Unfortunate events such as a serious illness, paralysis after a car accident, or a death in the family are part of life, and although we don't like to admit it, they can affect us at any time. Once they occur, they impose a financial burden on the whole family in the form of long-term expenses or lost income. A good insurance policy can help in a difficult situation. We often only realise its importancewhen it is too late.

Insurance is not the only form of protection against risk, so it brings a different mix of advantages and disadvantages for different people. In this blog, we explained for whom, when, and in what form we think it's worth having. Finax will soon be expanding the range of available insurance options for those who identify themselves in the text.

In the article, you'll learn:

• How does insurance work?
• What risks are worth insuring?
• What amount of insurance coverage to choose?
• What are the possible disadvantages of insurance?
• Who is insurance worthwhile for?
• How to choose insurance?

How Does Insurance Work?

Insurance is an agreement with an insurance company to pay you money in exchange for regular premium payments if a certain insured event occurs. You can insure for both negative events (e.g., death, car accident, illness, fire) and positive events (e.g., life insurance). The payment of money by the insurance company is called a claim.

There are different types of insurance. It can be divided according to the obligation into compulsory (e.g., compulsory car insurance), statutory (health insurance), and voluntary (accident insurance). It can also be categorized according to the type of insurance company into public (provided by the state Social Insurance Institution) and commercial.

The two important types of insurance also arise from what you insure with them. These are life and non-life insurance. Life insurance covers the risks associated with your life such as death, survival, or critical illness. Non-life, on the other hand, protects against property damage, liability, etc.

When you buy the insurance, you agree on the amount of the sum insured. This is the amount of money used to determine the amount of compensation in the event of an insurance claim. In some cases, this is the maximum amount that will be paid out in the event of an accident, while at other times the payout may be several times the sum insured.

The benefit does not have to be paid to the person who took out the insurance. Some types of insurance allow you to choose any eligible person to whom money will be paid in the event of a claim.

Insurance is therefore a form of risk sharing. An insurance company has many clients, each of whom pays a smaller amount on a regular basis. In the event of a loss, part of the amount collected is used for compensation. Thus, it does not have to be paid by the unfortunate person alone, but is shared by several people, which makes it more financially bearable.

However, insurance companies are just companies and try to avoid loss. Because of this, they need to estimate in advance the risk and the amount they will have to pay out. They use two techniques to do this.

The first is to distinguish the risk before the insurance occurs. The insurance company will check the client's characteristics and adjust the individual premium price to them. These checks are referred to as 'screening'.

For example, young people face a lower risk of death than those in their fifties. Conversely, the risk of a car accident is usually higher for young people (less experience behind the wheel, higher chance of "showing off"). Thus, young people will pay a low price for life insurance but a higher price for accident insurance.

The second technique prevents excessive risk-taking after the insurance has been taken out. The contract defines the exclusions, that is, the circumstances under which the benefit will not be paid. Exclusions can include an accident in extreme sports, death during a terrorist attack in a foreign country, or a car accident caused by drunk driving.

The Emergency Fund May Not Be Sufficient

A proper emergency fund covers 3-6 months of expenses. It allows us to pay for most of the common emergencies that everyone encounters in life (car orappliance breakdown, temporary disability, etc.). Since a sufficient reserve protects us from accumulating debt, we consider it an essential goal for every investor.

Over the long term, accumulated wealth is also good insurance. If you die prematurely, for example, your family can draw the inherited money as supportive incomeor use it to pay off the mortgage.

The advantages of wealth and an emergency fundare immediate availability and thefreedom to use it for any expense. On the other hand, if you want to cover all the smaller risks with insurance, you will need several additional insurances (for risks such as sickness, hospitalisation, etc.).

At the same time, you need to be paid as soon as possible in the event of an insurance claim. It rarely happens that you are on sick leave or in hospital for more than three weeks. The price for quicker payment is a high premium compared to the potential benefit.

Therefore, we recommend an emergency fundand wealth building as the primary means of risk protection. However, there are cases where these measures are not sufficient. These are events that are less likely (i.e. do not happen to many of us) compared to normal emergencies but incur extremely high expenses.

You are diagnosed with cancer and your family will not be able to afford the thousands of euros needed for treatment. You fall off the roof of a building and you are left with children to take care of and debts to pay. You become paralyzed in a car accident and are unable to work a job that would pay for your care, therapies, or wheelchair-accessible home equipment.

Don't underestimate the likelihood of such risks. Did you know that cancer and circulatory system disease were the leading causing of mortality in Europe? Not all of them occur at an old age, e.g. female critical illnesses are most likely to occur at an active age between 20 and 45 years of age.

In Europe, approximately 4 million new cancer patients are diagnosed every year. In 2020, about 1.9 million people died in hospitals due to an accident. Misfortune lurks for the unprepared who do not admit such a possibility.

A full emergency fund may not be enough in such cases; you would need several tens of thousands of euros. Such a large insurance policy can be built up by investing. However, it will require a fair amount of patience to fully appreciate the power of compound interest and minimize the risks associated with investing.

So people with low assets (especially young people who have not had enough time to build them up) need to look around for other ways to protect themselves against bad luck.

In general, then, insurance is worth considering for risks that would bring expenses beyond the emergency fund (3-6 months of expenses) and net worth (assets - outstanding debts). For lower contingency expenses, it is more advantageous to use the reserve and assets.

Recovery Time

The question is what amount of insurance coverage you need against these risks. This amount depends on the individual situation. That’s why we do not want to tie you down to specific numbers. Your insurance should cover the difference between the amount of expenses related to the specific risk and your wealth.

You should therefore try to estimate what the expenses would be for the event in question (of course, these will not be exact figures, approximate ones will do). Determine the period of time needed to recover from the event, heal the injury, possibly find a job that suits your new medical condition, move to a smaller property, etc. It is usually recommended to allow 5 years for this.

Take the example of an injury that would prevent you from doing your original job. Estimate the expenses of living and bringing up children over the next 5 years, rehabilitation, or care.

For risks such as premature death, include the cost of total debt repayment. Subtract your partner's estimated income, available assets, and any state support.

The resulting difference will give you an idea of the ideal amount of the potential insurance claim. This amount will give you enough time to recover, retrain, and look for a new job. As your assets grow, you can gradually reduce the sum insured, which we'll come back to later in the article.

The Pitfalls in the World of Insurance

We've just covered the potential benefits of insurance. In order to make an informed decision, you also need to know about the potential pitfalls you should look out for when making your choice.

The first is price. Many people pay unnecessarily high premiums that would be lower with competitors. In addition, as the risk increases, insurance will become more and more expensive. If you want to insure against the risk of death or critical illness, you will pay several times less if you do it at a young age.

You also need to watch out for fees. These are particularly dangerous with the popular investment life insurance product. Unlike term life insurance, in this product, the entire premium does not go towards covering the risk. It also contains an investment component, so the insurance company will invest a portion of your premium each month.

Sounds nice, but there's a catch. Most of your money is gobbled up by fees in these products. That's why it's preferable to build wealth separately in low-fee products. You can take out a separate risk insurance policy to protect you from the risks. In addition to saving on fees, you also get the option to cancel the policy at any time without high early termination fees.

Oftentimes, there are no investment insurance products that are more advantageous than separate investment and separate risk insurance.

Another pitfall is overpaying premiums despite relatively low risk. If you don’t have children (or other dependents), have accumulated high assets, and have paid off most of your debts, you don't need as much coverage from the insurance company. That's why, for example, it pays off to gradually reduce the sum insured as your wealth grows, since you'll cover the rest with the assets you've built up in the meantime.

Here comes another pitfall - paying for risks that you will no longer have insurance for. Many Slovaks choose life insurance where they will pay the same premiums until death (so the price reflects the increased risk later in life). Meanwhile, the average life expectancy of an insurance policy is 6 to 7 years. Clients will therefore be paying unnecessarily for future risks that the policy will no longer cover.

The last disadvantage is the exclusions. In a number of situations, you and your family may get nothing from the insurance company. Will you die in an occupation that the policy excludes from coverage? Do you suffer a permanent injury in a sport designated as extreme? In either case, forget about the insurance claim.

In addition, claiming money in a contract with many exclusions is administratively burdensome. The insurance company is likely to ask for medical reports and similar evidence, which takes a lot of time and running around the offices. In this day and age when time is money, we probably all want to avoid the bureaucratic burden.

So Who Is Insurance Worthwhile for?

Based on the previous sections, we think it's worth taking out insurance if you meet one or more of the following conditions:

• you can get low premiums,
• you have liabilities and low wealth,
• you face an increased risk.

Low Premiums

As long as the insurance company perceives you to be relatively low risk, it will allow you to get insurance on the cheap. For example, with life insurance (risk of death or critical illness), young people can get a much better price.

With accident insurance, if you are over 25, have a clean slate of traffic offenses, and a cheaper car that is not too old, that will play into your hands.

Liabilities and Low Assets

In the event of death, long-term illness, or incapacity, you need sufficient assets to cover expenses and pay off debts. If you don't have it, these risks will hang over you like the sword of Damocles, so it's better to put on the helmet of insurance. This is especially true for young people or those who have only recently started to build up their wealth and need plenty of time to build it up.

Increased Risk

If you do manual labor, your grandparent had a critical illness, or you drive frequently, you are at greater risk for the aforementioned expenses. Beware of exclusions and screening, however. Multiple insurers may not cover that risk or may try to charge you a higher price. So ideally, look for a quote with a minimum of exclusions and screening.

How to Choose Insurance?

If the previous section has convinced you that insurance would be worthwhile for you, you will need to choose one of the available offers. We recommend that you consider a number of criteria when making your choice.

The first is price. Perhaps no one wants to pay unnecessarily much in insurance premiums. Beware, however, that the price of cheap insurance might come in the form of a number of exclusions and bureaucratic delays in the event of a claim.

So look for a good value for money insurance policy. Decide which risks you want to be insured for and find deals that cover them. Only then look for the lowest possible premiums among them. Include all fees in the calculation.

When choosing the type of insurance, also be careful not to spend money unnecessarily on future risks that the policy will no longer cover. A model that does not set the same premium for life, but adjusts it gradually, may therefore be more appropriate.

This brings us to the next criterion: flexibility. Circumstances change, built-up assets grow over time. So you will not need the same amount of insurance in the future. It is therefore a good idea to be able to reduce the sum insured gradually or to cancel the insurance altogether at any time.

A final criterion to consider is the administrative burden associated with exclusionsand screening. Apart from making our insurance more expensive, running around to doctors and branches is time-consuming and inconvenient. Finding a deal with minimal screenings and screenings will save you time and nerves.