Life insurance is certainly one of the main aspects of any individual's financial plan. However there is large amount of misunderstanding about life insurance, mainly due to the way life insurance products have been sold over the years in India. We've discussed some traditional mistakes insurance buyers should avoid when buying insurance policies.
1. Underestimating insurance requirement: Many life insurance buyers choose their insurance covers or sum assured, on the basis of the plans their agents want to sell and how much premium they could afford. This a wrong approach. Your insurance requirement is a function of one's financial situation, and has nothing do in what products are available. Many insurance buyers use thumb rules like 10 times annual income for cover. Some financial advisers say that the cover of 10 times your annual income is adequate because it provides your household 10 years worth of income, when you are gone. But this is not always correct. Suppose, you've 20 year mortgage or home loan. How will your household pay the EMIs after 10 years, when most of the loan is still outstanding? Suppose you've very young children. Your household will go out of income, when your young ones need it the most, e.g. due to their higher education. Insurance buyers need to take into account several factors in deciding how much insurance cover is adequate for them.
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· Repayment of the entire outstanding debt (e.g. home loan, car loan etc.) of the policy holder
· After debt repayment, the cover or sum assured should have surplus funds to generate enough monthly income to cover all of the living expenses of the dependents of the policy holder, factoring in inflation
· After debt repayment and generating monthly income, the sum assured must also be adequate to generally meet future obligations of the policy holder, like children's education, marriage etc.
2. Choosing the lowest priced policy: Many insurance buyers like to purchase policies which are cheaper. That is another serious mistake. A cheap policy isn't any good, if the insurance company for some reason or another cannot fulfil the claim in the event of an untimely death. Even when the insurer fulfils the claim, when it takes a very long time for you to fulfil the claim it is obviously not really a desirable situation for family of the insured to be in. You need to look at metrics like Claims Settlement Ratio and Duration wise settlement of death claims of different life insurance companies, to pick an insurer, that may honour its obligation in fulfilling your claim in a reasonable manner, should such a sad situation arise. Data on these metrics for the insurance companies in India is available in the IRDA annual report (on the IRDA website). It's also wise to check claim settlement reviews online and only then select a company that has an excellent track record of settling claims.
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3. Treating life insurance as an investment and buying the wrong plan: The common misconception about life insurance is that, it is also as an excellent investment or retirement planning solution. This misconception is basically due for some insurance agents who like to sell expensive policies to earn high commissions. In the event that you compare returns from life insurance to other investment options, it simply doesn't seem sensible as an investment. If you're a investor with a long time horizon, equity is the greatest wealth creation instrument. Over a 20 year time horizon, investment in equity funds through SIP can lead to a corpus that's at the least 3 or 4 times the maturity number of life insurance plan with a 20 year term, with the exact same investment. Life insurance should always been viewed as protection for your household, in the event of an untimely death. Investment should be considered a completely separate consideration. Even though insurance companies sell Unit Linked Insurance Plans (ULIPs) as attractive investment products, for your own personel evaluation you need to separate the insurance component and investment component and pay consideration to what portion of one's premium actually gets allocated to investments. In early years of a ULIP policy, merely a touch goes to purchasing units.
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An excellent financial planner will always advise you to purchase term insurance plan. A term plan could be the purest type of insurance and is a straightforward protection policy. The premium of term insurance plans is significantly less than other kinds of insurance plans, and it leaves the policy holders with a much larger investible surplus that they'll purchase investment products like mutual funds that provide greater returns in the future, in comparison to endowment or money back plans. If you're a term insurance policy holder, under some specific situations, you could opt for other kinds of insurance (e.g. ULIP, endowment or money back plans), in addition to your term policy, for your specific financial needs.
4. Buying insurance for the objective of tax planning: For quite some time agents have inveigled their clients into buying insurance plans to save tax under Section 80C of the Income Tax Act. Investors should recognize that insurance is probably the worst tax saving investment. Return from insurance plans is in the number of 5 - 6%, whereas Public Provident Fund, another 80C investment, gives near 9% risk free and tax free returns. Equity Linked Saving Schemes, another 80C investment, gives greater tax free returns on the long term. Further, returns from insurance plans may possibly not be entirely tax free. If the premiums exceed 20% of sum assured, then to that extent the maturity proceeds are taxable. As discussed earlier, the main thing to note about life insurance is that objective is to provide life cover, not to generate the best investment return.
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5. Surrendering life insurance policy or withdrawing as a result before maturity: This can be a serious mistake and compromises the financial security of your household in the event of a sad incident. Life Insurance should not be touched before unfortunate death of the insured occurs. Some policy holders surrender their policy to generally meet an urgent financial need, with the hope of buying a fresh policy when their financial situation improves. Such policy holders need to consider two things. First, mortality is not in anyone's control. That is why we buy life insurance in the very first place. Second, life insurance gets very costly since the insurance buyer gets older. Your financial plan should give contingency funds to generally meet any unexpected urgent expense or provide liquidity for a time period in the event of an economic distress.
6. Insurance is a one-time exercise: I'm reminded of an old motorcycle advertisement on television, which had the punch line, "Fill it, shut it, forget it" ;.Some insurance buyers have the exact same philosophy towards life insurance. Once they buy adequate cover in an excellent life insurance plan from a reputed company, they believe that their life insurance needs are looked after forever. This can be a mistake. Financial situation of insurance buyers change with time..
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Compare your overall income along with your income 10 years back. Hasn't your income grown repeatedly? Your lifestyle would also provide improved significantly. If you purchased a life insurance plan 10 years ago based on your own income in the past, the sum assured won't be adequate to generally meet your family's current lifestyle and needs, in the unfortunate event of one's untimely death. Therefore you should buy an additional term intend to cover that risk. Life Insurance needs have to be re-evaluated at a typical frequency and any extra sum assured if required, must certanly be bought.
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