Common mistakes in life insurance and ways to avoid them

By: | Published: August 18, 2016 12:18 PM

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.

Common mistakes in life insurance and ways to avoid themDue to poor awareness and an abundance of mis-selling in the market, many people make some big mistakes while taking a life insurance policy. (Photo: PTI)

Everyone recognises 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 have, as far as possible, 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. But as a discerning customer, you would be wise to stay away from them and invest on a pure insurance product – also called term insurance. 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 life insured (the policy holder) should always be the earning member(s) of the family, while the nominees can be the children or the aged. 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.

The author is Co-Founder, Fisdom.com

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Switch to Hindi Edition