Many of us are forced into
buying insurance products which we do not really need. We get to hear a number
of horror stories of misselling by insurance advisors. In order to help readers
understand the basics of life insurance, I have decided to discuss various
aspects and variations of life insurance products so that they do not fall
victim to such misselling.
Need for buying life
insurance
The basic purpose of buying
life insurance is to provide financial security to the people financially
dependent on you. Many young people think of buying life insurance as soon as
they start earning. This is not the correct approach. One should not buy life insurance
until somebody becomes dependent on you financially or you have any debt like
home loan etc. Likewise, insurance should never be bought for tax saving. The
availability of tax benefits is an incidental benefit that may accrue to you
but it should never be considered the main benefit. The main benefit should
always be the financial protection of financially dependent persons. For tax
saving, you can select many more tax-efficient products which will fetch you
better returns as well in the long run as compared to any insurance product.
When asked the amount the
quantum of life insurance they have, many would tell the amount of the premium
they were paying. Most of the people are not able to quantify their insurance
needs. One has to buy adequate life insurance. In my opinion, one needs to have
life insurance of minimum of 12-15 times of annual income. The insurance needs
of a person at the beginning of the career would be a higher multiple of the
annual income to factor into the fact that income would gradually increase. So
if you are below 45 years, opt for at least 15 times your annual income as the
amount of life insurance cover needs. For those over 45 may take insurance of
around 12 times their annual income. This is the thumb rule. You have to take
into account various other factors into account like financial liabilities and
the quantum of assets already owned by you.
Basic categories of
life insurance products
Life insurance products can
be divided into two broad categories. Pure risk products: Under this category
comes all the variants of term insurance plans. Under the term plan, the person
who is named as nominee/beneficiary gets the insurance amount in case of the
death of the insured person. However, in case the insured stays alive till the
term of the insurance term, nobody gets any money. So the term plan basically
covers the pure risk of life and thus is very cheap as compared to any other
life insurance product. Under this category, insurance companies have
introduced many variants under which the payment on the death of the insured is
staggered over a few years instead of the same being fully paid instantly on the
death. It is advisable to opt for a lump sum if you feel your dependent can
manage funds well after your death.
You can buy the term
insurance online or offline through the help of an insurance advisor. Since no commission
is payable in respect of the online term insurance product, the online plans
are very cheap as compared to the offline variants. Sometimes the difference
between the premium for an offline and online term plan is to the extent of
30%. Since no insurance advisor is involved in the sale process the dependents/nominees
themselves have to go through all the hassles of the claim settlement process.
So in case you are confident of your dependent being able to handle the claim without
much difficulty opt for an online term plan.
Investment products: Under
the second category come various investment cum-insurance products. These
products can further be divided into two subcategories. Endowment plans: This
is the first category under which the beneficiary/nominee gets the sum assured with
accrued bonus in case the insured person dies during the tenure of the
insurance plan. In case the 8 insured person survives, he gets the sum assured with a bonus accrued if
the policy is participating one. There are various variants under the
endowments plans. Money-back is one of the variant of endowment plans. Under
the money-back policies, the insured person gets a certain percentage of the
sum assured at predefined intervals and the sum assured is paid to the
beneficiary/nominee in case of death occurs during the tenure of the policy. In
case the insured person survives the tenure the balance of the sum assured
after deducting the amounts already paid with bonuses due, are paid to the
insured person. Whole life polices: This is the second category of life insurance
cum investment products. Under this category, the money becomes payable only on
the death of the person to the nominee/beneficiary and no money becomes payable
before the death of the person. So this product is similar to the term product
as far as for the person who gets the money on the death of the insured person.
Since term plans have fixed tenure so the money becomes payable only if the death
occurs during the predefined tenure but in case of whole life policies the
money will eventually become payable after the death of the insured as and when
it happens. The premium paying term for all these products may not necessarily
extend for the whole tenure of the policy. The premium may be payable upfront
by way of single premium policy or it may have premium paying term periodically
like monthly, quarterly and yearly. The premium paying term may be coterminous with
the term of the policy or it may have limited premium paying term.
Why you should not
invest in the life insurance products
Buying life insurance
products for investment is an oxymoron. In case you buy a life insurance product
for investment, you neither get enough of insurance nor adequate returns on
your investments. Since the investment products of life insurance companies
have a very high premium as compared to the premium payable on term plans the
sum assured is far lower than what you would have got with the same premium
under a term plan. Since no one has unlimited recourses, one should use the
same optimally to get maximum life insurance needed. Secondly, due to various costs
involved, the investment cum insurance products fetch you very low return, far
lower than on pure investment products.
Why guaranteed
returns products/money-back products do not make sense as investment products?
The life insurance companies
offer various products where you are offered guaranteed returns to entice you
into buying it. Generally guaranteed returns offered by the insurance companies
are even lower than what you get from the safest pure debt products like
government securities. As a significant investment by insurance companies is
made in debt products, the returns generated by insurance companies are generally
dependent on the interest rate cycle in the economy. The guarantee is generally
offered in terms of absolute amounts or as a certain percentage of the sum assured
without giving you the details as to what CAGR (Compounded Annual Growth Rate)
your contributions will fetch. So in the absence of the CAGR, you cannot figure
out as to whether the returns guaranteed on such products are comparable to the
returns generated by other pure investment products. Let us take the case of money-back policies. In
case of money back policies, the insurer offers you to pay a certain sum of
money at periodic intervals. The person selling the money-back policy gives the
logic that the regular stream of money received under these policies will serve
as regular income for the person. As an average person does not know how to calculate
the return on such insurance policies, he is unable to judge whether the
product is worth a buy or not. Generally, the return generated on with-profits
policies historically, except the unit-linked insurance policies (ULIP), is not
more than 5-6%. Even in the case of ULIP products due to various charges
including the mortality charges, the returns generated are no comparison with
other pure investment products. We will discuss ULIP products some other day in
detail. In some of the cases, the returns on such policies are even lower than
the interest on savings bank accounts.
One more product in this
guaranteed return category is annuity plans. Annuities are not risk products per
se. The annuities can be simply explained as reverse of the life insurance
policies where you pay a lump sum to the insurance company at the beginning and
the insurance company agrees to pay you afixed sum of money either for a fixed
period or for the whole life with or without an option to receive the principal
amount back on death. These products also do not give the returns which you can
get from other pure investment products. The annuities generally do not offer
you more than 6% returns which are inadequate looking at the inflation rate and
returns generated by other products.
So to sum up, buy life
insurance if you have any person financially dependent, buy a term plan
preferably online term plan equal to at least 12-15 times your annual income.
0 Comments