Life insurance is among the main components of any individual’s financial plan. However there is lot of misunderstanding about life insurance, mainly because of the way life insurance products have now been sold over time in India. We have discussed some common mistakes insurance buyers should avoid when buying insurance policies.
1. Underestimating insurance requirement: Many life insurance buyers choose their insurance covers or sum assured, based on the plans their agents want to offer and how much premium they could afford. This a wrong approach. Your insurance requirement is really a function of one’s financial situation, and has nothing do in what items 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 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 a lot of the loan continues to be outstanding? Suppose you have very young children. Your family will go out of income, when your children need it the absolute most, e.g. for their higher education. Insurance buyers need to take into account several factors in deciding 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 most 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 meet up future obligations of the policy holder, like children’s education, marriage etc.
2. Choosing the cheapest policy: Many insurance buyers like to get policies which can be cheaper. This is another serious mistake. A cheap policy is no good, if the insurance company for some reason or another cannot fulfil the claim in the case of an untimely death. Even when the insurer fulfils the claim, when it takes a lengthy time for you to fulfil the claim it is obviously not really a desirable situation for group 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 pick an insurer, that’ll honour its obligation in fulfilling your claim in a reasonable manner, should such an unlucky situation arise. Data on these metrics for the insurance companies in India is available in the Levens verzekeringen RDA annual report (on the IRDA website). It’s also advisable to check claim settlement reviews online and only then choose a company that has a good background of settling claims.
3. Treating life insurance as an investment and buying the wrong plan: The normal misconception about life insurance is that, it is also as a good investment or retirement planning solution. This misconception is essentially due for some insurance agents who like to offer expensive policies to earn high commissions. In the event that you compare returns from life insurance to other investment options, it just doesn’t sound right as an investment. If you are a investor with quite a while 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’s at the least 3 or 4 times the maturity quantity of life insurance plan with a 20 year term, with exactly the same investment. Life insurance should always been viewed as protection for your loved ones, in the case of an untimely death. Investment should be a completely separate consideration. Even though insurance companies sell Unit Linked Insurance Plans (ULIPs) as attractive investment products, for your own evaluation you must separate the insurance component and investment component and pay consideration to what portion of one’s premium actually gets allocated to investments. In the early years of a ULIP policy, merely a touch goes to buying units.
A great financial planner will always advise you to get term insurance plan. A term plan may be the purest form of insurance and is really 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 bigger investible surplus they can spend money on investment products like mutual funds that provide much higher returns in the future, compared to endowment or money back plans. If you are a term insurance plan holder, under some specific situations, you might decide for other types of insurance (e.g. ULIP, endowment or money back plans), in addition to your term policy, for the specific financial needs.
4. Buying insurance for the goal of tax planning: For quite some time agents have inveigled their clients into buying insurance plans to save lots of tax under Section 80C of the Income Tax Act. Investors should recognize that insurance is just about the worst tax saving investment. Return from insurance plans is in the range of 5 – 6%, whereas Public Provident Fund, another 80C investment, gives near 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 main thing to note about life insurance is that objective is to offer life cover, never to generate the very best investment return.
5. Surrendering life insurance plan or withdrawing as a result before maturity: This is a serious mistake and compromises the financial security of your loved ones in the case of an unlucky incident. Life Insurance shouldn’t be touched until the unfortunate death of the insured occurs. Some policy holders surrender their policy to meet up an urgent financial need, with the hope of purchasing 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 very expensive since the insurance buyer gets older. Your financial plan should give contingency funds to meet up any unexpected urgent expense or provide liquidity for a time period in the case of a financial distress.
6. Insurance is really a one-time exercise: I am reminded of a classic 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 a good life insurance plan from a reputed company, they believe that their life insurance needs are looked after forever. This is a mistake. Financial situation of insurance buyers change with time. Compare your present income with your income 10 years back. Hasn’t your income grown many times? Your lifestyle would likewise have improved significantly. If you bought a life insurance plan 10 years ago based on your own income in those days, the sum assured will not be sufficient to meet up your family’s current lifestyle and needs, in the unfortunate event of one’s untimely death. Therefore you should get an additional term plan to cover that risk. Life Insurance needs have to be re-evaluated at a regular frequency and any extra sum assured if required, must be bought.