10 commandments of life Insurance
Insurance, in India, has generally been bought or sold not for what it is intended – the risk cover. But it is the ‘tax saving’ which has been the primary reason for the purchase of an insurance policy.
Hence most of us are saddled with policies which
a) neither serve the purpose of insurance as the sum assured is grossly inadequate as compared to the earning potential of the insured,
b) nor do they give adequate returns to be considered as a viable investment option.
It may be useful to keep the following 10 commandments in mind when buying an insurance policy, to be able to make an informed decision.
1. Thou shall buy insurance for risk cover
The purpose of an insurance policy is to protect the family members of a person from any financial difficulties in case of his/her untimely death. Such unfortunate eventuality to a breadwinner in the house can put the other family members in serious financial difficulty. Insurance seeks to provide financial help in such times.
This, therefore, should be the main objective for buying an insurance policy. Any other benefit such as tax advantge etc. should be of secondary consideration.
2. Thou shall not consider insurance as an investment option
The primary objective of the insurance policy is to provide a risk cover. Hence a part of the premium paid is first appropriated towards this purpose. The balance amount is invested in financial instruments, which are usually very safe ones. Also, the commissions and charges are appreciably higher than other investment options.
Consequently the returns from an insurance policy are nothing much to talk about and hence it cannot be considered as a viable investment option vis-à-vis other competing financial products.
3. Thou shall preferably buy only a term policy
Term policies are pure insurance products with no investment add-on. They are the cheapest and the simplest of the variety. But here cheapest does not mean that they are in any way inferior to other costlier insurance policies. As far as the basic objective of risk cover is concerned, there is no difference. And usually for most of us this term policy should be more than sufficient.
In such policies the premium paid is foregone at the expiry of the policy and one does not get anything if one survives the policy. This fact that one does not get anything back is perhaps the most important psychological factor for the low popularity of a term policy.
4. Thou shall preferably a savings-linked insurance policies
In contrast to the term policies are the savings-linked insurance policies such as money-back, endowment and whole-life. These policies provide the risk cover and also give back some returns to the insured at the end of the policy, in case nothing happens to him/her in the interim. The premiums of such policies are much higher compared to the term policies. This assurance of getting some returns at the end of the policy term is why most people opt for such savings-linked policies vis-à-vis term policies.
They however fail to appreciate the fact that a part of the premium is anyway earmarked to provide for risk cover. Then a part of the premium goes towards paying commissions, administrative and other charges. And it is only the balance amount, which gets invested to provide some returns to the insured at the end of the policy. These returns are generally very low as the investment is made in risk-free low-return options.
Therefore, a person may be better-off if he were to buy the cheaper term policy and invest the balance amount, which would have otherwise gone towards high premiums of saving-linked policies, in say MFs. This way he would be risk-covered and also generate higher returns.
5. Thou shall be wary of the hype
From their business perspective the insurance companies and the agents may be more keen to sell saving-linked policies vis-a-vis the term policies, as the premiums and commissions are much higher. And hence the advertisements and promotions may speak more about such policies.
Therefore, it is for the insured to keep his interests & needs in mind and not be carried away by persuasive agents and publicity.
6. Thou shall buy ULIP only if your horizon is long term
Unit Linked Insurance Policies (ULIPs) offer an alternative to traditional policies where the returns can be market-linked. Further, one can also choose one’s own investment objective amongst equity, debt and balanced.
However, the charges in the initial years are quite high. Thus the actual benefit of ULIP starts accruing only if one has a long-term investment horizon. The minimum lock-in period of 3-5 years may look attractive, but is too short a period to fully compensate for the high charges in the first 2-3 years. ULIP can prove to be a good investment option (together with insurance) if one keeps paying premium for at least for 10-12 years.
7. Thou shall not insure yourself if you a lone bird
Insurance is for the benefit of the dependents. Thus, if you are single with no one being financially dependent on you, it may not really be necessary for you to buy an insurance policy.
8. Thou shall not insure if you are wealthy
You are person of abundant means. You have lots of wealth – properties, bank balances, investments, etc. In your absence, this may be more than sufficient for your family and dependents to continue living comfortably. A few lakhs of rupees from an insurance company may not make any material difference to their future financial well-being.
If such were the case, then you may not need any insurance.
9. Thou shall not insure the child
Any unfortunate eventuality involving a child is no doubt emotionally very traumatic. But it usually does not hurt the family financially. Whereas, insurance cover is for mitigating the financial difficulty, that may arise with the death of the insured.
Hence, taking a policy for a child is meaningless. It is an unnecessary expense.
10. Thou shall read the fine print carefully
As they say ‘the devil is in the details’. Therefore, understand the features of the policy, the charges etc., before you buy an insurance policy.
Further, most insurance companies offer a 15-day look-in period after you have taken the policy. Go over the terms and conditions in the policy very carefully. And if you feel that it does not meet your requirement, you can cancel the policy. You may have to pay some administrative charges, but this would be much better than holding on to a bad policy for years to come.
Insurance is a long-term contract usually spanning over decades. Also, these contracts have very little flexibility. A wrong insurance product can financially hurt for a very very long time, unlike many other financial products. Therefore, one should be extra careful and vigilant when deciding on how much to insure, how long to insure, which policy to buy, etc. Once a person is clear about the objective, choosing the right policy at the right price is just a matter of detail.