Life insurance is one of the most important 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 been sold over the years 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
sell and how much premium they can afford. This a wrong approach. Your
insurance requirement is a function of your financial situation, and has
nothing do with what products are available. Many insurance buyers use thumb
rules like 10 times annual income for cover. Some financial advisers say that a
cover of 10 times your annual income is adequate because it gives your family
10 years worth of income, when you are gone. But this is not always correct.
Suppose, you have 20 year mortgage or home loan. How will your family pay the
EMIs 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 the most, e.g. for their higher education. Insurance buyers
need to consider several factors in deciding how much insurance cover is
adequate for them.
· 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 the living expenses of the
dependents of the policy holder, factoring in inflation
· After debt repayment and generating monthly income, the sum assured
should also be adequate to meet future obligations of the policy holder, like
children's education, marriage etc.
2. Choosing the cheapest policy: Many insurance buyers like to buy policies
that are 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 event of an untimely death. Even if the insurer fulfils the claim, if it
takes a very long time to fulfil the claim it is certainly not a desirable
situation for family of the insured to be in. You should look at metrics like Claims
Settlement Ratio and Duration wise settlement of death claims of different life
insurance companies, to select an insurer, that will honour its obligation in
fulfilling your claim in a timely manner, should such an unfortunate situation
arise. Data on these metrics for all the insurance companies in India is
available in the IRDA annual report (on the IRDA website). You should also
check claim settlement reviews online and only then choose a company that has a
good track record of settling claims.
3. Treating life insurance as an investment and buying the wrong plan: The
common misconception about life insurance is that, it is also as 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 returns from life insurance to other investment
options, it simply does not make sense as an investment. If you are a young
investor with a long time horizon, equity is the best wealth creation
instrument. Over a 20 year time horizon, investment in equity funds through SIP
will result in a corpus that is at least three or four times the maturity
amount of life insurance plan with a 20 year term, with the same investment.
Life insurance should always been seen as protection for your family, in the
event 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 should
separate the insurance component and investment component and pay careful
attention to what portion of your premium actually gets allocated to
investments. In the early years of a ULIP policy, only a small amount goes to buying
units.
A good financial planner will always advise you to buy term insurance plan.
A term plan is the purest form of insurance and is a straightforward protection
policy. The premium of term insurance plans is much less than other types of
insurance plans, and it leaves the policy holders with a much larger investible
surplus that they can invest in investment products like mutual funds that give
much higher returns in the long term, compared to endowment or money back
plans. If you are a term insurance policy holder, under some specific
situations, you may opt for other types 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 purpose of tax planning: For many years agents
have inveigled their clients into buying insurance plans to save 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 over the long term.
Further, returns from insurance plans may 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 most important thing to note about life
insurance is that objective is to provide life cover, not to generate the best
investment return.
5. Surrendering life insurance policy or withdrawing from it before
maturity: This is a serious mistake and compromises the financial security of
your family in the event of an unfortunate incident. Life Insurance should not
be touched until the unfortunate death of the insured occurs. Some policy
holders surrender their policy to 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 is not in anyone's
control. That is why we buy life insurance in the first place. Second, life
insurance gets very expensive as the insurance buyer gets older. Your financial
plan should provide for contingency funds to meet any unexpected urgent expense
or provide liquidity for a period of time in the event of a financial distress.
6. Insurance is a one-time exercise: I am reminded of an old motorcycle
advertisement on television, which had the punch line, "Fill it, shut it,
forget it". Some insurance buyers have the same philosophy towards life
insurance. Once they buy adequate cover in a good life insurance plan from a
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 current income with your income ten years back. Hasn't your
income grown several times? Your lifestyle would also have improved
significantly. If you bought a life insurance plan ten years ago based on your
income back then, the sum assured will not be enough to meet your family's
current lifestyle and needs, in the unfortunate event of your untimely death.
Therefore you should buy an additional term plan to cover that risk. Life
Insurance needs have to be re-evaluated at a regular frequency and any
additional sum assured if required, should be bought.
Conclusion
Investors should avoid these common mistakes when buying insurance
policies. Life insurance is one of the most important components of any
individual's financial plan. Therefore, thoughtful consideration must be
devoted to life insurance. Insurance buyers should exercise prudence against
questionable selling practised in the life insurance industry. It is always
beneficial to engage a financial planner who looks at your entire portfolio of
investments and insurance on a holistic basis, so that you can take the best
decision with regards to both life insurance and investments.
Article Source: https://EzineArticles.com/expert/Dwaipayan_Bose/1976106
