Insurance is the first step in financial planning. Before getting your investments right, you must get your insurance portfolio right. If you get your investments wrong, you may still get another chance especially if you are young. However, if you get your life insurance wrong, there won’t be a second chance. If you get health insurance requirements wrong, you may have to compromise on the quality of healthcare for your family. You wouldn’t want to do that. Would you?
It is not difficult to understand that insurance is an extremely important part of overall financial planning. Still, not many of us pay due attention to our insurance portfolio. It is not uncommon to find people with annual income of Rs 15 lacs or more content with a life cover of Rs 10 lacs or a family of four relying on employer group health cover of Rs 2 lacs in a metro city such as Mumbai. Why does this happen? Why do otherwise smart investors ignore insurance completely?
In this post, I shall discuss some of the common mistakes that people commit when they think about insurance. By the way, life and health insurance plans are not the only insurance plans you need. There are a few others insurance plans that you cannot do without. However, I will limit the discussion to life and health insurance only.
My Employer Provides Me Life and Health Cover. Why Do I Care?
Many employers in the organized sector provide health covers to their employees and their immediate families. Some employers also provide life cover to their employees. Health cover is typically Rs 2-4 lacs for the entire family. Life cover, if any will range from 2-5 times the annual income. You need to ask yourself this question. Is this amount enough? Is Rs 3 lacs health cover for a family of 4 enough in a big city like Delhi, Mumbai, Bangalore or Chennai? Will the family be able to maintain their lifestyle with Rs 30 lacs if you were not around (if your annual income was Rs 10 lacs). Would you want your employer to control how much life and health insurance you need? Would you want your employer to control which hospital you want to go for treatment? Who knows better about your insurance needs? You or your employer? Of course, you. Moreover, your employer cover is only as long as you are with the same employer. If you switch, your new employer may not offer the same level of coverage. Even if it does, you will be without cover from the day you quit your old employer till the day you join your new employer. Don’t leave everything to your employer. Take control of your financial life. Take control of your insurance portfolio.
You Purchase Insurance to Save Tax
This is an unfortunate reality. You get tax benefits for purchasing life insurance and health insurance. Many purchase these products merely to reduce tax liability. Premium paid for life insurance is tax deductible under Section 80C while health insurance premium fetches tax benefits under Section 80D of the Income Tax Act. You must purchase insurance to guard against unfortunate and unexpected events in life and not just to save taxes.
I Don’t Want My Insurance Premium to Vanish in Thin Air. I Want Some Return.
Many investors have settled for low returns because of this very notion. Premium paid goes waste if I don’t get any return. How much wealth has been destroyed because of this approach?
LIC agents (at least some of them) have made a fortune selling such insurance and investment combo products. I am talking about traditional life insurance plans. Endowment plans, money back plans etc fall in the same category. These plans are opaque and provide poor coverage. These plans provide guaranteed poor returns. I don’t think there is any other financial product which provides poor returns with such certainty. To be fair to LIC, LIC is not the only company selling such products. All the insurers sell such products. Then, why are traditional plans sold? For anything to be sold, someone must make money. As an investor, you won’t. The intermediaries do.
Another variant of investment and insurance combo products is Unit Linked Insurance Plan (ULIP). I do not like Unit Linked Insurance Plans (ULIPs) much even though these are better than traditional life insurance plans. The problem with ULIPs is that Sum Assured is a multiple of annual premium (say 10 times annual premium). So, in a way, your premium paying ability can limit your life cover. So, if you want life cover of Rs 1 crore, you need to pay annual premium of Rs 10 lacs. If you can pay only Rs 5 lacs, you will settle for a lower cover of Rs 50 lacs.
Your life insurance requirement does not go down just because you cannot afford high premium. Do not mix insurance and investment. Keep things simple. Purchase a pure term life cover and invest the remaining in mutual funds or PPF or any other investment product. You will do much better than traditional life insurance plans and ULIPs.
I Am Young and Healthy. I Don’t Need Insurance.
Sure. You are less likely to get hospitalized if you are young. However, you can still fall ill and may have to get hospitalized. You don’t want lower quality medical treatment just because you are young. Do you? Hence, health insurance is a must irrespective of your age. Health insurance premium is low when you are young. Moreover, you will get the policy easily since you are less likely to have contracted any major illnesses at an early age.
You may be in the best of health but an unfortunate accident can still leave your family fending for themselves. You may have taken a home loan which may need to be repaid before your family takes possession of the house. You can postpone purchase of life insurance if you don’t have any financial dependents and you don’t have any financial liabilities (loans etc). This can happen when you are single, have not taken any loan and your parents do well financially. Otherwise, you need life insurance too.
I Want to Save for My Children’s Future. I Have Bought an Insurance Plan on the Life of My Child.
For God’s sake, please don’t do this. You purchase life insurance so that needs of your family are taken care off in your absence. If you purchase life insurance (on the life of your child) and something happens to you, insurance company won’t pay up because you are not the one whose life is insured. And such mistakes can happen when you mix insurance and investment needs. You would never purchase term insurance on the life of your child because you can easily realize the absurdity of the entire idea.
I Can’t Say NO to a Friend or Even a Distant Relative
How many of us have purchased an insurance plan just because salesperson (insurance agent) was a friend or a relative? Almost everyone. Why? Because we couldn’t say NO. And your relative (or your friend or friend’s relative) was not selling you a term insurance plan. He never will because commissions are low in a term plan. He will most likely be selling a traditional life insurance plan. It is difficult to believe that your friend or relative does not understand what he is selling. Of course, he does. Despite this, if he can sell you a life insurance plan simply for high commission (with absolutely no regard to your requirement), you should not feel guilty turning him away. And commissions are high in insurance plans. Don’t be surprised if 40%-50% of the first year premium goes to the intermediary.
Fall for the Sales Pitch
A smart salesperson appeals to your emotions while making a presentation. It is difficult to say No to a plan with keywords Young Star, Udaan or Education. You will die of guilt if you say no to such a plan. What kind of parent am I if I even think twice about ensuring quality education for my kids? A smart salesperson is aware of this. So, you better be aware. You are right. You are not doing your job well if you do not ensure quality education for your parents. But there is better way to do this rather than purchasing a plan with fancy keywords. Purchase a term plan and invest for children’s education in pure investment products (mutual funds, PPF etc). Always keep your emotions away while making financial decisions.
- Purchase adequate health and life cover.
- Do not just rely on health (or life) insurance cover by your employer.
- Do not mix insurance and investments needs.
- Purchase adequate term life cover.
- Do not fall for the sales pitch.
- And Learn to say No.