What is life insurance and how it works

There is a certain set pattern that most life insurance policy advertisements follow; the husband looks dubiously at his wife prior to signing on the dotted line of a life insurance policy, while the wife is convinced that the insurance cover is necessary and is the only way to secure their future.

The husband then, turns to his wife and asks, “Mere bina jee paogi?”, and the wife responds in the negative. Upon being asked what she would do with the money once he passed, she replies that the insurance money would secure their child’s future and the family’s retirement. She explains how when everything is guaranteed, there is no tension; no tension results in a longer life. Thus, it is essentially for their long lives that he signs on the dotted line. The ad ends with the husband signing the papers and joking about having to endure the same wife for his entire life. It was one such advertisement that had my friend’s wife nervous and coaxing him to purchase insurance policies for their daughter’s future and their own retirement. For the same, they got in touch with a couple of insurance companies, who pitched a multitude of products, ranging from children’s plans to pension plans. But instead of giving them some peace of mind, all these meetings led to excessive confusion on their part. When they approached me for some advice, their main question was, “What exactly is life insurance?”.

Well, primarily, life insurance is a risk transfer tool which can be used to transfer the financial risk of the family, in case of the holder’s untimely demise, to the insurance company. The first step is to understand what risk means. Every individual faces two types of risks. Pure risk is present in situations where there can only be a loss. This includes risk to life from death or illness and risk to property as a result of theft or any natural or man-made calamity.

It also includes professional risk such as the personal liability of doctors and accountants. Speculative risk (the kind that arises from making choices) is present in situations where there can be a loss or a gain, like investing in a business. If this decision leads to a gain, then it’s the reward for taking the risk. Other examples of this type of risk include gambling and investing in equities, commodities, real estate and gold.

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