knocks on the neighbour's door. Yet, misfortunes happen, with or less gravity: broke a water pipe, flooded the house and damaged the ceiling from your downstairs neighbour. No matter what, it is essential to carry out for the most adequate insurance cover possible and do not disregard its annuity. Imagine if you must pay for all the repairs because you skipped your last premium! This and other more severe situations can be a slap on your budget or even your assets.
What is Insurance?
Mark Richard Greene, professor and co-author of "Risk and Insurance", defines insurance "as a system under which the insurer, for a consideration usually agreed upon in advance, promises to reimburse the insured or to render services to the insured in the event that certain accidental occurrences result in losses during a given period. It thus is a method of coping with risk". In other words, insurance is a contract represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools clients' risks to make payments more affordable for the insured.
The principle of insurance is quite simple: we know that accidents happen. We understand that the damage can have a high cost to repair. So, the idea is that all insured pay a minor amount, per year, to pass on the damage's payment responsibility to the insurer. In this way, all insured persons are covered, and when a claim arises, the injured parties or victims will be duly reimbursed. And if there is a person responsible for the damage, you will no longer have to worry about paying any large amounts due. All you must do is verify that the insurer complies with its responsibilities.
Here's a simple example: in a condominium of 8 apartments. All tenants are required to have insurance to cover the fire damage. Currently, policies are mostly multi-risks (covering various damages: water, electrical damage, appliances, and so on), but for the use of this example, we will simply talk about the case of a house fire. On a birthday, a fire broke out on the first floor that affected the entire building, making it temporarily uninhabitable. Since it began on the first floor, the owner of the apartment will be responsible for paying all repairs on the building, which can result in a bill of thousands, or even millions of euros. But as he regularly paid insurance, the insurance company that undergoes thousands of insured persons paying a small amount of money per year can take over the damage.
Policy premiums are estimated based on the amount of capital insured and the likelihood of an accident occurring in the portfolio at its disposal. The more people have insurance, the more diluted the premium gets. By making the insurance, you are not only protecting you and your family's patrimony but also third parties.
Compulsory Insurance
The most common is car insurance and home insurance. The first is mandatory in the European Union and in several other European and Mediterranean countries (such as Tunisia and Turkey), for a total of 56 countries and territories that are part of the Motor Insurance Green Card agreement.
You should always have Civil Liability coverage, which is the coverage that protects you against liability for material and bodily damage to other people (third party - Third Party Insurance). As we already observed, it is the legal minimum.
If you buy a brand-new car, it is recommended that you also cover your own damage — Own Damage Vehicle Insurance. Every year, you should consider the revision of your policy premium. Insurers tend to systematically increase this value. Though the civil liability insurance maintains, own damage coverage tends to be revised downwards from the insured capital (as the value of the car goes down from year to year). Meaning, when your vehicle gets five years old, there's no reason to maintain the coverage plan you hired initially (multi-risk or own damage coverage). You will need to check with the insurer or your insurance agent, the best premium/coverage option.
In the case of housing, fire insurance is mandatory in most instances. Hence, we recommend carrying out more comprehensive insurance like the multi-risk package, which, as remarked above, allows a much more comprehensive-risk coverage.
Perform an external consultation for your entire insurance portfolio, at least every two years - keeping your attention to the annuity. In the auto insurance market, which is very competitive, the gain in changing the coverage package is between EUR 80 and EUR 221 for the most common cars in Portugal, Italy or Belgium. This is only a reference, because, as we mentioned, the constituents that influence the premium are many.
In a portfolio review, it is common to save hundreds, even thousands of euros, especially if you have various assets insured: autos, motorcycles, home, health or life insurance). For example, in Belgium, comparing insurance policies for a house of 215 square meters, near the city of Liége, have differences of almost EUR 500 per year, between the most expensive and the average on the market. If you need help about this subject, contact the Euroconsumers Invest Team Network of insurance experts based in Belgium; Italy or Portugal.
Most common insurances
Besides the compulsory insurance, it is strongly recommended to sign for other insurance products according to your needs. For example, one of the most common is the life insurance, which is requested by the banks when applying for a mortgage loan. To increase the guarantees when granting credit, banks tend to ask insurance for the home itself and temporary life insurance for those who request the loan, besides the house mortgage. We say "temporary life insurance" because the time length of this cover is entirely set by the number of years it takes to pay off the lent. This life insurance has the duration of the loan, and the sum insured is the total bank borrowed to the client.
As the debt decreases, so does the insured capital, until it is extinct with the full repayment of the credit. Thus, if any fatality occurs with the borrowers or at least one of them, the life insurance will pay the outstanding balance that relates to the deceased borrower or even the entire debt. This is one of the concerns you should have: life insurance is guaranteed to what kind of risk? Total or partial per holder? Always query the bank or the insurance company about it.
Another insurance product that can be very useful for you is travel insurance. Some countries call for travel insurance when visiting, but not all. However, for the sake of prudence, especially when travelling to cross-continents or countries with more fragile health systems, sign-off for travel insurance and peek one that covers your expenses in the event of a hazard. Also, ensure repatriation is included if something more serious occurs.
Compare the cost of the policy, but especially the coverage. You will be safeguarding the worst-case scenario, but likewise the health of your wallet. For instance, being repatriated to Europe from Indonesia when you're bedridden is not exactly cheap. Not being a daily event (much less now in pandemic time), these situations are more frequent than you may guess.
Must-have insurance
Few families make risk analysis crossing their financial planning with unexpected events.What do we mean by risk analysis? As we mentioned at level 2 of the Money Framework, one of the most significant risks of family over-indebtedness is divorce, and the main cause is that the expenditures are no longer shared by the couple.
Here's an example: in a household with two wage-earners, one receives EUR 2 500/month and the other EUR 2 000/month, they have two kids. With the 4 500 euros, they pay all the expenses with the house (the rent is 1 000 euros), food, transportation, education of children, et all. After spending all costs, they manage to save 250 euros, which gives a household budget available for consumption of 3 250 euros. In other words, € 812,50 per person.
Suddenly, the partner with the highest salary dies. Making EUR 2 500 less in the monthly budget. The family has an income drop of 55.5% (from 4,500 to 2,000 euros), but each household member has a much larger decrease of 66.7% (two thirds less) - because it goes from EUR 812,50 available to just EUR 250 (even giving up the saving of EUR 250 per month. Each member would have only EUR 333,33 available per month - it would still be a drop in income of 59%).
Besides the loss of a loved one, this family also loses financial stability. This reflection must be carried out by all families to be prepared for unwanted situations. The "better safe than sorry" solution would be to make life insurance with the protection of death and invalidity.
Here's what we advocate for a look-a-like scenario:
- Missing income to consider
The capital to consider for the insurance would be the highest salary of the household, in this case, EUR 2 500 euros times 12 months to find the annual salary, it would be 30,000 euros per year. This would be the amount covered.
- For how many years?
It depends on several situations. Let's say to secure children higher education. Admitting that the youngest of the descendants would be 10 years old and would miss 8 years of high school. Coverage could cover only this period — 8 years (considering the child could start working by 18 and pay for his/her studies at Uni). Looking at the period of the University (Bachelor's and Master's) would be another 5 years on top, therefore a total of 13 years.
- What would be the sum insured?
For the high school completion, it would be 30 000 x 8 = 240 000 euros. For the 13 years, to ensure university education until children can enter the labour market would be 30 000 euros x 13 = 390 000 euros. This would be the safe capital values you could opt. Other considerations could be conveyed either to increase (leave a reservation, or append to the funeral expenses, for example) or decreases (no need to use all spouse's salary to match the essential expenses) the insurance capital.
- How much does it cost?
The younger you are, the cheaper these insurances are. We recall, as we mention in the previous article, it is up to 40 years that, as a rule, the patrimony is smaller (stage of accumulation of patrimony). For a 40-year-old, depending on countries and companies, we are talking about premiums with annual rates of 0.15% to 0.24% on the insured capital (benchmark price in Belgium). Thus, for the above examples, we are talking about values between 30 to 80 euros a month.
Is it worth living with your heart in your hands? Perform a simulation with your agent or insurance company. And remember, as your assets increase and your risks decrease, reduce your insured capital or even better, consider cancelling your insurance if your financial situation improves.
Insurance for retirement
Lastly, insurance is one of the most popular instruments for preparing your retirement. Not only do they have specific products for this purpose, but they also have associated tax advantages in many countries that other products do not award. In some countries, life insurance saving products are not taxed as an inheritance tax in the event of the death of the holder, for instance, as an inheritance from parents to kids.
The primary recommendation is to set off very early to save to be able to have a decent saving in the end when deciding whether to retire by law. We have seen in previous articles that it is better to save less for a long time than to try to keep a great deal in the years before retirement. And better than a state pension is to collect a lump sum every month from another source.
There are insurance products that allow these solutions. Pension funds are also prepared for this. However, our studies from several countries say it is better to bail out all the money when you retire and manage it by yourself. You can invest it with specialized help to achieve better performances.
Don't hesitate to share your resource-raising strategy with your co-workers. Recommend Euroconsumers Invest in your company's HR Department. Ask them to contact us and learn more about our counselling services.
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The "Are You Serious About Your Money" is a Euroconsumers Invest series of eight articles authored by Pedro Moreira, edited by Manuel Ribeiro, and designed by Helena Carvalho.