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Many people ask me for tips on how to avoid bad insurance policies that are sold in the market.It is important for consumers to understand the purpose of insurance and how to identify the good insurance policies.
Purpose of insurance
Insurance allows the consumer to manage risks through the principle of pooling. A consumer needs to manage the risk of damage or loss to the home, car or other property caused by fire, flood or many other perils, and to manage the risk of death or injury caused by accidents.
An insurance company provides a service to consumers to manage this risk through insurance. Each consumer pays a premium towards the insurance pool, which is then used to pay compensation to the participants or policyholders who suffered a loss during the year.
How do the consumers find out if they are paying a fair amount of premium to cover the risk? They can study the financial results of the insurance pool. The premium should be adequate to cover the claims, expenses and give a fair margin of profit to the insurance company. Usually, the ratio of claims to premiums should be 60 percent to 70 percent.
Here are some of the characteristics of bad insurance policies:
- Unclear definition of coverage or exclusions that are covered in small print. This allows the insurance company to reject claims for legitimate losses suffered by the policyholder.
- Uncertainty of coverage. The insurance company can declare the policy to be void due to alleged non-disclosure of the risk by the policyholder.
- High profit margin earned by the insurance company on complex policies. This is an indication that consumers are being over-charged.
Here are examples of bad insurance policies sold in the market
- Whole life and investment linked policies where a large part of the premiums paid over the years, together with the investment income earned on the premiums, are taken away to pay commission to the insurance agents, expenses of the insurance company and to the profit margins. This gives a poor return to the policyholder
- Medical and critical illness policies where the coverage provided by the policies is not clearly defined and may be excluded by small prints. For example, many consumers think that they are covered for cancer under a critical illness policy, but they are shocked to learn that the coverage applies only to advanced stage of cancer and that the early stages are not covered. They also face the risk of claims being rejected due to alleged non-disclosure of pre-existing conditions — including medical conditions that they were not aware of.
Here are some tips to avoid the bad insurance policies:
- Do not buy any insurance policy where the coverage is not clear to you. Read the policy and the written brochure and understand what you are actually covered. Read the perils and exclusions. If it is not clearly explained in writing, avoid the insurance policy.
- Do not rely on the verbal explanation of the insurance agent. The agent will usually tell you the positive interpretation, as he or she is interested to close the sale and earn the commission. You will find out later, that the real facts may be different from the explanation.
- Compare the premium rates charged by a few companies for the same coverage. If you are not able to compare, avoid the insurance policy.
