Life insurance is among the most important components of any individual's financial plan. However, there's large amount of misunderstanding about life insurance, mainly due to the way life insurance products have already been sold over time in India. We have 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 simply how much premium they could afford. This a wrong approach. Your insurance requirement is a function of one's financial situation and has nothing to do use what goods 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 offers your loved ones 10 years worth of income, when you're 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 most of the loan continues to be outstanding? Suppose you have very young children. Your household will go out of income, when your children want it the most, e.g. for their higher education. Insurance buyers need to consider several factors in deciding simply how much insurance cover is adequate for them.
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· 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 must 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 should 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 buy policies which can be cheaper. That is another serious mistake. A low priced policy isn't any good, if the insurance company for some reason or another cannot fulfil the claim in case of an untimely death. Even when the insurer fulfils the claim, if it requires a extended time and energy to fulfil the claim it is obviously not a desirable situation for group of the insured to be in. You must 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 all your insurance companies in India will come in the IRDA annual report (on the IRDA website). It's also advisable to check claim settlement reviews online and only then pick a company that's a good track record of settling claims.
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3. Treating life insurance being an investment and buying the incorrect 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 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 just doesn't make sense being an investment. If you're a young investor with quite a while horizon, equity is the best wealth creation instrument. Over a 20 year time horizon, investment in equity funds through SIP can lead to a corpus that is at the least three or four times the maturity level of life insurance plan with a 20 year term, with exactly the same investment. Life insurance should been viewed as protection for your loved ones, in 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, on your own evaluation you need to separate the insurance component and investment component and pay careful attention as to the portion of one's premium actually gets allocated to investments. In early years of a ULIP policy, merely a small amount goes to buying units.
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A great 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 a lot significantly less than other types of insurance plans, and it leaves the policy holders with a much larger investible surplus that they'll spend money on investment products like mutual funds that give greater returns in the future, compared to endowment or money-back plans. If you're a term insurance coverage holder, under some specific situations, you could opt for 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 goal of tax planning: For several years agents have inveigled their clients into buying insurance plans to save tax under Section 80C of the Income Tax Act. Investors should understand that insurance has become 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 greater tax free returns within the long term. Further, returns from insurance plans may possibly not be entirely tax free. If the premiums exceed 20% of sum assured, then compared 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 supply life cover, not to generate the most effective investment return.
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5. Surrendering life insurance coverage or withdrawing from it before maturity: This can be a serious mistake and compromises the financial security of your loved ones in case of an unlucky 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 first place. Second, life insurance gets very costly since the insurance buyer gets older. Your financial plan should offer contingency funds to generally meet any unexpected urgent expense or provide liquidity for a time frame in case of a financial distress.
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6. Insurance is a one-time exercise: I'm 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. After they buy adequate cover in a good life insurance plan from the reputed company, they assume that their life insurance needs are taken care of forever. This can be a mistake. Financial situation of insurance buyers change with time. Compare your present income together with your income ten years back. Hasn't your income grown many times? Your lifestyle would also provide improved significantly. If you got a life insurance plan ten years ago based in your income in the past, the sum assured will not be enough to generally meet your family's current lifestyle and needs, in the unfortunate event of one's untimely death. Therefore you should buy one more term want to cover that risk. Life Insurance needs have to be re-evaluated at a typical frequency and any extra sum assured if required, ought to be bought.
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