Life insurance is one of the most important components of
any individual's financial plan. However there is lot of misunderstanding about
life insurance, mainly due to the way life insurance products have been sold
over the years in India. We have discussed some common mistakes insurance
buyers should avoid when buying insurance policies.
1. Underestimating insurance requirement: Many life
insurance buyers choose their insurance covers or sum assured, based on the
plans their agents want to sell and how much premium they can afford. This a
wrong approach. Your insurance requirement is a function of your financial
situation, and has nothing do with what products 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
gives your family 10 years worth of income, when you are gone. But this is not
always correct. Suppose, you have 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 of income, when
your children need it the most, e.g. for their higher education. Insurance
buyers need to consider several factors in deciding how much insurance cover is
adequate for them.
· Repayment of the entire outstanding debt (e.g. home loan,
car loan etc.) of the policy holder
· After debt repayment, 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 holder, factoring in inflation
· After debt repayment and generating monthly income, the
sum assured should also be adequate to meet future obligations of the policy
holder, like children's 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 some reason or another cannot
fulfil the claim in the event of an untimely death. Even if the insurer fulfils
the claim, if it takes a very long time to fulfil the claim it is certainly not
a desirable situation for family of the insured to be in. You should look at
metrics like Claims Settlement Ratio and Duration wise settlement of death
claims of different life insurance companies, to select an insurer, that will
honour its obligation in fulfilling your claim in a timely manner, should such
an unfortunate situation arise. Data on these metrics for all the insurance
companies in India is available in the IRDA annual report (on the IRDA
website). You should also check claim settlement 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
as a good investment or retirement planning solution. This misconception is
largely due to some insurance agents who like to sell expensive policies to
earn high commissions. If you compare returns from life insurance to other
investment options, it simply does not 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 life insurance plan with a 20 year term, with the same investment.
Life insurance should always been seen as protection for your family, in the
event 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, for your own evaluation you should
separate the insurance component and investment component and pay careful
attention to what portion of your premium actually gets allocated to
investments. In the early years of a ULIP policy, only a small amount goes to
buying units.
A good 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 much
less than other types of insurance plans, and it leaves the policy holders with
a much larger investible surplus that they can invest in investment products
like mutual funds that give much higher returns in the long term, compared to
endowment or money back plans. If you are a term insurance policy holder, under
some specific situations, you may opt for other types of insurance (e.g. ULIP,
endowment or money back plans), in addition to your term policy, for your
specific financial needs.
4. Buying insurance for the purpose of tax planning: For
many years agents have inveigled their clients into buying insurance plans to
save tax under Section 80C of the Income Tax Act. Investors should realize that
insurance is probably 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 much higher tax free returns over
the long term. Further, returns from insurance plans may not be entirely tax
free. If the premiums exceed 20% of sum assured, then 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 provide life cover, not to
generate the best investment return.
5. Surrendering life insurance policy 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 incident. Life Insurance
should not be touched until the unfortunate death of the insured occurs. Some policy
holders surrender their policy to meet an urgent financial need, with the hope
of buying a new policy when their financial situation improves. Such policy
holders need to remember 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 expensive as the insurance buyer gets older. Your financial
plan should provide for contingency funds to meet any unexpected urgent expense
or provide liquidity for a period of time in the event of a financial distress.
6. Insurance is a one-time exercise: I am reminded of an old
motorcycle advertisement on television, which had the punch line, "Fill
it, shut it, forget it". Some insurance buyers have the same philosophy
towards life insurance. Once they buy adequate cover in a good life insurance
plan from a reputed company, they assume that their life insurance needs are
taken care of forever. This is a mistake. Financial situation of insurance
buyers change with time. Compare your current income with your income ten years
back. Hasn't your income grown several times? Your lifestyle would also have
improved significantly. If you bought a life insurance plan ten years ago based
on your income back then, the sum assured will not be enough to meet your
family's current lifestyle and needs, in the unfortunate event of your untimely
death. Therefore you should buy an additional term plan to cover that risk.
Life Insurance needs have to be re-evaluated at a regular frequency and any
additional sum assured if required, should be bought.
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 prudence against
questionable selling practised in the life insurance industry. It is always
beneficial to engage a financial planner who looks at your entire portfolio of
investments and insurance on a holistic basis, so that you can take the best
decision with regards to both life insurance and investments.
A Beginner's Guide to Insurance
Having the right kind of insurance is central to sound
financial planning. Some of us may have some form of insurance but very few
really understand what it is or why one must have it. For most Indians
insurance is a form of investment or a superb tax saving avenue. Ask an average
person about his/her investments and they will proudly mention an insurance
product as part of their core investments. Of the approximately 5% of Indians
that are insured the proportion of those adequately insured is much lower. Very
few of the insured view insurance as purely that. There is perhaps no other
financial product that has witnessed such rampant mis-selling at the hands of
agents who are over enthusiastic in selling products linking insurance to
investment earning them fat commissions.
What is Insurance?
Insurance is a way of spreading out significant financial
risk of a person or business entity to a large group of individuals or business
entities in the occurrence of an unfortunate event that is predefined. The cost
of being insured is the monthly or annual compensation paid to the insurance
company. In the purest form of insurance if the predefined event does not occur
until the period specified the money paid as compensation is not retrieved.
Insurance is effectively a means of spreading risk among a pool of people who
are insured and lighten their financial burden in the event of a shock.
Insured and Insurer
When you seek protection against financial risk and make a
contract with an insurance provider you become the insured and the insurance
company becomes your insurer.
Sum assured
In Life Insurance this is the amount of money the insurer
promises to pay when the insured dies before the predefined time. This does not
include bonuses added in case of non-term insurance. In non-life insurance this
guaranteed amount may be called as Insurance Cover.
Premium
For the protection against financial risk an insurer
provides, the insured must pay compensation. This is known as premium. They may
be paid annually, quarterly, monthly or as decided in the contract. Total
amount of premiums paid is several times lesser than the insurance cover or it
wouldn't make much sense to seek insurance at all. Factors that determine
premium are the cover, number of years for which insurance is sought, age of
the insured (individual, vehicle, etc), to name a few.
Nominee
The beneficiary who is specified by the insured to receive
the sum assured and other benefits, if any is the nominee. In case of life
insurance it must be another person apart from the insured.
Policy Term
The number of years you want protection for is the term of
policy. Term is decided by the insured at the time of purchasing the insurance
policy.
Rider
Certain insurance policies may offer additional features as
add-ons apart from the actual cover. These can be availed by paying extra
premiums. If those features were to be bought separately they would be more
expensive. For instance you could add on a personal accident rider with your
life insurance.
Surrender Value and Paid-up Value
If you want to exit a policy before its term ends you can
discontinue it and take back your money. The amount the insurer will pay you in
this instance is called the surrender value. The policy ceases to exist.
Instead if you just stop paying the premiums mid way but do not withdraw money
the amount is called as paid-up. At the term's end the insurer pays you in
proportion of the paid-up value.
Now that you know the terms this is how insurance works in
plain words. An insurance company pools premiums from a large group of people
who want to insure against a certain kind of loss. With the help of its
actuaries the company comes up with statistical analysis of the probability of
actual loss happening in a certain number of people and fixes premiums taking into
account other factors as mentioned earlier. It works on the fact that not all
insured will suffer loss at the same time and many may not suffer the loss at
all within the time of contract.
Types of Insurance
Potentially any risk that can be quantified in terms of
money can be insured. To protect loved ones from loss of income due to immature
death one can have a life insurance policy. To protect yourself and your family
against unforeseen medical expenses you can opt for a Mediclaim policy. To
protect your vehicle against robbery or damage in accidents you can have a
motor insurance policy. To protect your home against theft, damage due to fire,
flood and other perils you can choose a home insurance.
Most popular insurance forms in India are life insurance,
health insurance and motor insurance. Apart from these there are other forms as
well which are discussed in brief in the following paragraphs. The insurance
sector is regulated and monitored by IRDA (Insurance Regulatory and Development
Authority).
Life Insurance
This form of insurance provides cover against financial risk
in the event of premature death of the insured. There are 24 life insurance
companies playing in this arena of which Life Insurance Corporation of India is
a public sector company. There are several forms of life insurance policies the
simplest form of which is term plan. The other complex policies are endowment
plan, whole life plan, money back plan, ULIPs and annuities.
General Insurance
All other insurance policies besides Life Insurance fall
under General Insurance. There are 24 general insurance companies in India of
which 4 namely National Insurance Company Ltd, New India Assurance Company Ltd,
Oriental Insurance Company Ltd and United India Insurance Company Ltd are in
the public sector domain.
The biggest pie of non-life insurance in terms of premiums
underwritten is shared by motor insurance followed by engineering insurance and
health insurance. Other forms of insurance offered by companies in India are
home insurance, travel insurance, personal accident insurance, and business
insurance.
Buying Insurance
There are an umpteen number of policies to choose from.
Because we cannot foresee our future and stop unpleasant things from happening,
having an insurance cover is a necessity. But you need to choose carefully.
Don't simply go with what the agent tells you. Read policy documents to know
what is covered, what features are offered and what events are excluded from
being insured.
1. Know your Needs
Determine what asset or incident must be protected against
loss/damage. Is it you life, health, vehicle, home? Next determine what kinds
of damage or danger exactly would the assets be most probably be exposed to.
This will tell you what features you should be looking for in a policy. Of
course there will be losses which cannot be foreseen and the cost of dealing
with them can be very high. For instance nobody can predict that they'll never
suffer from critical illnesses no matter if they're perfectly healthy at
present.
The biggest mistake while it comes to buying insurance,
particularly life insurance is to view it as an investment. Clubbing insurance
and investment in a single product is a poor idea. You lose out on both fronts
because for the premiums you're paying more cover could've been got in a term
plan and if the premiums were invested in better instruments your returns
could've been several times more.
Be wary of agents who want to talk you into buying
unnecessary policies like child life insurance, credit card insurance,
unemployment insurance and so on. Instead of buying separate insurance for
specific assets or incidents look for policies that cover a host of possible
events under the same cover. Whenever possible choose riders that make sense
instead of buying them separately. Unless there is a fair chance of an event
happening you do not need insurance for it. For instance unless you are very
prone to accidents and disability due to your nature of work or other reasons
you do not need an Accident Insurance policy. A good Life Insurance policy with
accidental death rider or waiver of premium rider or a disability income rider
will do the job.
2. Understand Product Features and Charges
The worst way of choosing an insurance product or insurer is
to blindly follow the recommendation of an agent or a friend. The good way to
do it is to shop around for products that suit your need and filter out the
ones offering lower premiums for similar terms like age, amount of cover, etc.
All details you need about the product features and charges will be provided on
the company's website. Many insurance policies can now be bought online. Buying
online is smarter because premiums are lower due to elimination of agent fees.
If buying offline in case of life insurance, tell the agent that you're
interested only in term insurance.
Before you sign on the contract make sure you have
understood what items are covered and what items are exempted from the cover.
It would be so devastating to learn in the event of damage or loss that the
item you hoped to cover with the insurance was actually excluded. So many
people rush to their insurers after being treated for diseases only to realize
that the particular disease was excluded. Understand details like when the
cover begins and ends and how claims can be filed and losses be reported.
Don't choose an insurance company because your neighbourhood
friend is their agent and never let them coax you into buying from them.
Insurance premiums run for years and it means a sizeable amount of money. Apart
from the premiums charged look for the service provided. When you are faced
with a peril you want the claims collection processed to be complicated with
non-cooperating staff in the insurance company's office. Seek answers from
people who have had previous experience with the company for questions like how
customer friendly and responsive the company is when it comes to handling
claims.
3. Evaluate and Upgrade in Time
As you walk from one life stage to another or when the asset
insured changes your policies must be reviewed. Perhaps your cover will need to
be increased (or decreased) or you'll need to top it up with a rider. Some
instances when you need to review your cover are when you getting married, when
you have children, when your income increases your decreases substantially,
when you're buying a house/car and when you're responsible for your ageing
parents.
