Common mistakes in life insurance and ways to avoid them

Often underestimated, but understanding the right way to buy a life insurance can go a long way.

This article has been published in “The financial express” on 18th August, 2016

Due to poor awareness and an abundance of mis-selling in the market, many people make some big mistakes while taking a life insurance policy.

Everyone recognizes that life insurance is a must-have. Yet, due to poor awareness and an abundance of mis-selling in the market, many people make some big mistakes while taking a life insurance policy. Given that such policies are expensive and cover a long period of time, such mistakes are costly and almost impossible to undo.

The following are the most common mistakes, and suggested ways to avoid them.

Mistake 1: Not taking enough insurance
The insurance industry talks in terms of premiums. This is great for the insurance companies and the brokers who make their money from premiums collected. But what you as a customer should worry about is the amount of insurance cover.

An unmarried person without dependents should aim for a life cover that is 5 times her annual income. A married person or one with dependents should aim for a life cover 10 times her annual income. Most people fall far short of these numbers, and hence end up under-insured.

The rationale for these thumb-rules is simple. The idea is for the family to approximately maintain the same lifestyle if the earning person is not around.

Mistake 2: Mixing insurance and investments
This is probably the biggest mistake of all – trying to take a single plan that offers both investments and insurance. In the process, you end up having much less insurance than necessary, and the investments give very poor returns. For instance, most endowment and whole-life policies give less than 5% return – even lower than the humble fixed deposit!

Such combined plans are popular only because they offer the broker more commissions. As a discerning customer, it is wise to stay clear of these schemes. A term insurance (pure insurance product) would serve the purpose better. Term insurance products have a very low premium. For instance, a 30-yr old can get a Rs 50 lakh life cover for as low as Rs 6,000 per year. Contrast this with an endowment policy which will cost over Rs 1 lakh per year of premium for a similar life cover.

Mistake 3: Buying through brokers or banks, without comparison
The vast majority of insurance brokers, agents and banks sell insurance of only a single provider. Thus, you as a customer are deprived of the benefit of comparing premiums of different providers and deciding the cheapest plan.

Term life insurance is a simple product, and you should have the benefit of comparing premiums of all the plans in the market. The difference is not trivial – it can be as high as 50 per cent. Since this premium is locked-in on day one, you can end up with a more expensive product for life, if you do not do your homework. Fortunately, there are several online sites available where you can compare premiums and buy the best (cheapest) plan.

Secondly, buying direct or online is a lot cheaper than buying through brokers or banks. Broker commissions are often 30 per cent-40 per cent of your first year premium, so you can save that by going online. In any case, all service thereafter is provided by the insurance company directly, so the broker is of no value to you.

Mistake 4: Insuring the wrong person(s)!

This may seem like a trivial point, but it’s surprising how many insurance policies have children and retired persons as the life insured. This is often due to lack of awareness among the customers, and agents pushing them the wrong products.

The earning member should be the policy holder. Other family members can be nominees. The idea is that life insurance substitutes the earning potential of the policy holder, in the case of any unfortunate event. Since children or the retired are not earning, by definition life insurance in their name is a waste.