If a traditional policy is closed before three years, the entire premium paid goes up in smoke. Even after three years, the policyholder ends up paying surrender charges and gets back barely 30-35% of what he paid. In Ulips, the money goes into a discontinuation fund and comes back to the policyholder only after the 5-year mandatory lock-in ends. Why do so many people bite the bullet and terminate policies bought just 1-2 years ago with great expectations? Why do they pour hard earned money into an investment that ends in the junkyard within a year? Some buyers quit because they can’t afford to pay the premium every year. Others realise they can get better returns elsewhere. Some unfortunate souls also discover they have been conned into buying insurance.
It’s easy to blame the agents for misselling the plans or the insurance companies for not taking action against errant distributors. Agents are known to overstate the benefits or provide selective information with impunity. Relationship managers at banks are guilty too. Their high sales targets and fat commissions on insurance products have turned them into salesmen. They know that buyers don’t have any proof of the verbal promises doled out in the sales pitch. Though mis-selling is rampant, the buyer too must share the blame for the financial mishap.
Also Read: Does your insurance company have money to pay claims easily? Find out here
As a buyer, it is your responsibility to understand what you are getting into before you sign on the cheque. With the tax planning season in full swing, many people may have firmed up plans to buy life insurance. If you are one of them, this week’s cover story will be useful. We have drawn up a list of some fundamental questions relating to your finances that you need to ask yourself. Make sure you answer these questions accurately so that the lynchpin of your financial portfolio doesn’t become a millstone around your neck later.
Mis-sold or mis-bought?
India has very low insurance persistency. By the fifth year, almost 60% of the policies issued either lapse or are surrendered.
1.DO YOU NEED LIFE INSURANCE?
Life insurance is important, but do you really need it? The cover offered by the policy is meant to replace the future income of the policyholder, the breadwinner. It is an absolute must if there are people dependent on your income, such as your spouse, children, parents and even dependent siblings. But if you are not married and nobody depends on your income, you don’t need an insurance cover.
Also, if you have built substantial assets and your spouse also earns enough to sustain the family without you, then there is no need to buy a life insurance policy. Lastly, retirees who have stopped working also don’t need life insurance. Death will not have any financial impact on the family so there is no need to insure yourself beyond your working years.
2.IS THE COVER ADEQUATE?
Next, find out if you are buying adequate life cover. One broad approximation is about 8-10 times your annual income. But this is a broad approximation and may not give a true picture of your insurance needs. The life insurance cover should be big enough to generate income that can take care of the expenses of the family till your dependents are self-sufficient and settle all outstanding debts, especially big-ticket home loans. If an individual is paying a chunky EMI and something untoward happens to him, the bank will move in and his family will be left without a home.
Apart from this, the insurance should also provide for crucial financial goals, such as a child’s higher education and marriage. These are one-time expenses and their present cost should be taken into account to calculate the cover. Don’t be lulled into thinking that a cover of Rs.1 crore is enough. It may seem like a lot of money right now, but inflation will reduce its purchasing power in the long run. Even if you assume 9% returns and 7% inflation, an inflation-adjusted monthly withdrawal of Rs.1 lakh will deplete the entire corpus in less than 10 years. Use the table on the right to find out how much cover you need.
Calculate your insurance needs
The life insurance policy should replace the income of the individual, settle all debts and provide for future expenses. Find out how much cover you need.
3.CAN YOU AFFORD THE PREMIUM?
Given that life insurance exudes an aura of protection and long term security, it is common for people to get carried away and commit more than they can afford when they sign up for a policy. But reality bites when the next year’s premium is due. That’s when many policyholders decide to cut their losses and quit. The persistency data is a harsh reminder of how hard earned money goes down the drain.
Before you buy, make sure you can afford the premium of the policy for the full term. One rudimentary calculation is that the life insurance premium should not take up more than 5% of your net income. That means a person with an annual income of Rs.10 lakh should not be paying more than Rs.50,000 premium in a year. Don’t factor in future income when you do this calculation.
4.ARE YOU BUYING ONLY TO SAVE TAX?
ET Wealth has steadfastly maintained that life insurance is the worst way to save tax. Yet, instead of being seen as a protection tool, life insurance continues to be seen as a tax-saving device. In fact, the January-March quarter is the busiest period for insurance distributors because close to 70% of the business is transacted during these three months. Insurance is a bad choice as a tax saving instrument because it requires a multiyear commitment. Tax saving investments under Section 80C are no different from regular investments so one should apply the same parameters to assess them. An individual’s priorities change over time.
But the insurance premium will force him to continue putting money in the policy even though he may have other, more pressing financial goals. Many other investment options under Section 80C offer better returns than life insurance and at a lower cost. The PPF and Sukanya Samriddhi Yojana have no costs at all, while ELSS mutual funds charge only 2-2.5% and offer far better returns than insurance policies that yield barely 5-6%. More importantly, options such as ELSS, Sukanya and PPF offer flexibility of investment wherein the buyer can invest at any time of the year and any amount that suits his pocket.
5.HAVE YOU CALCULATED THE RETURNS?
Insurance are long-term contracts of 20-25 years. The power of compounding can work wonders over such a long investing horizon. Buyers tend to get carried away by the enormous maturity value projected by the insurance agent without calculating the returns on an annual basis. For instance, a policy with an annual premium of Rs.50,000 and a maturity value of `30 lakh after 25 years might appear lucrative, but the returns work out to only 6.22%. Use an internal rate of return calculator to find out how much your policy will yield.
The low returns are just one part of the story. The other part is inflation, which eats into the purchasing power of money. As mentioned earlier, in 25 years, even a modest 6% inflation will reduce the purchasing power of Rs.30 lakh to less than Rs.7 lakh. So, take inflation into account and understand the time value of money when investing in a long-term product. The time value of money also comes into play in term insurance plans with return of premium. These plans give back the entire premium paid if the policyholder survives the full term. Though it might appear very lucrative, the money you get back after 20-30 years would have lost a lot of its value by then.
Don’t get swayed by maturity value
Returns of insurance policies with a premium of Rs.50,000 per year.
6.HAVE YOU FILLED IN CORRECT INFORMATION?
Withholding crucial information about your health and social habits can have serious ramifications. If the insurer finds out that a policyholder concealed information that affected the risk to his life, out goes the claim. Every year, about 2% of the claims end up in the trash can. In 2020-21, nearly 12,500 death claims for roughly `954 crore were rejected. One of the most common lies is about tobacco use. Tobacco use in any form pushes up the premium by 25-50%, so it’s quite tempting to tick on No.
But this lie will not go undetected. Insurance companies go to any length to find out if a policyholder has lied in the application form, hidden facts or submitted fake documents. A panel of medico-legal experts scans the documents submitted with a claim for any discrepancy or attempt to mislead. Remember, you will not be around to do the explaining if they ask about nicotine traces in the bloodstream. It will be your nominee running around to get the sum assured promised under the policy. The small amount saved on the premium by furnishing incorrect information is not worth the risk of jeopardising the insurance cover.