Life insurance is one of the most important components of any individual’s financial plan. However, there are many misunderstandings about life insurance, mainly due to the way life insurance products have been sold over the years in India. We have discussed some common mistakes insurance buyers should avoid when shopping for insurance policies.
1. Underestimating the insurance requirement: Many life insurance buyers choose their insurance coverages or the amount insured, based on the plans their agents want to sell and the premium they can afford. This is a wrong approach. Your insurance requirement is a function of your financial situation and has nothing to do with the products available. Many insurance buyers use rules of thumb like 10 times annual income for coverage. Some financial advisers say that coverage of 10 times your annual income is adequate because it gives your family 10 years of income when you are gone. But this is not always correct. Let’s say you have a 20-year mortgage or home loan. How will your family pay the EMI after 10 years, when most of the loan is still outstanding? Suppose you have very young children. Your family will run out of income when your children need it most, for example, for their higher education. Insurance buyers should consider several factors when deciding what insurance coverage is right for them.
Repayment of all outstanding debt (for example, home loan, car loan, etc.) of the policyholder
· After payment of the debt, the coverage or sum insured must have excess funds to generate enough monthly income to cover all living expenses of the policyholder’s dependents, taking inflation into account
· After the payment of the debt and the generation of monthly income, the insured sum must also be adequate to meet the future obligations of the policy holder, such as children’s education, marriage, etc.
2. Choosing the cheapest policy: Many insurance buyers like to buy cheaper policies. This is another serious mistake. A cheap policy is of no use if the insurance company for one reason or another cannot honor the claim in the event of an untimely death. Even if the insurer honors the claim, if it takes a long time to honor the claim, it is certainly not a desirable situation for the insured’s family. You should look at metrics such as claims settlement rate and intelligent settlement duration for death claims from different life insurance companies to select an insurer that will meet its obligation to meet your claim in a timely manner, should for such an unfortunate situation to arise. Data on these metrics for all insurance companies in India is available in the IRDA annual report (on the IRDA website). You should also check claims settlement reviews online and only then choose a company that has a good track record of claims settlement.
3. Treating life insurance as an investment and buying the wrong plan: The common misconception about life insurance is that it’s also a good investment or retirement planning solution. This misconception is largely due to some insurance agents who like to sell expensive policies to earn high commissions. If you compare the returns on life insurance to other investment options, it just doesn’t make sense as an investment. If you are a young investor with a long-term horizon, equities are the best wealth creation tool. In a 20-year time horizon, investment in variable income funds through SIP will result in a corpus of at least three or four times the maturity amount of the 20-year term life insurance plan, with the same investment. Life insurance should always be seen as a protection for your family, in case of eternal death. Investment should be a completely separate consideration. Although insurance companies sell Unit-Linked Insurance Plans (ULIPs) as attractive investment products, for your own evaluation, you should separate the insurance component and the investment component and pay careful attention to how much of your premium is actually allocated to investments. In the first few years of a ULIP policy, only a small amount goes toward the purchase of units.
A good financial planner will always advise you to purchase a term insurance plan. A term plan is the purest form of insurance and is a direct protection policy. The premium for term insurance plans is much lower than for other types of insurance plans, leaving policyholders with a much larger investable surplus that they can invest in investment products such as mutual funds that provide much higher returns at long term, compared to endowment or cash back plans. If you own a term insurance policy, in some specific situations, you may choose other types of insurance (eg, ULIP, endowment, or money back plans), in addition to your term policy, for your needs specific financial
4. Purchase of insurance for tax planning purposes: For many years, agents have tricked their clients into purchasing insurance plans to save taxes under Section 80C of the Income Tax Act. Investors need to realize that insurance is probably the worst tax-saving investment. The return on insurance plans is in the 5-6% range, while the Public Provident Fund, another 80C investment, provides close to 9% risk-free and tax-free return. Equity-linked savings schemes, another 80C investment, provide much higher tax-free returns in the long run. Also, returns from insurance plans may not be completely tax-free. If the premiums exceed 20% of the sum insured, then, to that extent, the maturity income is taxable. As discussed above, the most important thing to keep in mind about life insurance is that the goal is to provide life coverage, not to generate the best return on investment.
5. Giving up the life insurance policy or withdrawing before expiration: This is a serious mistake and compromises your family’s financial security in the event of an unfortunate incident. Life Insurance should not be touched until the unfortunate death of the insured occurs. Some policyholders surrender their policy to meet an urgent financial need, hoping to purchase a new policy when their financial situation improves. Such policyholders should remember two things. First, mortality is not under anyone’s control. That’s why we buy life insurance in the first place. Second, life insurance becomes very expensive as the insurance buyer ages. Your financial plan should provide for contingency funds to cover any unexpected urgent expenses or provide liquidity for a period of time in case of financial difficulties.
6. Insurance is a one-time exercise: I am reminded of an old motorcycle ad on TV, which had the joke: “Fill it up, lock it up, forget it.” Some insurance buyers have the same philosophy regarding life insurance. Once they purchase the right coverage in a good life insurance plan from a reputable company, they assume their life insurance needs are taken care of forever. This is a mistake. The financial situation of insurance buyers changes over time. Compare your current income with your income ten years ago. Has your income not grown several times? His lifestyle would have been significantly improved as well. If you purchased a life insurance plan ten years ago based on your income at that time, the sum insured will not be enough to meet your family’s current lifestyle and needs, in the unfortunate event of your untimely death. Therefore, you must purchase an additional term plan to cover that risk. Life insurance needs to be re-evaluated on a regular basis and any additional sum insured, if necessary, must be purchased.
conclusion
Investors should avoid these common mistakes when purchasing insurance policies. Life insurance is one of the most important components of any individual’s financial plan. Therefore, careful consideration should be given to life insurance. Insurance buyers should beware of questionable sales practiced in the life insurance industry. It is always beneficial to hire a financial planner who will look at your entire investment and insurance portfolio holistically, so that he or she can make the best decision regarding life insurance and investments.