Some financial risks are too large for a household to carry alone: the death of a breadwinner, a serious illness, a house fire or a major accident. Insurance transfers such risks to an insurer in exchange for a regular payment called a premium. It does not prevent the event, but it prevents the event from becoming a financial disaster. Choosing the right cover, in the right amount, is a core part of personal financial planning.
What you will learn
- Explain how insurance works through risk pooling
- Describe the main types of life, health, property and liability insurance
- Estimate how much life cover a family needs
- Understand key policy terms and avoid common mistakes
How insurance works: risk pooling
An insurer collects premiums from many people facing similar risks and pays the claims of the few who suffer losses. Because the number of losses across a large group is far more predictable than for any individual, the insurer can price the risk.
Worked example: pooling a fire risk
Suppose 1,000 households each face a 1% chance a year of a fire causing a 1,000,000 loss (illustrative figures).
- Expected losses for the group: 1,000 × 1% × 1,000,000 = 10,000,000 a year — about 10 fires.
- Expected loss per household: 1% × 1,000,000 = 10,000.
- With a 25% loading for expenses, reserves and profit, the premium is about 12,500.
Each household swaps an uncertain chance of losing 1,000,000 for a certain cost of 12,500. Insurers use better data to refine these estimates — see RegTech and InsurTech.
Insurance is most valuable for low-probability, high-impact risks. Small, frequent costs are usually cheaper to cover from savings and an emergency fund. This is risk transfer, one of the four basic risk treatments — see risk mitigation strategies.
Main types of insurance
| Type | What it covers | Who needs it |
|---|---|---|
| Term life insurance | Pays a sum if the insured dies during the term | Anyone with dependants or debts |
| Whole life / endowment | Life cover plus a savings or investment element | Those wanting combined cover and saving (usually costlier) |
| Health insurance | Hospital and medical costs | Everyone not fully covered by an employer or the state |
| Critical illness | A lump sum on diagnosis of specified illnesses | Those whose income would stop during serious illness |
| Disability / income protection | Replaces income if unable to work | Earners whose families depend on their income |
| Property insurance | Damage to homes and contents from fire, flood, theft | Homeowners and tenants (contents) |
| Motor insurance | Vehicle damage and liability to others | Vehicle owners (third-party cover is often compulsory) |
| Liability insurance | Claims from others for injury or damage | Professionals, businesses, property owners |
Term life insurance provides the most cover per unit of premium because it has no savings element. Many planners suggest buying term cover and investing separately, rather than combining insurance and investment in one product — compare costs, returns and surrender charges carefully.
How much life cover?
The aim is to replace the financial support the insured person provides. A simple needs-based approach:
Worked example: estimating life cover
A parent earns 900,000 a year. If they died, the family would need about 70% of that income — 630,000 a year — for 20 years. The family also has a home loan of 2,000,000 and plans education costs of 1,500,000. Existing savings are 800,000 (illustrative figures). Assume money set aside earns 2% a year above inflation.
- Present value of income needs: 630,000 for 20 years at 2% ≈ 10,301,400.
- Add debts and goals: + 2,000,000 + 1,500,000.
- Subtract existing savings: − 800,000.
- Cover needed ≈ 13,001,400 — about 14 times annual income.
Rules of thumb such as "10 times income" give a starting point, but a needs calculation reflects the family’s actual situation. Review it as debts fall, children grow and savings rise. See education planning.
Key policy terms
- Premium: the price of cover, paid monthly or annually.
- Sum insured / sum assured: the maximum amount payable.
- Deductible (excess): the part of each claim the policyholder pays first. A higher deductible lowers the premium.
- Co-payment: a percentage of costs the policyholder shares, common in health insurance.
- Exclusions: events not covered — read these carefully.
- Waiting period: time before certain benefits start, common for pre-existing conditions.
- Nominee / beneficiary: the person who receives the payout.
- Underinsurance: if property is insured for less than its value, claims may be reduced proportionally.
Buying insurance wisely
- Prioritise: protect against the largest risks first — death of an earner, serious illness, disability, property loss.
- Disclose honestly: non-disclosure of health or other facts can lead to claims being refused.
- Compare insurers on claim settlement record, financial strength and service, not just price.
- Check regulation: buy from licensed insurers; in Bangladesh, insurers are regulated by the Insurance Development and Regulatory Authority (IDRA). International standards for insurance supervision are set out in the IAIS Insurance Core Principles.
- Keep documents organised and tell nominees where to find them.
- Review cover after major life events.
Common mistakes
- Having no life cover while supporting dependants.
- Buying too little cover because premiums for investment-linked policies are high.
- Relying only on employer health cover that ends with the job.
- Not reading exclusions and waiting periods.
- Insuring small, affordable risks while leaving large ones uncovered.
Key terms
- Premium — the amount paid for insurance cover.
- Risk pooling — combining many similar risks so losses become predictable.
- Deductible — the part of a claim paid by the policyholder.
- Term insurance — life insurance for a fixed period without a savings element.
- Exclusion — an event or cause of loss that a policy does not cover.
Frequently asked questions
Is insurance an investment?
Pure insurance is protection, not an investment. Some policies combine both, but their costs and returns should be compared with separate insurance and investing.
Do I need life insurance if I have no dependants?
Usually less, unless someone relies on your income or you have debts that others would have to repay.
Why was my claim reduced?
Common reasons include deductibles, co-payments, exclusions, non-disclosure and underinsurance. The policy wording sets out the rules.
Key takeaways
- Insurance transfers large, unpredictable losses to a pool in exchange for a predictable premium.
- Prioritise cover for death of an earner, illness, disability and major property loss.
- Estimate life cover from income needs, debts and goals minus existing savings.
- Read exclusions, disclose honestly, buy from licensed insurers and review regularly.