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Avoid These Six Common Life Insurance Mistakes

Life insurance is one of the most important components of any individual’s financial plan. However, there is a lot of misunderstanding about life insurance, mainly because of the way life insurance products have been sold over the years in India. We have discussed some common mistakes that insurance buyers should avoid when purchasing insurance policies.

1. Underestimating insurance demand: Many insurance buyers choose their insurance policies or sum assured, based on the plans their agents want to sell and how much premium they can afford. This is a wrong approach. Your insurance requirement is a function of your financial situation, and has nothing to do with what products are available. Many insurance buyers use rules of thumb such as 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 of income when you are gone. But this is not always correct. Suppose you have a 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 when your children need it most, e.g. for his higher education. Insurance buyers must consider several factors to decide how much insurance coverage is right for them.

· Repayment of all outstanding debt (eg home loan, car loan etc.) of the policy holder

· After the repayment of debt, 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 owner, taking into account inflation.

· After debt repayment and generation of monthly income, the sum assured should also be adequate to meet future obligations of the policy holder, such as child 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 one reason or another cannot fulfill the claim in the event of an untimely death. Even if the insurer fulfills the claim, if it takes a very long time to fulfill the claim, it is certainly not a desirable situation for the family of the insurer to be in. claims from different life insurance companies, to choose an insurer who will honor their obligation to settle your claim in a timely manner should such an unfortunate situation arise. Data on these metrics for all insurance companies in India is available in the IRDA annual report (on the IRDA website). You should also check claims 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 like a good investment or retirement planning solution. This misconception is mostly due to some insurers who like to sell expensive policies to earn high commissions. If you compare life insurance returns to other investment options, it just doesn’t 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 a life insurance policy with a 20-year term, with the same investment. Life insurance should always be seen as protection for your family, in the event of an untimely death. Investing should be an entirely separate consideration. Although insurance companies sell Unit Linked Insurance Plans (ULIPs) as attractive investment products, for your own evaluation you need to separate the insurance component and investment component and pay close attention to what part of your premium is actually allocated to investments. In the early years of a ULIP policy, only a small amount goes towards buying units.

A good financial planner will always advise you to buy a term insurance plan. A term plan is the purest form of insurance and is a simple protection policy. The premium of term insurance plans is much less than other types of insurance plans, and it leaves the policyholders with a much larger investable surplus, which they can invest in investment products such as mutual funds, which give much higher returns in the long term, compared to. endowment or money-return plans. If you are a term policy holder, under some specific situations, you can opt for other types of insurance (eg ULIP, endowment or cash back), apart from your term policy, for your specific financial needs.

4. Buying insurance for tax planning: For many years agents have been encouraging their clients to buy insurance plans to save tax under Section 80C of the Income Tax Act. Investors should note that insurance is probably the worst tax-saving investment. Return of insurance plans is in the range of 5 – 6%, while Public Provident Fund, another 80C investment, gives close to 9% risk free and tax free return. 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 completely tax-free. If the premiums exceed 20% of the sum assured, then according to that measure the maturity income is taxable. As discussed earlier, the most important thing to note about life insurance is that the purpose is to provide life cover, not to generate the best investment return.

5. Surrendering life insurance 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 event. Life insurance should not be affected until the unfortunate death of the insured occurs. Some policyholders surrender their policy to meet an urgent financial need, with the hope of purchasing a new policy when their financial situation improves. Such politicians must remember two things. First, mortality is not in anyone’s control. That’s why we buy life insurance in the first place. Second, life insurance becomes very expensive as the insurance buyer ages. Your financial plan should provide contingency funds to meet any unexpected emergency expense or provide liquidity for a period of time in the event of financial distress.

6. Insurance is a one-time exercise: I’m reminded of an old motorcycle commercial on TV that had the punchline, “Fill it up, close it up, forget it.” Some insurance buyers have the same philosophy toward life insurance. Once they buy a suitable cover in a good life insurance policy from a reputable company, they assume that their life insurance needs are taken care of forever. This is a mistake. Financial situation of insurance buyers changes over time. Compare your current income with your income ten years ago. Has your income not increased several times? Your lifestyle would also improve significantly. If you bought a life insurance plan ten years ago based on your income then, the sum assured will not be enough to meet the current lifestyle and needs of your family, in the unfortunate event of your untimely death. Therefore, you should purchase an additional term plan to cover that risk. Life insurance should be revalued on a regular basis and any additional sum assured if required, should be purchased.

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 caution against dubious sales practices practiced in the life insurance industry. It is always beneficial to hire a financial planner who looks at your entire portfolio of investments and insurance policies on a holistic basis so that you can make the best decision regarding both life insurance policies and investments.

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