Life insurance is one of the most important components of any individual’s financial plan. However there are many misconceptions about life insurance, mainly because of the way life insurance products have been sold over the years in India. We’ve covered some of the common mistakes insurance buyers should avoid when purchasing an insurance policy.
1. Underestimating insurance terms: Many life insurance buyers choose their insurance coverage or sum assured, based on the plan their agent is willing to sell and how much premium they can afford. This is the wrong approach. Your insurance requirements are a function of your financial situation, and have nothing to do with what products are available. Many insurance buyers use a rule of thumb such as 10 times annual income for coverage.
Some financial advisors say that coverage of 10 times your annual income is sufficient because it provides your family with 10 years of income, when you are gone. But this is not always true. Let’s say you have a 20-year mortgage or home loan.
How will your family pay for the EMI after 10 years, when most of the loan is still outstanding? Suppose you have very small children. Your family will run out of income, when your children really need it, e.g. for their higher education. Insurance buyers need to consider several factors in deciding how much insurance coverage is adequate for them.
· Repayment of all debts (eg house loans, car loans, etc.) from the policyholder
After repayment of debt, the insured or sum assured must have excess funds to generate sufficient monthly income to cover all dependent living expenses of the policyholder, taking inflation into account
· After paying the debt and generating monthly income, the sum insured must also be sufficient to meet the policyholder’s future obligations, such as children’s education, marriage, etc.
2. Choose the cheapest policy: Many insurance buyers like to buy a cheaper policy. This is another serious error. Cheap policies are not good, if the insurance company for some reason cannot fulfill the claim in the event of an untimely death. Even if the insurance company fulfills the claim, if it takes a very long time to fulfill the claim it is certainly not a desirable situation for the insured family to be in.
You should look at metrics like Claim Completion Rate and Death completion time wise. claims from different life insurance companies, to choose an insurance company, which will honor its obligations in fulfilling your claim in a timely manner, should an unfavorable situation arise.
Data on this metric for all insurance companies in India is available in the IRDA annual report (on the IRDA website). You should also check claims settlement reviews online and only then choose a company that has a good track record of claim settlement.
3. Treating life insurance as an investment and buying the wrong plan: A common misconception about life insurance is that insurance is also a good investment solution or retirement plan. This misunderstanding is mostly caused by some insurance agents who like to sell expensive policies for high commissions. If you compare the returns from life insurance with other investment options, it makes absolutely no sense as an investment.
If you are a young investor with a long time horizon, equities are the best wealth creation instrument. Over a 20 year timeframe, investing in an equity mutual fund through SIP will result in a corpus that is at least three or four times the maturity amount of a 20 year life insurance plan, with the same investment. Life insurance should always be seen as protection for your family, in the event 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 from the investment component and pay close attention to what portion of your premium is actually allocated for investment. In the early years of the ULIP policy, only a small amount was used to purchase units.
A good financial planner will always advise you to buy a term insurance plan. Term plans are the purest form of insurance and are direct protection policies.
Term insurance plan premiums are much less than other types of insurance plans, and this leaves policyholders with a much larger investment surplus so they can invest in investment products such as mutual funds that provide much higher returns over the long term, compared to endowments. or endowment. . money back plan. If you are a term insurance policy holder, under certain circumstances, you may choose another type of insurance (eg ULIP, endowment or cash back plan), in addition to your term policy, for your specific financial needs.
4. Purchase insurance for tax planning purposes: For years agents have investigated their clients for purchasing insurance plans to save taxes under Section 80C of the Income Tax Act. Investors should be aware that insurance may be the worst tax saving investment. Returns from insurance plans are in the 5 – 6% range, while the State Administration Fund, another 80C investment, provides a risk-free and tax-free return of nearly 9%.
The Equity Linked Savings Scheme, another 80C investment, provides significantly higher tax-free returns in the long run. Furthermore, returns from insurance plans may not be completely tax-free. If the premium exceeds 20% of the Sum Insured, then as long as it is still due, it is subject to tax. As discussed earlier, the most important thing to note about life insurance is that its purpose is to provide life protection, not to produce the best possible investment returns.
5. Submitting a life insurance policy or withdrawing it before maturity: This is a serious mistake and jeopardizes 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 policyholders give up their policies to meet urgent financial needs, with the hope of buying a new policy when their financial situation improves.
Such policyholders need to remember two things. First, death is not in anyone’s control. That’s why we bought life insurance in the first place. Second, life insurance becomes very expensive as the insurance buyer ages. Your financial plan should provide an emergency fund to meet unexpected urgent expenses or provide liquidity for a certain period of time in case of financial difficulties.
6. Insurance is a one-time exercise: I remember the old motorcycle commercial on television, which had the phrase, “Fill it up, close it, forget it.” Some insurance buyers have the same philosophy towards life insurance. Once they purchase adequate coverage in a good life insurance plan from a reputable company, they assume that their life insurance needs have been met forever. This is a mistake.
The financial situation of the insurance buyer changes from time to time. Compare your current income with your income ten years ago. Didn’t your income increase several times? Your lifestyle will also improve significantly. If you purchased a life insurance plan ten years ago based on your current income, the sum insured would not be sufficient to meet your current lifestyle and family needs, should you die prematurely.
Therefore you should purchase an additional timeframe plan to cover that risk. The need for Life Insurance must be re-evaluated periodically and any additional sum insured if necessary, must be purchased.
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, careful consideration should be given to life insurance. Insurance buyers should beware of dubious selling practiced in the life insurance industry. It is always beneficial to engage a financial planner who looks at your entire investment and insurance portfolio holistically, so that you can make the best decisions regarding life insurance and investments.