Insurance policies: Risks that could trip you

Subrat Mohanty

Has your life insurance consultant ever told you about how much life insurance you need to secure your family’s standard of living? Were you worried when you heard that your neighbour had to settle for lesser return on his Unit Linked Insurance Plan (ULIP) for surrendering early? It is your responsibility to ask the consultant as many questions until you actually understand the pros and cons of investing in life insurance, otherwise the risks could trip you.

Buying an incorrect plan

The very first risk is buying an incorrect plan. The primary objective of buying any life insurance policy has been as a risk-mitigating tool to protect a person’s family and its standard of living, not merely as an investment for the sake of returns. 

While a pure term insurance plan provides a lump sum payout in the unfortunate death of the policyholder, it does not pay anything if the policyholder survives the policy term. On the other hand, a person who wishes to get maturity benefits of the policy if the policyholder survives the policy term along with the comfort of protection of the family otherwise, can opt for a traditional or a market-linked endowment plan.

For instance, the new ULIPs (after September 2010) have become very low-cost as compared to those plans offered before this period.

However, the lock-in period for new ULIPs has been raised from three years to five years. Therefore, one cannot withdraw money from unit-linked insurance plan before five years or use this investment vehicle for immediate liquidity, but for fulfilling future financial goals. Notwithstanding the benefits of new and low-cost ULIPs, one should remember that since these plans invest in the equity market, the returns will be in line with the volatility of stock market.

People with low-risk appetite should stay away from investing in equity funds as they may panic due to short-term volatility and exit at loss.

A policyholder should go through detailed checks and balances when buying an insurance plan. After deciding the type of plan to be bought, the decision on the premium paying ability of the policyholder will influence the quantum of premium and thereby the insurance cover. It is advisable to agree on a premium that will not adversely affect the policyholder’s ability to pay, should there be adverse financial conditions in any particular period during the term of the policy. The policyholder should read and understand all policy terms and conditions thoroughly and reveal all pertinent information about medical and family history, before signing the dotted line.

Not cross-checking the credentials 

of insurance agent/consultant

Another risk could be that of not cross-checking the credentials of your insurance agents. Often, a few insurance agents insist on buying a new policy with the renewal premium amount for an existing policy looking at their short-term gains or use other ways and means to misguide a policyholder or a prospective insurance buyer. Such practices have resulted in customers being skeptical towards all insurance agents and insurers.  It is better to conduct due diligence about the insurance agents and the suggested plans from other sources, before buying a plan.

Buying insurance as a tool to save tax

The next risk arises from the fact that life insurance is still majorly considered as a tool to save tax in India. Though a life insurance policy, purchased in any particular year to avoid higher tax payment will provide a financial protection in an unfortunate event, the sum may not be adequate for your family to maintain the same standard of living. A general thumb rule of buying life insurance to provide adequate financial security to your family and protect your future financial goals is that you buy life insurance worth 8-10 times of your current annual income, not just the amount of the premium that covers the gap to meet the limit in Section 80C of the Income Tax Act.

Not considering the brand 

One more important risk is that when you buy life insurance you’re counting on the insurer to keep its commitment years or decades from now. Therefore, it is important to consider the brand and the companies backing this promise. It’s better to pay a slightly higher premium to a trustworthy insurance company and be sure of a payout in case of the unfortunate demise of the policyholder or after the policy term, instead of paying a lower premium to a new, untested industry player.

Once you are mindful of these risks, deciding to buy the right insurance will be a piece of cake.

The author is Head of Marketing and Sales Quality (Institutional Business), Bajaj Allianz Life Insurance Co Ltd. The views expressed in this article are his own