Many of us are forced into buying insurance products which we do not really need. We get to hear number of horror stories of misselling by insurance advisors. In order to help readers understand basics of life insurance I have decided to discuss various aspect and variations of life insurance products so that they do not fall victim of such misselling.
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Need for buying the life insurance for whom, when and how much
The basic purpose of buying life insurance is to provide financial security to the people financially dependent on you. Many young people think of buying life insurance as soon as they start earning. This is not the correct approach. One should not buy life insurance until somebody becomes dependent on you financially or you have any debt like home loan etc. Likewise insurance should never be bought for tax saving. Availability of tax benefits is an incidental benefit which may accrue to you but it should never be considered the main benefit. The main benefit should always be the financial protection of financially dependent persons. For tax saving you can select many more tax efficient products which will fetch you better returns as well in the long run as compared to any insurance product.
When asked amount the quantum of life insurance they have, many would tell the amount of the premium they were paying. Most of the persons are not able to quantify their insurance needs. One has to buy adequate life insurance. In my opinion one needs to have life insurance of minimum equal to 12-15 times annual income. The insurance needs of a person at the beginning of the career would be a higher multiple of the annual income to factor into the fact that income would gradually increase. So if you are below 45 years, opt for at least 15 times of your annual income as the amount of life insurance cover needs. For those over 45 may take insurance of around 12 times of their annual income. This is thumb rule. You have to take into account various other factors into account like financial liabilities and the quantum of assets already owned by you.
Basic categories of life Insurance Products:
The life insurance products can be divided into two broad categories.
Pure risk products: Under this category come all the variants of term insurance plans. Under the term plan the person who is named as nominee/beneficiary gets the insurance amount in case of death of the insured person. However in case the insured stays alive till the term of the insurance term, nobody gets any money. So the term plan basically covers the pure risk of life and thus is very cheap as compared to any other life insurance product. Under this category insurance companies have introduced many variants under which the payment on the death of the insured is staggered over a few years instead of the same being fully paid instantly on the death. It is advisable to opt for lump sum if you feel your dependent can manage funds well after your death.
You can buy the term insurance online or offline through help of an insurance advisor. Since no commission is payable in respect of the online term insurance product, the online plans are very cheap as compared to the offline variants. Sometime the difference between the premium for offline and online term plan is to the extent of 30%. Since no insurance advisor is involved in the sale process the dependents/nominees themselves have to go through all the hassles of claim settlement process. So in case you are confident of your dependent being able to handle the claim without much difficulty opt for online term plan.
Investment products: Under the second category come various investment cum-insurance products. These products can further be divided in two sub categories.
Endowment plans: This is the first category under which the beneficiary/nominee gets the sum assured with accrued bonus in case insured person dies during the tenure of the insurance plan. In case the insured person survives, he get the sum assured with bonus accrued if the policy is participating one. There are various variants under the endowments plans. Money back is one of the variant of endowment plans. Under the money back polices, the insured person gets certain percentage of the sum assured at predefined intervals and the sum assured is paid to the beneficiary/nominee in case death occurs during tenure of the policy. In case the insured person survives the tenure the balance of the sum assured after deducting the amounts already paid with bonuses due, are paid to the insured person.
Whole life Polices: This is the second category of life insurance cum investment product. Under this category the money becomes payable only on death of the person to the nominee/beneficiary and no money becomes payable before death of the person. So this product is similar to the term product as far as for the person who gets the money on death of the insurance person. Since term plans have fixed tenure so the money becomes payable only if the death occurs during the predefined tenure but in case of whole life policies the money will eventually become payable after death of the insured as and when if happens.
The premium paying term for all these products may not necessarily extend for the whole tenure of the policy. The premium may be payable upfront by way of single premium policy or it may have premium paying term periodically like monthly, quarterly and yearly. The premium paying term may be co-terminus with the term of the policy or it may have limited premium paying term.
Why you should not invest in the life insurance products
Buying life insurance products for investment is an oxymoron. In case you buy life insurance product for investment, you neither get enough of insurance nor adequate returns on your investments. Since the investment products of life insurance companies have very high premium as compared to the premium payable on term plans the sum assured is far lower than what you would have got with the same premium under term plan. Since no one has unlimited recourses, one should use the same optimally to get maximum life insurance needed. Secondly due to various costs involved, the investment cum insurance products fetch you very low return, far lower than on pure investment products.
Why guaranteed returns products/money back products do not make sense as investment products?
The life insurance companies offer various products where you are offered guaranteed returns to entice you into buying it. Generally guaranteed returns offered by the insurance companies are even lower than what you get from safest pure debt products like government securities. As the significant investment by insurance companies is made in debt products, the returns generated by insurance companies are generally dependent on the interest rate cycle in the economy. The guarantee is generally offered in terms of absolute amounts or as certain percentage of the sum assured without giving you the details as to what CAGR (Compounded Annual Growth Rate) your contributions will fetch. So in absence of the CAGR , you cannot figure out as to whether the returns guaranteed on such products are comparable to the returns generated by other pure investment products.
Let us take the case of money back polices.
In case of money back policies the insurer offers you to pay a certain sum of money at periodic intervals. The person selling the money back policy gives the logic that the regular stream of money received under these policies will serve as regular income for the person. As average person does not know how to calculate the return on such insurance policies, he is unable to judge whether the product is worth a buy or not. Generally the returns generated on with-profits policies historically, except the unit linked insurance policies (ULIP), is not more than 5-6%. Even in case of ULIP products due to various charges including the mortality charges, the returns generated are no comparable with other pure investment products. Will discuss ULIP products some other day in detail. In some of the cases the returns on such polices are even lower than the interest on saving bank accounts.
One more product in this guaranteed return category is annuity plans. Annuities are not risk products per se. The annuities can be simply explained as reverse of the life insurance policies where you pay a lump sum to the insurance company at the beginning and the insurance company agrees to pay you a fixed sum of money either for a fixed period or for the whole life with or without an option to receive the principle amount back on death. These products also do not give the returns which you can get from other pure investment products. The annuities generally do not offer you more than 6% returns which is inadequate looking at the inflation rate and returns generated by other products.
So to sum up, buy life insurance if you have any person financially dependent, buy a term plan preferably online term plan equal to at least 12-15 times of your annual income.
The writer is a tax and investment expert and can be reached on jainbalwant@gmail.com and @jainbalwant on his twitter handle
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Informative, thanks for sharing!