Life insurance is one of the most crucial elements of anyone’s financial plan. However, there are many misconceptions about life insurance, mainly due to how these products have been marketed over the years. This series of articles covers nine common mistakes insurance investors should avoid while purchasing policies.

1. Underestimating the need for insurance

Many life insurance policy owners separate their insurance money according to the plans the insurance agent offers and the premium amount they can generate. This approach is incorrect. Your financial status should determine whether you need insurance, which has nothing to do with the commercially available insurance products.

According to some financial experts, a financial commitment equal to 10 times your yearly income is acceptable because it will give your family ten years of support after your passing.

However, this is not entirely accurate. Say you have a home loan or mortgage that is 20 years long. How will your family pay the EMIs after the first ten years when most of the debt is still unpaid?

Let’s say you have young children. Your family’s financial situation will deteriorate when your kids need the most money for their higher education. To determine how much insurance coverage is acceptable, insurance policy owners must consider these three factors when deciding whether they need life insurance.

• Repayment of the policyholder’s unpaid debt (such as a car loan, mortgage, etc.)

• The insurance payout should be sufficient to provide a monthly income to cover all of the living expenses of the insurance policyholder’s dependents after debt repayment.

• The remaining amount after debt repayment should be enough to satisfy the policyholder’s future responsibilities, like paying for their education.

2. Opting for a shady policy

Many insurance brokers choose to purchase shady policies as they are often cheaper. This is a grave error on all sides. If the insurance customer cannot fulfill the criteria in the event of an untimely death for some reason, then the insurance policy is useless.

Even if the insurer complies with the requirement, the insured’s family shouldn’t be in this situation if it takes a very long time to do so.

To choose a life insurance company that will honor its commitment to meet your requirements promptly should such a sad circumstance arise, you should carefully consider metrics like claims settlement ratio and duration-wise settlement of death requirements. Information on these indicators for all Indian insurance companies is readily available (on the IRDA website).

Additionally, you should look up online reviews of need settlements before deciding on an insurer with a solid background in requiring settlements.

3. Buying the wrong plan and using life insurance as an investment

The thing that everyone misses out on when it comes to life insurance is that it also makes an excellent investment or retirement planning option. This shortfall is partly attributable to some insurance sellers who enjoy peddling expensive products to increase their commissions.

Life insurance does not make financial sense as an investment when returns are compared to those of other investment options. For instance, investment in probity funds through a systematic investment plan (SIP) will provide a corpus over a 20-year period that is at least three or four times the maturity value of a life insurance plan with a 20-year term and the same amount of investment.

Life insurance should be viewed as a way to protect your family in the event of your untimely demise. Your investments should be treated as a well-synthesized independent factor. Although insurance companies advertise Unit Linked Insurance Plans (ULIPs) as attractive investment products, you should separate the insurance component from the investment component for your evaluation and carefully consider how much of your premium is allocated to investments. Only a tiny amount of value is assigned to ownership units in the initial years of a ULIP insurance policy.

A skilled financial adviser will clearly explain how to purchase term insurance. The most basic type of insurance is a term plan, which is a plain insurance contract. Term insurance plans have substantially lower premiums than other plans, giving policyholders a larger investible surplus for products like bilateral funds, which offer much higher long-term returns than endowment or money-purchase plans.

If you have a term life insurance policy, you may add another type of insurance (such as a ULIP, endowment fund, or money purchase plan) to meet your unique financial needs.

The discussion continues in the next series>>

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Kathy Hollingsworth
Licensed Agent Federal Educators of America