Life insurance is an essential part of any person’s financial strategy. However, there is a lot of misconception about life insurance. This is mainly because of the way in which life insurance products are sold in India. In this article, we have talked about some of the common misconceptions that insurance buyers make when purchasing insurance policies.
Avoid These Six Common Life Insurance Mistakes
1. Underestimating insurance requirement
A lot of life insurance buyers select their life insurance cover or sum assured on the basis of the plans their agent wants to sell and the premium they are able to afford.
This is a flawed strategy. Your insurance needs are a result of your financial circumstances and have nothing to do with product availability.
A lot of insurance buyers rely on thumb rules, such as “10 times annual income”. According to some financial advisers, a cover is “adequate” because it provides your family with 10 years’ worth of income when you’re gone.
However, this isn’t always the case. For example, if you have a $20,000 home loan, how will your family manage to pay off the EMIs on that loan after 10 years?
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Suppose your children are very young and your family runs out of income at a time when your children are most in need of income, such as for their college tuition.
There are several factors that an insurance buyer must consider when determining how much coverage is appropriate for them.
2. Choosing the cheapest policy
Another common mistake that many insurance buyers make is buying policies that are cheap.
A cheap policy won’t do you any good if the insurer for any reason or another can’t fulfill the claim in case of untimely death of the insured.
Even if the claim is settled by the insurer, if it takes too long to settle the claim, it’s not a good situation for the family of the insured.
You should look at metrics such as Claims Settlement Ratio (SSR) and Duration wise settlement (DSS) of death claims of various life insurance companies to choose an insurer that will fulfill its obligation to settle your claim in good time in the event of such an unfortunate situation.
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Data on these metrics can be found in the annual report of the Indian Insurance Regulatory and Development Authority (IRDA) which is available on the IRDA website. You should also check the claim settlement reviews online. Only then choose a company with a good track record.
3. Treating life insurance as an investment and buying the wrong plan
One of the biggest misconceptions is that life insurance is also a good investment or a good solution for retirement planning.
This is mainly because some insurance agents like to sell high-priced policies to make high commissions. But if you look at the returns from life insurance compared to other investment alternatives, it simply doesn’t make sense.
Equity is the best way to build wealth over a long period of time. Over a 20-year time horizon, investing in equity funds through a systematic investment plan (SIP) will result in a return that is at least 3-4 times that of a life insurance plan that has a 20-year term and the same investment.
Life insurance should always be seen as a form of protection for your family in case of an unexpected death. Investment is a completely separate consideration.
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Insurance companies sell ULIPs as attractive investment products. However, for your own assessment, separate the insurance component from the investment component and pay close attention to how much of your premium actually goes to investments. Only a small portion of your ULIP premium goes to investment in the early years of your ULIP policy.
Your financial planner will always tell you to buy a term insurance plan.
A term plan is the cleanest form of insurance. It is a simple protection policy. The premiums of term insurance plans are much lower than those of other types of insurance.
Term insurance policyholders have a much larger investable surplus that they can use to invest in investment products such as mutual funds, which offer much higher returns over the long term than endowment and money-back plans.
If you’re a term insurance policyholder, under certain circumstances, you may choose to buy another type of insurance (such as a ULIP, an endowment, or a money-back plan) in addition to your current term insurance policy.
4. Buying insurance for the purpose of tax planning
For many years, agents have enticed their clients to purchase insurance plans in order to avail of tax relief under Section 80 C of the ITA.
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Investors should be aware that insurance is likely the worst of the tax-saving investments. The return from insurance plans ranges from 5-6%.
Public Provident Fund (another 80C investment) offers almost 9% risk-free and tax-free returns.
Equity Linked Saving Scheme (also an 80C investment) provides much higher tax-free returns in the long run.
Returns from insurance plans do not have to be 100% tax-free. If premiums are more than 20% of the sum assured, to that extent, the maturity proceeds will be taxable.
As mentioned earlier, the primary difference between life insurance and other investment vehicles is that life insurance’s primary objective is the provision of life cover, rather than to generate the highest investment return.
5. Surrendering a life insurance policy or withdrawing from it before maturity
This is a big mistake and puts your family’s financial future at risk in case of an unfortunate accident. Life Insurance shouldn’t be touched until after the insured’s untimely death.
Some policyholders give up their policy to cover an urgent financial emergency, hoping to buy a new policy as soon as their financial circumstances improve. These policyholders should remember two things:
First, mortality is outside of one’s control. That’s why we purchase life insurance.
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Second, life insurance becomes very expensive as an old person gets older.
Your financial plan should include contingency funds to cover an urgent emergency or to provide liquidity for an extended period in case of financial distress.
6. Insurance is a one-time exercise
I remember an old motorcycle ad on TV that said “Fill it up, shut it down, forget it”. Some insurance buyers follow the same logic when it comes to life insurance.
They think that once they buy adequate coverage in a reputable life insurance plan, they are done for good. But this is a fallacy.
The financial situation of the insurance buyer changes over time. Take a look at your current income and compare it to your income from a decade ago.
Hasn’t your income increased several times in that time? Your lifestyle has also changed dramatically.
If you purchased a life insurance policy ten years ago on the basis of your income at that time, then the sum assured today won’t be enough to cover your family’s lifestyle and needs in the event of your unfortunate death.
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Therefore, you should buy another term plan to meet that risk. Your life insurance needs need to be reviewed at regular intervals and if an additional sum assured is required, it should be purchased.
Life insurance is an important part of any investor’s financial plan. That’s why it’s important for investors to make sure they’re not making the following mistakes when purchasing insurance policies:
- Buying Life Insurance
- Buying Insurance
- Avoiding Questionable Selling Practices in the Life Insurance Industry
- Engaging a Financial Planner
It’s always a good idea to have a financial planner that looks at your whole portfolio of investments as well as your insurance policies. This way, you’ll be able to make the best decision for both your life insurance and your investments.