Savings not a substitute for insurance

Your discussion last week on emergency savings and pay advance was appropriate and timely. So far I have managed to build my own emergency savings fund equivalent to six times my monthly salary, as recommended in sound financial planning. With an emergency fund in place, do I really need to have an insurance cover? Explain to me the importance of having the two?

Vincent,

Mombasa.

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Vincent, the role of emergency fund and insurance coverage is something that has been confusing many people who think one is a substitute for the other.

As a result, many policyholders have unwisely cancelled their insurance covers upon building their emergency funds whilst others have failed to set up emergency savings in the comfort that they have an insurance cover.

But this has plunged many people into financial distress during emergencies or uncertainties.

Insurance cover and emergency savings are not substitutes for each other, but are separate plans that should complement and reinforce each other in financial planning.

Although the two complement each other, their roles are different .

An emergency savings fund is to help you cope with emergencies requiring ready money.

These emergencies may come in the form of a job loss, a significant medical expenses resulting from injuries and even home repairs.

Whenever an emergency strikes, you will be compelled to seek additional source of money to meet you expenditure before you can regain your financial muscle

For instance, in the case of a job loss, you will need to meet your monthly expenditures even though you will not be getting any income in form of a salary.

But an emergency fund can help you to meet your financial obligations as you look for another job .

An emergency fund is a financial buffer that safeguards you from plunging into debts or financial difficulty upon any sudden and temporary financial loss or deficit.

Due to the temporary nature of emergency occurrence , the size of an emergency fund is usually recommended to be equivalent to three to six times your monthly salary—an amount that can guarantee you some living expenses.

Conversely, insurance is about risk protection that safeguards you from any financial loss that would result from a risk or uncertainties such as accidents, illnesses, theft, and death, among others.

Like an emergency fund that does not prevent the occurrence of an emergency, insurance does not prevent uncertainty from occurring but only compensates for the financial loss .

Because the financial loss that can result from uncertainty are of a higher magnitude, the risk is usually transferred by buying an insurance cover where you make regular contributions to an insurance firm on an agreement to receive compensation or benefits upon the event of a risk.

These risks or uncertainties are of specific categories while emergencies are general.

By only having an emergency fund without an insurance plan, you risk suffering a financial loss in the event of uncertainty which may deplete your emergency kitty, force you to sell your assets and even plunge you into deeper debt.

Suppose you have an emergency fund equivalent to six times your monthly salary, then uncertainty knocks in form of a severe illness such as cancer which requires immediate medical attention.

Because you only have an emergency fund, you would be forced to use the money to cover medical expenses which may be insufficient pay for a significant amount of the medication.

You may even be forced to dispose of some of your assets to bridge the deficit.

But with a sound insurance cover, all your medical expenses will be taken care of.

But when you only have an insurance cover without an emergency fund, you would still find yourself in a financial dilemma.

This is because whenever an uncertainty knocks, you will not be able to field your claim and manage to get your compensation on the same day.

The process of claim settlement may stretch into days, months and even years before you can get access to the compensation as the insurance company conducts its own investigation to validate the claim.

From the time of the occurrence of the risk (for instance an accident) to the point of compensation, you will require immediate cash for your treatment, hospitalisation and even upkeep as you recover.

At this point you can utilise your emergency savings to meet your immediate financial needs as you wait for your compensation from the insurance company.

But there are certain risks such as job loss that are not covered by insurance companies and without an emergency fund you may not be able to meet your monthly expenses even though you may have an insurance cover.

Whenever such emergencies occur, the insurance company will expect you to meet you monthly premiums as usual without default.

Emergency savings will complement your insurance cover by guaranteeing you continuous premium payment to protect your insurance from any lapse in case of job loss.

Mr Opiyo is a personal financial consultant with Money-Plan Advisory & Solutions