Some unexpected events have a positive impact on people’s finances, such as an unexpected promotion at work or a lottery win. Other events have a negative impact, such as redundancy or reduced hours at work, repair bills, or an increase in rent or mortgage payments. This topic explores the action that people can take to maximise the positive impacts and minimise the negative impacts.

Insurance policies are financial products designed to protect people from the financial losses associated with unexpected events. There are four main types of insurance, shown in Figure 10.1.

Figure 10.1 Types of insurance

General insurance Life cover

Health insurance Pensions policies

Includes motor, buildings, home contents, travel, and pet policies

Designed to protect other people from the financial consequences of someone’s death

Used to protect people against the financial loss of being too unwell to work or being diagnosed with a critical illness

Enable people to save for their retirement.

This topic focuses on general insurance.

Buying insurance is one way that people can deal with the risk of losses due to unexpected events. Alternatively, people can save for emergencies or borrow to make repairs or replace items. Depending on the measures that people have in place to deal with financial loss, they may also need to change their budget to allocate funds to cover unexpected expenses that they had planned to use elsewhere.

10.1 Key features of insurance

Insurance policies offer protection against the financial consequences of events that might occur, for example, fire, theft or accident. Insurance is a financial product that is provided by specialist companies called insurers and is covered by the Financial Ombudsman Service. Drivers are legally required to take out motor insurance; people buy other forms of insurance if they think the risk of something happening makes it worthwhile paying the cost of the protection.

10.1.1 Premiums

The price of an insurance policy is called the premium. The premium is based on: ◆ how likely an event is to occur;

◆ the amount of money needed to put things right if the event happens (to replace a bicycle that has been stolen, for instance), known as the sum insured;

◆ the length of time that the policy will be in force, known as the term;

◆ the amount of money the policyholder will pay towards repairs or replacement, known as the voluntary excess; and

◆ how the premium is paid – that is, as one payment or in monthly instalments.

Insurance companies work out the risk of an event happening based on statistics, for example how likely it is that a particular car driver will have a car accident. To calculate the risk, insurance companies require detailed information from the person applying to buy the insurance.

People who have insurance build up a no claims discount for each year they do not make a claim. For example a one-year no claims discount on a motor policy can range between 27% and 57.5% depending on the insurance company. The higher the number of years that someone has not made a claim, the higher the no claims discount will be and so the lower the premium charged. Insurers typically offer a maximum no claims discount on motor policies of between 60% and 75% for four or more years of no claims, although some insurers offer a 90% discount for five years or more of no claims.

Insurance companies often offer a protection for their no claims discount (called protected no claims discount). For a premium, this means motorists can make a small number of claims each year without losing their no claims discount.

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Applying for motor insurance

Tanya and Rob are twins, aged 20, who are applying

for motor insurance. The application form asks for

personal information about them including the

following details:

◆ Where they live – cars are more likely to be

damaged or stolen in some areas than in others.

◆ Their age – younger drivers are more likely to be

involved in accidents than older, more experienced

drivers. In 2013, for example, over 6,500 drivers

were killed or seriously injured in car accidents and

24% of them were in their teens or early twenties

(RAC Foundation, 2015).

◆ How long they have been driving – this tells the insurer how much driving experience they have.

◆ Details of any penalty points they have on their driving licence or convictions for dangerous driving, or any accidents they have been involved in – the insurer uses this information to decide how likely the applicant is to be involved in accidents.

◆ Whether they have made a claim on a motor insurance policy in the past – this is an indication of how likely they are to claim again in the future.

The insurance company also wants to know details about the car they will drive, including its make and model, its engine size, its age and market value and if it is kept on the road rather than in a garage or on a driveway. All these factors will affect how likely the car is to be stolen or in an accident, and how much the insurer would need to pay to repair or replace it.

Until December 2012, the twins would also have been assessed on their gender, as statistically the accidents that involve young men are more expensive than the accidents that involve young women. Insurers can no long use gender to determine premiums however because the European Court of Justice ruled that this contradicted laws on discrimination.

Most general insurance premiums are subject to insurance premium tax. This tax was introduced by the Finance Act 1994 and is charged at 10% for most premiums and 20% for travel insurance. The cost of the tax is included in the premium the policyholder pays.

People may pay a one-off premium, for example for single-trip travel insurance, or an annual premium, such as for home contents insurance and motor insurance. People can spread the cost of an annual premium by paying monthly. Many providers charge customers extra for paying monthly, however, as it is a form of credit.

Insurers send renewal notices quoting the price of the next year’s premium to policyholders who have annual insurance. Policyholders can shop around for the policy that best meets their needs and decide whether to renew with their existing insurer or to switch to another company.

The insurance company puts all the premiums that are paid for a certain type of policy into a pool. Policyholders who actually experience the event for which they have taken out insurance cover, such as a burglary, are paid from the pool. Policyholders who do not experience the event they have insured against receive nothing.

10.1.2 Providing full information

Insurers use the information provided by people on their application forms to set the premium for the insurance policy. It is therefore very important that this information is accurate. If someone enters misleading information on an application form the insurance policy will be void and the insurer will refuse any claims made on it. For example, Miranda has bought travel insurance to cover her holiday to the USA. When she completed the application form she did not disclose that she has epilepsy. If she suffers a seizure while on her holiday, her insurance policy will not cover her medical expenses because her epilepsy is a pre-existing condition that the insurance company needed to know about before it accepted her risk.

In April 2013 the Consumer Insurance (Disclosure and Representations) Act 2012 came into force. Before this law was introduced, people were responsible for telling insurers any detail that might affect their policy, either at the application stage or while the policy was in force. This could cause policyholders problems if they did not realise that certain information was important, such as modifications made to their car. The Act makes it the insurer’s responsibility to ask for all the information they require to calculate the premium. According to the Money Advice Service (an independent service set up by the government to help people make the best use of their money), this change in the law is expected to result in far fewer claims being rejected on the basis that policyholders failed to disclose information. In the past, insurance companies have rejected claims because, for example, the policyholder did not tell the insurer about a childhood illness or a long-forgotten driving conviction (MAS, 2013).

10.1.3 Policy documents

When people have paid the insurance premium they receive a policy document and a certificate of insurance. The policy document details what is covered by the insurance policy and the terms and conditions for policyholders making a claim. It is often accompanied by a separate policy schedule that includes the specific details relating to the policyholder (such as the sum insured and excess). It is very important that policyholders check that the insurance they have bought:

◆ covers the events the policyholder wants to insure against; and

◆ will pay sufficient compensation if the event occurs.

The ‘sum insured’ is either a set amount of money or is described as ‘new for old’ (the insurer will pay for a new item) or replacement cost (the insurer will pay the value of an item with similar wear and tear).

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The insurance certificate details who the policyholder is and provides a summary of the cover given by the insurance. The certificate is proof that the policyholder is covered by the insurance and includes the policy number. This evidence is needed if the policyholder wishes to make a claim.

Motor insurance documents can be requested by the police following an accident. In the past, drivers had to show their insurance documents when they bought road tax for their vehicle at a post office. Now, however, when someone buys road tax at a post office or online, the Driver and Vehicle Licensing Agency (DVLA) checks electronically that an insurance policy is in place. If people need proof of insurance before a certificate has been printed, the insurer can issue a temporary cover note. This is particularly useful when people buy cars and need to have insurance cover before they can drive the car home.

10.1.4 Claims

If any of the events covered by the insurance policy occur, the policyholder can make a claim to the insurance company. The insurer’s claims department will assess the details of the claim to determine whether or not the policyholder is covered and how much the insurer will pay.

10.2 Motor insurance

The Road Traffic Act 1988 makes it compulsory for people who drive to have at least third-party motor insurance. If the driver causes injury to another person (a ‘third party’), or damages their car and other property in an accident, third-party insurance covers that person. It does not cover injury to the driver or damage to their car. People who are caught driving without insurance cover can be fined £300 and given six penalty points on their driving licence. If the case goes to court they can be given an additional unlimited fine and disqualified from driving. The police can also remove and, in some cases, destroy their car.

After an accident a claims assessor investigates the extent of the damage and the costs of repair.

10.2.1 Types of motor insurance

Third-party motor insurance is traditionally the lowest-cost motor insurance available. Motorists have a choice of two other types of policy as well:

◆ third-party, fire and theft; or

◆ comprehensive motor insurance.

Third-party motor insurance usually covers the cost of:

◆ injuries to other people, including passengers (for example, their medical costs); ◆ damage to other people’s property;

◆ accidents caused by passengers; and

◆ damage caused by a caravan or trailer while attached to the car.

Third-party, fire and theft motor insurance usually covers the cost of:

◆ all the third-party items listed above; and

◆ repairs to or replacement of the driver’s car if it is damaged or destroyed in a fire or is stolen.

Comprehensive motor insurance usually covers:

◆ all third-party and fire and theft items listed above;

◆ accidental damage to the driver’s car;

◆ a personal accident benefit: a sum of money paid on the death of the driver or for specific types of permanent disablement that the driver (and sometimes their spouse or family member) sustains in an accident;

◆ medical expenses related to an accident, up to a stated limit; and

◆ loss of or damage to personal possessions in the car, up to a stated limit. When choosing which motor insurance product to buy, motorists need to consider: ◆ what they can afford;

◆ how much it would cost to make repairs to or replace their car; and

◆ whether or not their personal possessions are covered by another insurance policy.

The terms and conditions of policies vary, so it is important that people read the details of what is covered before choosing a specific insurance product. Some premiums are quoted with standard ‘extra’ services, such as cover for legal costs, for example. Comprehensive motor cover may be more expensive than third-party, fire and theft, or it may turn out cheaper, because insurance providers have noticed that drivers who only buy third-party insurance are more likely to make a claim (Moneysupermarket, 2018). Different providers have different pricing structures, however, so people can benefit from shopping around for the best prices for the cover they need.

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10.2.2 Pay-as-you-go insurance

People who do not drive very often can reduce the costs of insurance by choosing a pay-as-you-go policy. The insurer fits a telematic GPS tracking device, sometimes called a ‘black box’, to the car. This device records the number of miles driven and driving habits in terms of speed, the type of road the car is travelling on, the time at which the journey is made, and how the driver is braking and cornering. This information is transmitted to the insurer via satellite. The insurer uses the information to charge a per-mile cost which is based on how safely the driver is driving, when they drive and how long their journeys are. For example, people who drive short distances during off-peak times are less likely to be involved in accidents and therefore have lower per-mile costs. Many insurers give the driver access to the data and advice on how to drive more safely to reduce the cost of the premium.

Pay-as-you-go insurance may not work out cheaper than conventional insurance if drivers have to travel during peak hours such as the rush hour and cannot keep to a low mileage. Further, some insurers charge a fee for the black box and/or for installing it in a car.

10.2.3 Reducing the cost of motor insurance

The Association of British Insurers (ABI) gives the following advice for cutting the cost of car insurance (ABI, 2019):

◆ When shopping around, compare the details of what is covered by different policies, as well as the cost.

◆ Fit an approved alarm or immobiliser, as insurers offer discounts for cars that are secure. Premiums may also be lower for cars kept in a garage, rather than parked on the street or in a driveway.

◆ Pay a higher voluntary excess, as this will mean the insurer pays less on any claims made.

◆ Only use the vehicle for social, domestic and pleasure purposes, as business use increases premiums.

◆ Build up a no-claims discount. These discounts can be between 30% for one claim free year and 60% for five claim-free years.

◆ Pay the premium as one payment if possible because some insurers charge extra for paying in instalments.

◆ Drive a lower-powered car, as a smaller engine size usually means a lower premium.

uSwitch (2018) adds the following tips:

◆ Pick the right cover: look at all three levels of cover as third party is not always the cheapest.

◆ Protect your no claims discount: pay a fee to ensure you do not lose it in the event of a claim.

‘Fronting’

Neil’s daughter, Jasmine, is 17 years old and has

recently passed her driving test. He has decided to buy

her a small secondhand car. As car insurance is very

expensive for young drivers, Neil is thinking about

taking out an insurance policy that names him as the

main driver and adding Jasmine as a ‘named driver’,

that is, someone who might drive the car occasionally.

He thinks that this might be a good way of reducing the

cost of the insurance policy. Luckily, before he puts his

idea into action, Neil reads a newspaper report that

explains this practice is called ‘fronting’ and is illegal

because it is fraud. The penalties for fronting include a fine or even a prison sentence for the older driver and the younger driver can be banned from driving.

10.3 Buildings and home contents insurance

Buildings insurance covers the cost of repairing or rebuilding a property if it is damaged or destroyed, for example in a fire or by subsidence. Policyholders may be able to add accidental damage for an extra premium, to cover risks such as a car hitting the property. If people are renting a property, the buildings insurance will be paid for by the landlord. People who own a property or are buying it will need enough buildings insurance to cover the cost of rebuilding the property if necessary. Lenders will insist that borrowers take out buildings insurance to protect the property on which the mortgage is secured.

Contents insurance covers belongings kept in the home that people can take with them when they move, such as:

◆ electrical goods like televisions, computers, fridges and freezers;

◆ personal items such as DVDs, CDs, books and mobile phones;

◆ furniture;

◆ furnishings such as carpets and curtains;

◆ clothing;

◆ money; and

◆ valuables such as jewellery and cameras.

The risks covered are usually loss or damage from events such as:

◆ fire, explosion, lightning and earthquake;

◆ storm and flood;

◆ aircraft and items dropped from aircraft;

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◆ collision involving vehicles or animals;

◆ theft or attempted theft;

◆ falling trees and branches;

◆ falling TV or radio aerials and satellite dishes; and

◆ water escaping from tanks or pipes.

Policyholders can pay extra and receive cover for accidental damage or loss as well. There is usually a maximum limit on the value of goods that are covered by a policy, such as up to £75,000. The policyholder chooses the maximum when applying for the insurance and the insurer uses the maximum sum insured as part of the premium calculation.

The details of what is covered vary from policy to policy. For example, some policies cover personal belongings such as mobile phones when they are taken out of the home for short periods of time. Others cover the contents of gardens, freezers or students’ possessions at university. The exclusions also vary from policy to policy. For example, some policies do not cover contents in a home that is left unattended for long periods of time. People need to investigate the details of a policy before buying it rather than basing their decision on price alone.

10.4 Other types of insurance

There are many different types of insurance to suit people with different needs. Examples include the following:

◆ Pet insurance – this covers the cost of vet bills in case a pet needs treatment.

◆ Travel insurance – this covers people for the costs of medical treatment when on holiday, and the cost of replacing luggage or belongings that are lost, stolen or damaged. These policies often cover the costs of delays to a journey, too, for example the cost of having to stay in a hotel for extra nights.

◆ Mobile phone insurance – this covers loss or damage to mobile phones. People need to be careful not to overinsure their mobile phone as it may already be covered under their home contents policy.

10.5 Revising budgets

Another way in which people can deal with unexpected expenses is to pay them from current income by revising their budget. This will not always be an option; it depends on the scale of the unexpected expense compared with the allowance for discretionary expenditure in the budget.

For example, Brodie’s boiler needs to be repaired and he has been given a quote for £202. Brodie can afford to pay this unexpected bill if he pays using his credit card and allocates £101 from his discretionary expenses in the current and the following month (around £25 a week) to repayments. He plans to reduce his discretionary spending on other expenses over these two months by:

One way of dealing with an unexpected car repair bill would be to use public transport while saving up to pay for the work to be done.

◆ reducing the amount he spends on socialising – rather than always meeting in pubs, restaurants or at the cinema, Brodie will invite friends to his home for supermarket pizza and to watch DVDs from his collection;

◆ cutting back on the coffees he buys on the way to work – as he buys a large cappuccino most mornings at £2.50 each, he currently spends £12.50 over five days; and

◆ delaying spending on clothes, DVDs and games until after he has repaid the bill.

10.6 Saving

People can also prepare for unexpected expenses by saving in an instant access account such as an ISA. The Money Advice Service suggests having enough in emergency funds to pay mandatory and essential expenses for three months (MAS, no date). For example, Meg Ford receives £2,200 a month from her job as an IT project manager and allocates £1,500 of this to mandatory and essential expenditure in her budget. She is concerned about what will happen to her family if she loses her job as they would find it difficult to make ends meet on her husband Kurt’s income alone. If she lost her current job, Meg thinks she could probably find another one within three months because she has specialist skills that are in demand in the local area. So every month she saves £150 in a cash ISA with the goal of having an emergency fund of £4,500 (£1,500 x 3). It will take her approximately two and a half years to build up this fund.

Another option when faced with an unexpected expense is to consider if it must be paid immediately. For example, Piper’s television set has broken and she has received a quote of £180 to repair it. She cannot afford this cost from her current finances. She could, however, save enough over the next two months to pay for the repair. In the meantime, she could watch television on her computer.

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10.7 Borrowing

Sometimes people find that they have to pay

an unexpected expense but are not covered

by insurance, they cannot afford the costs

by changing their budget and they do not

have enough in savings to pay for it. At this

point people will consider whether or not to

borrow. This decision should be based on

how much money they need and how much

they can afford to repay. Budgets are a key

tool in identifying a realistic repayment that

someone can afford to pay every month. We

looked at budgeting in Topic 9 and at short

term borrowing products in Topic 6.

In emergencies, people can be tempted to borrow money they cannot afford to repay and to use less reputable providers. There are a number of providers that offer short term loans at high costs. If people have been turned down by other providers, they may consider these lenders as the only option. In these cases it is vital that borrowers repay the loan as soon as possible. The danger is that people who can only afford small repayments on expensive loans find their debts grow far faster than they can afford to repay them. Topic 11 covers the help available for people who are finding it difficult to repay debt.

The Money Advice Service website (www.moneyadviceservice.org.uk) makes a distinction between ‘good debt’ and ‘bad debt’. It defines a good debt as ‘one that is a sensible investment in your financial future, should leave you better off in the long-term and should not have a negative impact on your overall financial position’ such as repairing a car so you can travel to work. Another ‘good debt’ would be a student loan to help finance your studies, which should lead to better employment prospects and a higher income later in life. A final example of ‘good debt’ is a mortgage, borrowed over about 25 years to pay for a property; this provides the borrower with a home which can one day be passed on or sold.

The MAS defines bad debts as ‘those that drain your wealth, are not affordable and offer no real prospect of “paying for themselves” in the future’ (MAS, no date). An example of ‘bad debt’ is not paying off a credit card balance in full, meaning that the balance takes longer to pay off and ends up costing you more.

10.8 Benefits

The government can help with unexpected events that mean people are unable to afford their living expenses. For example, if people lose their jobs or can no longer work because of medical conditions, there are unemployment and disability or incapacity benefits. The government can also help people on low incomes with bills such as funeral expenses, fuel costs or the costs of emergency housing after a fire. When the unexpected happens, people can get expert advice from Job Centre Plus or Citizens Advice to ensure they apply for the benefits that are designed to help them.

10.9 Unexpected income

Unexpected events do not always mean that people face unexpected expenses: sometimes, they result in an increase in income, perhaps from a new job or a one off payment such as an inheritance. In these situations, people need to decide how to use the additional funds. Figure 10.2 shows the main options.

People will have different priorities depending on their personal circumstances and attitudes. In general terms, people should consider using the money in the following ways.

10.9.1 An emergency fund

People can use the extra income to make sure they have savings they can access instantly in an emergency. As we saw in section 10.6 above, the MAS recommends an emergency fund equivalent to essential expenditure for three months. However, people with expensive debts need to consider having a smaller amount of savings and repaying their borrowing.

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10.9.2 Repaying debt

Once the emergency fund is in place, people should consider repaying outstanding debt, starting with their most expensive borrowing. People usually pay more interest on their debt than they can earn on their savings. So using extra money to reduce the cost of borrowing means people are better off overall. Some borrowing products such as loans have penalty charges for early repayment, however, so people need to find out the full cost of repaying debt before making a final decision. The most expensive borrowing products are usually credit cards or store cards, followed by overdrafts and loans.

10.9.3 Saving

Once debt has been repaid, people can consider saving, for example by using their cash ISA allowance for the year. If people already have sufficient instant access savings, they can consider longer-term savings accounts that may offer higher returns.

10.9.4 Spending

When people have repaid expensive debt and saved some of their unexpected income, they may decide to spend on assets that will lower their living costs such as replacing an old, unreliable car with a newer one that is likely to need fewer repairs. They may also decide to spend it on products and services they want.

Key ideas in this topic

◆ Using insurance.

◆ Revising budgets to meet unexpected expenses.

◆ Emergency savings.

◆ Borrowing.

◆ Benefits.

◆ Dealing with unexpected income.

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Topic 10 Insurance - Unit 1 LIBF

Topic 10

Dealing with unexpected events

Learning outcome

After studying this topic, students will be able to:

◆ provide solutions for dealing with unforeseen events that impact on current finances.

Introduction