Avoid these six common life insurance mistakes

Life insurance is one of the most important parts of any individual’s financial plan. However, there are many misconceptions about life insurance, mainly due to the way life insurance products have been sold in India over the years. We’ve discussed some common mistakes insurance buyers should avoid when purchasing insurance policies.

1. Underestimating Insurance Needs: Many life insurance buyers choose their coverage or sum insured based on the plans their agents want to sell and the premium they can afford. This is a wrong approach. Your insurance needs depend on your financial situation and have nothing to do with the products available. Many insurance buyers use rules of thumb like 10 times annual income for insurance coverage. Some financial advisers say that coverage of 10 times your annual income is reasonable because it will provide your family with income for 10 years after you are gone. But that’s not always right. Say you have a 20-year mortgage or home loan. How will your family pay the EMIs after 10 years with the majority of the loan still outstanding? Suppose you have very young children. Your family will run out of income when your children need it most, such as for their college education. Insurance buyers need to consider several factors to decide how much coverage is appropriate for them.

· Pay off all of the policyholder’s outstanding debt (eg, home loan, car loan, etc.).

· After the debt has been paid off, the cover or sum insured should have sufficient funds to generate sufficient monthly income to cover all living expenses of the policyholder’s dependents, taking inflation into account

· After paying off the debt and earning a monthly income, the sum insured should also be sufficient to meet future obligations of the policyholder such as raising children, getting married, etc.

2. Choosing the cheapest policy: Many insurance buyers like to buy policies that are cheaper. This is another fatal error. A cheap policy is useless if for some reason the insurance company cannot meet the claim in the event of an untimely death. Even if the insurer settles the claim, it is certainly not a desirable situation for the insured’s family if the claim takes a long time to settle. You should look at metrics such as claims ratio and death settlement claims from various life insurance companies to select 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 research claims adjustment reviews online and only then select a company that has a good track record of claims adjustment.

3. Treat life insurance as an investment and buy the wrong plan: The common misconception about life insurance is that it’s also a good investment or retirement solution. This misconception is largely due to some insurance agents who like to sell expensive policies to earn high commissions. If you compare the return on life insurance with other investment options, it simply makes no sense as an investment. If you’re a young investor with a long-term horizon, equity is the best wealth-building tool. Over a 20-year time horizon, investing in equity funds via SIP results in a corpus that is at least three or four times the life of a 20-year life insurance plan with the same investment. Life insurance should always be viewed as protecting 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, you should separate the insurance component from the investment component for your own assessment and be careful about how much of your premium is actually used for investments. In the early years of a ULIP policy, only a small amount goes into purchasing shares.

A good financial planner will always advise you to get term life insurance. A term plan is the purest form of insurance and a simple protection policy. The premium of term life insurance plans is much lower than other types of insurance plans, leaving policyholders with a much larger investable surplus to invest in investment products such as mutual funds, which yield much higher returns over the long term compared to endowment or money-back plans. If you are a term life insurance holder, you may, in certain circumstances, elect to purchase other types of insurance (e.g., ULIP, endowment insurance, or money back plans) for your specific financial needs in addition to your term life insurance.

4. Purchasing Insurance for Tax Planning Purposes: For many years, agents have enticed their clients into purchasing insurance plans in order to save tax under Section 80C of the Income Tax Act. Investors should be aware that insurance is probably the worst tax-saving investment out there. Returns from insurance plans are in the 5-6% range, while the Public Provident Fund, another 80C investment, yields nearly 9% risk-free and tax-free returns. Equity Linked Saving Schemes, another 80C investment, yields much higher tax-free returns over the long term. In addition, income from insurance plans may not be entirely tax-free. If the premiums exceed 20% of the sum insured, the proceeds due are taxable in this respect. As mentioned, the most important thing to remember about life insurance is that the goal is to offer life insurance, not to get the best investment return.

5. Cancel or cancel life insurance early: This is a serious mistake and puts your family’s financial security at risk in the event of an unfortunate incident. Life insurance should not be touched upon until the unfortunate death of the insured occurs. Some policyholders are canceling their policy to meet an urgent financial need, hoping to purchase a new policy when their financial situation improves. Such policyholders need to remember two things. First, mortality is not in anyone’s hands. That is why we primarily take out life insurance. Second, life insurance becomes very expensive as the policyholder ages. Your financial plan should include contingency funds to cover unexpected urgent expenses or to provide liquidity for a period of time in the event of a financial emergency.

6. Insurance is a one-off exercise: I remember seeing an old motorcycle ad on TV that had the punch line: “Fill, shut up, 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 are met forever. This is a mistake. The financial situation of policyholders changes over time. Compare your current income with your income ten years ago. Hasn’t your income grown many times over? Your lifestyle would also have improved significantly. If you took out life insurance ten years ago based on your income at the time, in the event of your early death, the insured amount will not be sufficient to cover your family’s current lifestyle and needs. Therefore, you should purchase an additional term plan to cover this risk. Life insurance needs must be reassessed regularly and any additional sum insured, if required, should be purchased.

Conclusion

These are common mistakes investors should avoid when buying insurance policies. Life insurance is one of the most important parts of any individual’s financial plan. Therefore, careful consideration must be given to life insurance. Insurance buyers should exercise caution with the questionable sales practiced in the life insurance industry. It’s always beneficial to hire a financial planner who can take a holistic view of your entire investment and insurance portfolio so you can make the best decision in both life insurance and investing.