Many people start their personal financial journey by thinking about where to invest. But the foundation of a secure financial future is protection—protecting one’s ability to earn an income in the future. Hence, whenever we meet new customers, one of the first things we try to do is understand how well their future incomes and existing wealth are protected. Insurance of various kinds is the ideal way to take necessary and adequate protection and within that, life insurance is one of the most critical yet underutilised weapons in an investor’s financial armoury.
What is ironic is that even where it is availed of, we often see cases of poor utilisation. Over the last many years of interactions, we have seen many significant mistakes that people end up making in their life insurance decisions. We are sharing below seven common ones.
Many policies is not enough insurance
One of the common refrains when we ask people “do you have life insurance” is “Yes, I have many policies.” Unfortunately, many policies does not necessarily mean you are adequately protected. The amount of life insurance (ie, the sum assured) you need is the sum of your future financial goals and your existing liabilities. Unfortunately, we have a profusion of small-ticket policies being sold (and bought), which, while they look impressive, do not add up to anywhere close to what is actually needed in terms of life cover.
Mixing investments and insurance
While the quantum of insurance is nowhere close to being adequate, the premiums paid still end up making a hefty dent in your income because of one simple reason—you are buying products that are sold as insurance but are actually investment products with a miniscule amount of insurance. That the investment product itself is quite inefficient is another problem in itself, since most of these “endowment” policies have low single-digit internal rates of return—simply put, most likely your bank fixed deposit will give you a better return. While there are unit-linked insurance plans or ULIPs that are marginally better, they suffer from opacity as well as high costs (most of them), at least in the initial years.
Insurance in the name of the child
A very common mistake that is found, especially among grandparents, is buying an insurance policy in the name of the child (or grandchild). Again, these are investment products sold under the garb of insurance but have significant additional drawbacks, including long lock-ins. A case in point was a recent instance we saw a grandmother holding a whole-life policy on her six-year-old grandchild slated to mature, hold your breath, when the grandchild turns 99. And this is not a one-off—we had another case where the grandparents had got in touch with us, a year after the purchase, where they had invested in a ULIP in the name of the grandchild. By the time they realised that the product was not suitable, they were deterred from stopping it through lock-ins (five years) and punitive losses in surrender values.
Life insurance is needed only to cover the family from loss of future incomes or existing liabilities. A child has neither, and hence doesn’t need insurance. Hence next time someone tries to sell you a child policy, think twice.
I don’t get money back so it’s a waste—return of premium
Another mistake we come across is this irrational excuse that “the premiums go waste—I don’t get any money back”. The same person does not have a problem taking insurance for his or her car or bike. And product sellers have taken advantage of this irrational behaviour and have launched “return of premium” insurance products.
What people fail to understand is that the premium when returned 20 or 25 years later has lost nearly all of its value due to inflation. For instance, someone paying Rs 25,000 per year as an insurance premium for 20 years gets back Rs 5 lakh at the end of 20 years. The value of that is only around Rs 1.25 lakh in present value, assuming an average 7 percent inflation every year. And in order to get this small amount back, we end up paying inflated premiums for 20 years.
While the above four are largely “product mistakes”, the next three below are more “behavioural mistakes” that people make while taking life insurance.
Not buying it early, since ‘there is nothing wrong with me right now, can buy later’
Many a time, the decision to buy term insurance is postponed since the thought is “I don’t need it right now, nothing is going to happen to me”. What people don’t realise is that first, term insurance premiums are low at younger ages and these get locked in, and the later you buy, the premium goes up substantially. Second, term is available only when one has future income visibility, ie, employment, and in case of ill health, the policy can be rejected or come with hefty premiums. Hence it’s best to buy when one is young and healthy.
Another grave mistake people do is misrepresent information in the policy, for instance, information on health or habits. But any such issue makes the policy completely void if it comes to light later. And when your family actually needs the money, it may not be available.
Term of insurance shorter than term of liability to reduce premium
Last but not the least, an issue that we have come across with serious consequences (this has happened to someone we know during COVID) is home loan cover insurance, which is mandatory (though the quantum or period isn’t checked, I presume). Most loan companies sell this as a single-premium insurance as a top-up loan to the base home loan, which is then paid in separate equated monthly instalments (EMIs) over the loan tenure, parallel to the home loan.
In a bizarre case, the loan cover was purchased only for a five-year period (ostensibly to reduce the single-premium amount) while the loan was for 20 years. Tragically, the customer passed away during COVID, and when the family enquired, they were told that the insurance cover had expired three years previously, and hadn’t been renewed. Ironically, the EMI for that five-year insurance is still being paid by the family since it is coupled to the 20-year loan.Not having adequate life insurance to cover risks during your life’s journey to achieve your financial goals is akin to doing a trapeze act without a safety net. Unfortunately, people realise this only when it is too late. Check out the above mistakes and see if you have made any of them and if you have, correct them immediately before your financial journey gets rocked unpleasantly.