All You Want to Know Before You Buy Life Insurance Policy

Insurance - an obvious, but neglected need

Life insurance is something every bread-earner needs. After all, who has seen tomorrow? Wouldn't you want your family to have a similar lifestyle even if there were to be an eventuality? Very likely your kids have several years of studies to go before they can stand on their own feet. Some of you may have retired and dependent parents. Some of your assets like home and car may have loans running.

The thought of an eventuality is so unpleasant that we don't want to think/hear about it. In the process, we often miss out on life insurance. But in reality, as a popular ad goes, it is insurance that will make us more worry-free and hence help us live healthier and longer!

How much cover is appropriate?

The important thing in insurance is (obviously) the life cover you have. There is no need for detailed calculation of how much insurance you need. There is ample reason to have about 4-8 times your annual income as life insurance. Four times is enough if you are unmarried or have fewer dependents. Eight times is needed if you have children and any loans are being repaid.

Who needs to be covered?

Contrary to what you may hear in some misleading ads, you don't need life cover for children or for the aged in the family. They will often be nominees, not the life being insured. After all, life insurance is about protecting the income of the bread-earner- it is not about making a financial profit from death. Thus, the prime working age of between 25 and 55 years of age is when people require maximum insurance. In this period, several people depend on you. You are still in the process of building assets and retirement savings. Thus, it is crucial to protect your life.

Beware of being cheated!

Life insurance being so critical to your life, it is unfortunate that this is the most poorly regulated, unethical and fraudulent market in the country. Many products that are sold to you are irrelevant or outright harmful to your financial health. The good and appropriate products are rarely sold.

This sad state of affairs has been brought about by a combination of poor customer literacy and an unscrupulous agent network that has been given wrong incentives. What you will often be sold by banks, agents and brokers of all hues are either traditional 'LIC' plans, or unit linked 'ULIP' plans. As we shall see in the next couple of sections, both these are not only useless in giving you life cover; they actually amount to a swindle of your hard earned money.

We shall look at them in brief:

1. Traditional policies

A traditional life insurance cover is a combination of insurance and investment. They are typically long term policies having annual premiums. It offers negligible insurance- about 15-25 times the annual premium. Most of your money goes to one of the funds managed by the insurance company. These funds invest in debt securities for maximizing safety. This is, of course, at the cost of returns. You get small bonuses as returns. There is no way to know how well the fund is doing or how much returns are being generated.

On the whole traditional policies are a poor product on the insurance scale and investment scale. They have to be avoided. If you already have a traditional policy, you can cut further losses by surrendering them after 5 years and allocating those funds in suitable products for investment. Buy a term cover instead for your insurance need.

2. Unit Linked Plans

ULIPS are known by various names such as child plans, pension plans or even fanciful ones like 'Platinum Premier', 'Highest NAV', etc. A unit linked plan also combines life insurance with an investment. Like in traditional policies a small part of your contribution goes to give you a tiny amount of insurance-about 10 times the annual premium paid- and the rest is invested in funds managed by the insurance company. In ulips however, your money is exposed to equities and debt products in securities markets. So the returns you get depend on market's performance in that period, after deducting various charges of the company. Certain ulips like pension plans and annuities have no insurance cover at all.

Ulips are similar to mutual funds as far as their investment is concerned but that is also where the similarity ends. They lose out of the number of charges deducted from your contributions. Hence returns from ulips would always be low compared to a mutual fund with a similar investment allocation.

If you have ulips in your insurance (or investment) kitty you can cut further loss by stopping premium payment after 3 years. Post lock-in period you can redeem the ulip and put whatever you get from it in a good mutual fund.

So which is the best type of insurance?

Term insurance plans are a great idea. Here, you pay a small premium every year, in return for a large life cover. All life insurance companies have a term insurance plan on offer. While they are great for the customer, they do not give your broker much commission. So do not be surprised that your agent/broker never mentioned term plans to you, or tries to downplay their utility!

There is no concept of investment or returns in a term plan - you get no money back as long as you live. While this sounds strange, the fact is that insurance plans are not meant for returns anyway! They are there to cover any eventuality. There are plenty of much better options to take care of your investments and returns.

Since term plans do not mix insurance and investment, they end up being cheaper, simpler and more flexible for you. A term cover provides insurance for up to 500 times the annual premium paid. With online term policies it gets even better. You can get up to 1000 times insurance for annual premium paid. All that matters in a term insurance is the premium. So go ahead and get the policy with cheapest premiums.

For better understanding of why traditional policies and ulips are bad for you check out the Viewpoint page.


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