Here’s how you should think about insurance.

First think about the severity of the risk you are protecting against and secondly consider the possible scenarios that will occur in the future.

Severity of risk

Is the event you are insuring against likely to have a material impact on your finances and life?

For example, many people insure their mobile phones. Why exactly? If you damage or lose your phone it’s hardly going to alter your financial wellbeing or your life.

Sure, it would be incredibly frustrating and inconvenient, but just put your hand in your pocket and buy a new one.

Over the course of your life, the insurance premiums you pay for cover will outweigh how much you will receive for damaging or losing your phone.

With these small risks, you are far better to simply save your money and self-insure.

Larger risks however are the areas you should focus on. If you have a growing family and a large mortgage, can you really get by financially if you die, become incapacitated, or suffer from a critical illness?

These are huge life altering events for you and your family, and it’s highly unlikely that you will have sufficient savings or wealth to withstand these impacts.

Once you have decided about the types of financial risks you should be protecting against, you can consider the following possible scenarios to assess what could occur, before deciding what a prudent and sensible person would choose.

Possible scenarios

1. No insurance premiums paid and no claim required.

You choose not to pay for any insurance and you don’t suffer from any severe illness or early death.

This is the best scenario. The scenario we all wish for and financially the best outcome. You don’t have to give any money to insurance companies, don’t have to fill out any paperwork, your family’s finances do not suffer and you live a long and happy life.

Unfortunately, in this scenario you are basing your future prosperity on luck and have no plan at all.

2. Insurance premiums are paid but you do not need to claim on your policy.

You pay for insurance premiums and you don’t suffer from an illness or early death during the length of the policy.

In this scenario, you have essentially ‘lost’ the total sum of your insurance premiums. However you can rest easy knowing that you acted prudently and that the majority of these premiums would have gone to other insurance policyhilders who took out insurance but needed to claim.

Paying for insurance and never claiming can feel like a waste of money but it really isn’t.

You could view these contributions as a charitable gift. Most of your money has gone to help out other families in the UK who have taken out cover and needed to claim.

So take comfort in the fact that as well as acting sensibly and with foresight, you have helped others in their time of acute financial need.

3. Insurance premiums are paid and a claim is required.

This scenario is the whole reason people take out insurance. You pay for insurance premiums and you also need to claim.

You pay a small premium and receive a larger benefit to offset the financial impact of negative health related occurrences.

You have diligently paid for your insurance contract and one day you (or your family) need to make the call and claim on your policy. In most scenarios, that policy pays out in a timely manner to help out in a time of need and help to offset the potential financial shock and maintain prosperity.

4. You have no insurance cover and a claim is required.

In this scenario you don’t have any insurance but suffer from a severe illness, have a long period of time off work, or die before your time.

Unfortunately as you have no cover, you have no way of offsetting the financial impact this event causes. To add to the emotional stresses are now financial ones (which could have been prevented).

Your family would therefore need to get by with reduced prosperity and possibly even financial hardship and poverty.

Conclusion

These are the only four scenarios available to you in relation to insurance.

Option one is basing your future on pure luck and option four would be financially devastating.

Looking at it logically, options two and three are the only ones that make any sense and therefore you should act sensibly and take out some insurance to cover the major financial risks that can and do happen.

A solid protection plan is the foundation of a good overall financial plan.

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