Avoid These Six Common Life Insurance Mistakes

By | November 22, 2018

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.

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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.

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