As complexity of the task of managing personal financial risks increases, households will require a reasonable degree of financial literacy. Households, in particular, will need to use insurance mechanisms in an informed manner, and become adept at using financial advice.
There are many events, such as sudden death of the main income earner, or a catastrophic illness, whose chances of occurring are relatively low but the financial loss is substantial.
Assuming the value of each additional rupee is less as income increases (a well-off individual values an additional rupee less than a poor person), buying a policy can help smoothen income or wealth of households. This in turn improves the household's welfare.
When the probability of an event occurring is high, but amount involved is relatively low, such as routine medical needs, buying insurance may not be worthwhile. Self-insurance by households, involving regular savings, is more appropriate.
A household, therefore, must examine whether their cover for life, health, property, travel, and vehicle meet the above criteria. Often households purchase insurance (or their employers provide) for routine, predictable, small expenditures, but not for low-probability but high-expenditure events. In general, households must buy that kind of insurance, which is not already provided by their employers.
A policy is worthwhile if given its product features, it is actuarially fairly priced and if the providers are well regulated with appropriate standards of service and corporate governance. Tax advantages, and investment features associated with insurance products, while helpful for certain income groups, should not be elevated as prime considerations for most households.
Life expectancy in India in 2001 at age 60 was 16 years for men and 17 years for women, and this will rise. Longer life expectancy should lead to cheaper life insurance policies, but also to higher costs for health insurance and annuities.
There are additional contributory factors. India's morbidity pattern is undergoing a shift from communicable to lifestyle diseases.
India is also at early stages of introducing technology in its healthcare sector. The health insurance industry is also in early stages of development, and so are the regulatory structures. Its weak public sector health institutions are not able to check private sector costs. All these factors are likely to lead to rapid increases in healthcare costs.
For retirement financing, households must manage longevity and inflation risks. The former involves the probability that retirement resources may be exhausted before a person dies. At present, in India insurers do not have sufficient financial instruments to invest in to make annuities more affordable for a wider section of the population. There are also no instruments available to provide protection against inflation risks.
Appropriate risk sharing arrangements among insurance companies, households and the government will need to be evolved if longevity and inflation risks are to be addressed satisfactorily.
The Insurance Regulatory and Development Authority needs to be much more proactive in educating people about the benefits and pitfalls of insurance mechanisms so that they can better manage their financial risks and in enhancing professionalism and ethical standards of service providers.
It should also promote greater competition in both life and non-life insurance sectors. It should encourage product and process innovations, including micro-insurance and group insurance schemes, with a view to enhance access and affordability of insurance products for households, and assist them in managing livelihood risks.
The author is Professor, Lee Kuan Yew School of Public Policy, National University of Singapore.
