Life insurance is one of the most crucial components of any individual's financial plan. However there is lot of misunderstanding about life insurance, mainly due to the way life insurance products have already been sold over the years in India. We've discussed some traditional mistakes insurance buyers should avoid when buying insurance policies.
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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 simply how much premium they are able to afford. This a wrong approach. Your insurance requirement is just a function of your financial situation, and has nothing do using what products are available. Many insurance buyers use thumb rules like 10 times annual income for cover. Some financial advisers say a cover of 10 times your annual income is adequate because it gives your loved ones 10 years worth of income, if you are gone. But this isn't always correct. Suppose, you have 20 year mortgage or home loan. How will your loved ones pay the EMIs after 10 years, when all of the loan is still outstanding? Suppose you have very young children. Your household will go out of income, when your children want it probably the most, e.g. for his or her higher education. Insurance buyers need to take into account several factors in deciding simply how much insurance cover is adequate for them.
· Repayment of the whole 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 also needs to be adequate to generally meet future obligations of the policy holder, like children's education, marriage etc.
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2. Choosing the least expensive policy: Many insurance buyers like to purchase policies that are cheaper. This is another serious mistake. A cheap policy is not any good, if the insurance company for whatever reason or another cannot fulfil the claim in case of an untimely death. Even if the insurer fulfils the claim, when it has a very long time and energy to fulfil the claim it is unquestionably not a desirable situation for category of the insured to be in. You ought to look at metrics like Claims Settlement Ratio and Duration wise settlement of death claims of different life insurance companies, to choose an insurer, which will honour its obligation in fulfilling your claim in an appropriate manner, should such an unlucky situation arise. Data on these metrics for the insurance companies in India comes in the IRDA annual report (on the IRDA website). It's also wise to check claim settlement reviews online and only then pick a company that's an excellent history of settling claims.
3. Treating life insurance being an investment and buying the incorrect plan: The common misconception about life insurance is that, it can be as an excellent investment or retirement planning solution. This misconception is largely due with a insurance agents who like to sell expensive policies to earn high commissions. If you compare returns from life insurance to other investment options, it simply does not seem sensible being an investment. If you are a young investor with quite a long time horizon, equity is the better wealth creation instrument. Over a 20 year time horizon, investment in equity funds through SIP can lead to a corpus that is at least three or four times the maturity amount of life insurance plan with a 20 year term, with exactly the same investment. Life insurance should always been seen as protection for your loved ones, in case of an untimely 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 investment component and pay careful attention from what portion of your premium actually gets allocated to investments. In the first years of a ULIP policy, just a touch goes to purchasing units.
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A great financial planner will always advise you to purchase term insurance plan. A term plan may be the purest form of insurance and is just a straightforward protection policy. The premium of term insurance plans is a lot significantly less than other types of insurance plans, and it leaves the policy holders with a much bigger investible surplus that they'll spend money on investment products like mutual funds giving much higher returns in the future, in comparison to endowment or money-back plans. If you are a term insurance policy holder, under some specific situations, you could choose other types of insurance (e.g. ULIP, endowment or money-back plans), as well as your term policy, for your specific financial needs.
4. Buying insurance for the objective of tax planning: For many years agents have inveigled their clients into buying insurance plans to save lots of tax under Section 80C of the Income Tax Act. Investors should realize that insurance is probably the worst tax saving investment. Return from insurance plans is in the range of 5 - 6%, whereas Public Provident Fund, another 80C investment, gives close to 9% risk free and tax free returns. Equity Linked Saving Schemes, another 80C investment, gives much higher tax free returns within the long term. Further, returns from insurance plans might not be entirely tax free. If the premiums exceed 20% of sum assured, then to that particular extent the maturity proceeds are taxable. As discussed earlier, the most crucial thing to see about life insurance is that objective is to offer life cover, never to generate the best investment return.
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5. Surrendering life insurance policy or withdrawing as a result before maturity: This is a serious mistake and compromises the financial security of your loved ones in case of an unlucky incident. Life Insurance should not be touched until the 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 new policy when their financial situation improves. Such policy holders need to remember two things. First, mortality isn't in anyone's control. That's why we buy life insurance in the very first place. Second, life insurance gets extremely expensive as 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 case of an economic distress.
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6. Insurance is just a one-time exercise: I'm reminded of a vintage motorcycle advertisement on television, which had the punch line, "Fill it, shut it, forget it" ;.Some insurance buyers have exactly the same philosophy towards life insurance. If they buy adequate cover in an excellent life insurance plan from the reputed company, they assume that their life insurance needs are taken care of forever. This is a mistake. Financial situation of insurance buyers change with time. Compare your overall income with your income ten years back. Hasn't your income grown many times? Your lifestyle would also have improved significantly. If you got a life insurance plan ten years ago based on your income in those days, the sum assured won't be enough to generally meet your family's current lifestyle and needs, in the unfortunate event of your untimely death. Therefore you should buy an additional term intend to cover that risk. Life Insurance needs need to be re-evaluated at a typical frequency and any additional sum assured if required, ought to be bought.
