Insurance is designed to provide you with valuable financial support in the event of an unexpected event. It can range from life insurance if a loved one dies, to covering a big vet bill if your dog or cat needs an operation.
One question that many people have is “what’s the point of insurance?”
Many people plan for the unexpected by “self-insuring”. Essentially this means you set aside a certain amount of money each month in a savings account or emergency fund to cover any unplanned costs.
So, is there any point in paying for insurance if you’re already putting money aside and “self-insuring”? Here are four reasons why insurance can still be beneficial.
1. You simply might not have enough set aside
Putting money aside and keeping a rainy day fund in an easy-access savings account is a core part of a good financial plan. It means you always have money that you can get your hands on in an emergency.
While this might be enough to cover an unexpected car or home maintenance bill, or to pay for a new mobile phone, will it be enough to replace your income in the event that you die or suffer a serious illness?
Here’s an example.
Say you take out a mortgage for £200,000 when you buy a home with your spouse or partner. If you died 10 years into the term, you might still owe £150,000. Would there be enough in your “self-insurance” fund to repay this debt? It’s unlikely.
Without insurance, you simply might not have the cash you need to achieve financial security.
Likewise, if you’d been diagnosed with cancer or multiple sclerosis, you may have to take an extended period off work, or give up work entirely. Would your “self-insurance” fund enable to you maintain your standard of living while you focused on your recovery – perhaps for many months or even years? Again, this is unlikely.
Protection such as life insurance and Critical Illness cover are designed to provide a significant financial injection when you or your family really need it. The amounts you generally insure yourself for are usually way in advance of any rainy day fund you could put aside so, if you reply on your own savings, it may not be anywhere near enough.
2. Your savings or investment returns may not be enough to cover your costs
One of the arguments many people have is that they would rather invest money each month to generate a return than pay for insurance they may never use.
Of course, if you take out term life insurance or Critical Illness cover and are fit and well at the end of the term, you don’t get any return. In one sense, you have “lost” these premiums.
However, if you do have to claim during the term, it’s highly likely that they payout will be many times the value of the premiums you have paid.
You also have to bear in mind that, even though interest rates rose across 2022, it’s unlikely that any cash savings you have will be keeping pace with rises in the cost of living.
According to the latest Office for National Statistics (ONS) figures, the cost of living rose by 10.1% in the 12 months to January 2023. So, £100 of goods and services a year ago will cost you £110.10 now.
MoneySuperMarket say that, as of 11 March 2023, the highest paying instant access savings account pays an interest rate of 3.1%. Had you invested £100 a year ago, you’d have £103.10 now.
You can see that your cash savings would have lost value in real terms.
Even if you invest your money, it may not grow by enough to ensure you have “enough” if something terrible happens. While the value of the amount you set aside will hopefully increase over time, it’s unlikely to increase to the sort of levels you’d cover under a life insurance or Critical Illness cover policy.
3. Insurance is there to protect the value of your investment
Imagine a scenario where you were working and putting money aside each month into your pension to fund your retirement. You’ve worked out that the money you put aside will be enough to provide you with the standard of living you desire in later life.
You then have a serious heart attack and have to take an extended period off work. During this time you don’t make any pension contributions and, as your salary has reduced to half pay, you have to dip into your “self-insurance” savings to replace your lost income.
As well as depleting your savings, this will also leave you with a shortfall when it comes to your retirement as you have missed a lot of pension contributions. You may have to work for longer, or accept a lower standard of comfort in your later years.
In this instance, Critical Illness cover protects the value of your “self-insurance” savings. You can use your insurance payout to replace your lost income, so you don’t have to dip into your savings. You can also use this money to keep up your pension contributions, so you can still retire at the same time and with the same standard of living.
In many ways this is they key reason to take out protection. It’s there to provide a financial injection so you don’t have to deplete your other savings or resort to expensive borrowing. It also ensures you can maintain your lifestyle – both now and in the future.
4. You may have to take out insurance rather than “self-insuring”
Very simply, there are some circumstances in which you will have to take out insurance and where “self-insurance” is not an option.
The most obvious example of this is car insurance. It’s not enough to say that you have put savings aside to pay for any repairs or damage caused by an accident. It’s a legal requirement to have car insurance in the UK.
Similarly, your mortgage lender may have made it a condition that you have sufficient buildings insurance on your home when you buy it. Many lenders will want to see proof of your buildings insurance to ensure the bricks and mortar are protected against damage – your own savings will likely to be insufficient if, for example, there is a fire or flood.
Protection and “self-insurance” go hand in hand
If you want to put a solid financial plan in place for you and your family, a mixture of protection and self-insurance can give you the reassurance and peace of mind you need.
Self-insuring through savings and investments can help you build your wealth and generate positive returns. These can help you to achieve your medium- to long-term goals.
Alongside this, it’s important to have the right protection in place to provide valuable financial support when you really need it.
As you read above, protection can complement your plan by ensuring you don’t have to dip into your savings when the unexpected happens. It provides genuine peace of mind that you won’t have to sell your home, or compromise your or your family’s standard of living if the worst should arise.
As life insurance and Critical Illness cover experts, we can help you to put together the right package of protection to suit your specific needs. We work with dozens of the UK’s leading insurers and can scour the market to find you the most appropriate cover at the lowest price.
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