Is Insurance a risk protection tool ?

Let us find out the answer for these questions in this article.

People get confused with savings and Insurance in multiple instance, in fact it is not people’s mistake. The policies are developed targeting a mix of people to satisfy them.

Truth is, It is easy to sell a policy with benefits of maturity amount rather than sell it purely as a risk protection tool. Moreover when a maturity amount is guaranteed humans will get biased towards a guaranteed return rather than a higher return with little risk.

From my personal experience, I was sold an ULIP as a high return producing investment tool in 2008. As I didn’t know anything about insurance and this specific ULIP, I believed this 3 times return in 3 years from this ULIP provider. After 8 years staying in this policy, I just received capital with little more money. 

When I enquired with other friends, they also had made several mistakes while taking Insurance. 

Let us look at common mistakes you may do while taking different types insurance in life, 

1)    Thinking ULIP & Investment as same 

From my mistakes I understood ULIP returns will be of 4% to 8% only as per IRDA.

Remember that Insurance is a risk protection tool and returns are not a priority, therefore they try to give some returns at the end of the insurance period. RBI interest rates also got reduced in line with inflation in India. Therefore the investment returns from insurance also had gone down to less than 6%. 

If you consider inflation which is around 6-7% as per RBI, your investment returns has Inflation risk. For example, if a product costs Rs100 in this year and after a year this may become Rs107 due to inflation. Guaranteed returns of less than 6% in a year is not going to beat inflation itself and you may not be able to buy that product. 

Is there a solution ? Remember that insurance is not an investment tool and it is just savings. Consider a proper investment product like Mutual funds or stocks for better returns. 

2)    Expecting Guaranteed Income from life insurance    

You have already seen how guaranteed income has inflation risk in it based on returns. 

Point to note here is that only after 15 to 25 years you are going to get the maturity amount. 

Most of the time you will be asked by the insurance agent or the relationship manager in the bank, “How much payment you can make in a year ?”

Say you agreed to make 50,000 in a year and the policy has tenure for 20 years. At the end of 20 years, you would have made payment of 10 lakhs and the policy will have maturity amount of close to 20 lakhs. 

Considering money depreciation over such a long period due to inflation, the most important question you should ask is, “Does this 20 lakhs enough after 20 years ?”

If you had made the same amount in mutual fund at 12% equity benchmark returns, you may have 40 lakhs. Double of what you get in Insurance. 

3)    Term Insurance with return of premium

If you need an Insurance, you need to take Term Insurance first. 

Most common mistake asked by everyone is, “what is the maturity amount ?”

Remember that term insurance does not provide any maturity amount. This is the exact reason why insurance companies came up with Term insurance with return of premium option. But is it worth to go for this option ? consider the below example before you make your decision.

Recently for one of the customer who is aged 40, we provided pure term insurance with 1 crore coverage. Premium worked out, close to 48,000 per year as he was over weight and he wished to make all the premium by his age of 60.

Then he asked for return of premium in this term insurance. Premium for the same policy worked out to be close to 1.25 lakhs for the next 12 years. He will be getting the premium he paid after 20 years only.  

Can he pay an additional 75,000 for next 12 years. What if, he invests this extra 75,000 payment into mutual funds or stocks he will be able to make even more bigger returns than return of premium after 20 years. 

This is suitable for people, who are denied pure term insurance due to weight or insufficient income proofs etc 

Think twice and work out before opting for this policy. 

4)    Insurance for important financial goals – child education & Retirement 

If you take up a child Insurance policy by 3rd year of your child, it is easy to get maturity amount for his/her higher education. When you take up a child policy around age 5 or later, it is difficult to get maturity amount at the right age. 

Further, if you need higher corpus, you end up paying higher premium. 

Better choice as I keep repeating is to choose investment products like Mutual fund. You can start small monthly investing via SIP and this can help in accumulating a bigger corpus for any financial goal. As your age and experience increase, you can increase your investment amount easily. 

Same applies to Retirement policy as well. At your 40’s you will have many financial commitments and at that time it is difficult to allocate bigger premiums for retirement policy. Hence you lose out to focus on retirement.

5)    ULIP as Mutual fund

I was asking a client to invest in Mutual funds. He said he is already doing, so I asked him to share the fund name.

He quickly said that, he will be paying only for 5 years and further payment is not required. 

If you are sold something which has lock in period of 5 years, then it means it is an ULIP policy. 

NAV or Net Asset Value is the unit value in Mutual funds and ULIP

Fund names like Pure equity, Mid cap, Debt, Balanced etc is also similar in Mutual fund and ULIP

NAV changes based on market condition.

Mostly in Banks, ULIP is sold as a better alternative to mutual funds and sometimes it is sold as both are same. 

ULIP should be continued for the entire tenure and then only you end up getting better returns. You need to choose equity again for better returns as most of the initial investment amount will be deducted for Fees & Charges. Fees & Charges may go upto 10% in the initial 3-5 years. 

Further all Insurance companies like SBI, ICICI, HDFC, Kotak etc has banks and presence in Mutual funds. 

From diversification point of view, this may be suitable for someone who has already invested and accumulated bigger corpus in Mutual funds and stocks.

So be careful where you are investing.

6)    Insurance as Tax saving product 

The most common mistake everyone do is to take a life insurance product purely for tax saving purpose. Section 80C has limit of upto 1.5 lakhs and I have seen many taking insurance purely for this tax saving. 

First of all you need to take Term Insurance which will also get covered under Section 80C. 

Remember that tax saving limit is just 1.5 lakhs and you can show Home loan principal, Post office deposits, Tax saving bank deposits, Tuition fees, Tax saving Mutual funds etc will come under this limit only. 

7)    Buying Insurance for emotional Reasons 

Most of the time we end up buying things emotionally but justify logically. It applies in Insurance too.

Have you encountered someone in your family or friends take up a life insurance policy for their child or retirement. It is easy to sell these, as they were driven by emotional reason. 

I have my friend who took up several policies as he was not able to say NO to his relatives. 

Logically you can give reason like, “You will get some amount which is going to be helpful in the future”. 

You should always think logically but before investing that will bring in better returns in the future. 

8)    Having insufficient coverage 

Having insufficient coverage is a big mistake. 

If you go with traditional insurance policies you will end up taking 5 or 10 or 15 lakhs policy. There was a client who had loans worth 25 lakhs and his life insurance cover was just 10 lakhs. After his sudden demise, his family was forced to settle the loans with the accumulated investment corpus.

If he had taken term insurance with higher coverage, it could have been a big financial support. Also term insurance is going to cost less compared to any other traditional insurance products or ULIP. 

Same applies for health insurance coverage as well. If you have the base policy of 10 lakhs and if you are living in tier 1 or 2 cities, it is better to take top up policy with coverage of 20 or 30 lakhs. The premium will be much lesser in top up policies. 

9)    Not having separate health insurance cover 

If you are working in a corporate and have group insurance cover, still you need to have separate health insurance cover. 

Health insurance companies will provide cover only when you are in good health condition.  

Group insurance in companies may change once in a year or two and you will not have continuity.

One of the customer had switched company and he was in 10 days break. During that time he met with an accident and he was forced to make all the payments from his own pocket. A separate health insurance would have solved this issue easily. 

Also, you may end up getting lifestyle disease like Asthma, Blood pressure, Cholesterol or Diabetes  and after 50 if you retire or quit your company, you may not get any health insurance cover. 

So best choice is to get sufficient health insurance coverage for yourself and for your entire family.

These are the 9 common mistakes to avoid while choosing different type of insurance – Life, Term, Health, PAC, Critical Illness. share with me if you had done any other mistake while taking an Insurance.