Friday, November 29, 2013

How to buy a Life Insurance Policy / Best life insurance policy

Before starting you need to understand your need and how Life Insurance is useful for you.

What is Life Insurance? Life insurance is a cover to provide financial security against your untimely death to people who are dependent on your income.

Please note:
1.       Financial security: Insurance can provide only financial security and cannot save your life or fill the void created in life of your dependents due to your death.

2.       Dependent on your income: The person getting the benefit of insurance should be someone who is dependent on your income (note "dependent on your income" and not "dependent on you") . Your kids and wife who are financially dependent on your income for education, food, housing and other necessities and comforts of life. You will come across idiots who take insurance on life of their minor children or dependent wife, do not ape them.

3.       Untimely death: Insurance is required when sudden unexpected event can impact the normal life of the dependents. In early years of your life when you have limited savings and lot of responsibilities like education of kids etc., life insurance is more important although chances of your death is also remote. When you start approaching your retirement you has enough savings and most of your responsibilities like child education etc. are taken care off and hence there is limited utility of life insurance then, although chances of your death increases substantially. Around your retirement or post retirement you need medical insurance more and not life insurance.

I know everybody knows this but as they say common sense is uncommon. Even when everybody knows this you will come across the following follies by the best of people:

1.       Life insurance saves life: Everybody know that life insurance only compensate in terms of money in case of death but deep down people believe that life insurance cover saves life. And if you see most advertisements would also project that to you. Remember ICICI using ‘sindoor’. Frankly if you die you wife might get enough money to remarry but not your ‘sindoor’.

2.       Life insurance of kids: I know you are laughing that how can someone believe that life insurance policy saves life. Then tell me why people buy life insurance of their kids? God forbid if your kid dies your financial responsibility will only go down. Ask yourself what you would like to do with the money you receive on death of your kid, you will get the answer.

3.       Life insurance of wife: Are you dependent on your wife’s income? If yes, then it makes sense to buy insurance on her life otherwise not. There might be few cases where couple have stretched themselves to buy a house and contracted big EMI which can be paid only if both incomes are intact. In most cases it is not required. Remember if your wife is not there your monthly expenditure might also go down. (Please don’t give an argument that you will have to then hire maids, cook, crèche facility etc. if your wife is not there that would only display your mindset). Again ask yourself what you would like to do with money you receive from life insurance in case of your wife’s death. Of course, there might be ladies who might say why no insurance on my life, is my life not important. Well, tell her insurance cover won’t save her life.

4.       Life insurance for tax benefit: Life insurance premium is money down the drain (at least you hope it’s down the drain). People fool you when they tell you that by taking life insurance you are saving 30% tax. Infact you are putting 100% down the drain. Section 80C provides tax exemption of maximum Rs. 1 lakh and various investments including PF, PPF, child education etc is covered under this limit. Hence, in most cases you would be investing more than 1 lakh in PF, PPF and child education to cover this limit of Rs. 1 Lakh. If you have cash surplus and can afford you should maximize investment in PPF irrespective of tax benefit (I will cover this in separate blog later in details). Investment upto Rs. 100,000 is allowed in PPF and that is enough to take care of Section 80C exemption.
 If you donot have cash surplus to invest in PPF, PF, child education then think whether you can afford life insurance. And in that case either you are not earning enough to be paying taxes or you are spending way beyond your means. Bottom-line: Never take a life insurance for tax planning.

5.       Life insurance is investment: As I mentioned earlier, Life insurance premium is money down the drain (at least you hope it’s down the drain). Do not mix insurance and life insurance. Pure term policy provides the maximum cover at the lowest cost and one should go for that. Tax free bonds, FDs, PPF, VPF etc. all provide better rate of return & security than any ‘life insurance investment scheme’ can ever provide. So if you are paying say Rs. 50,000 per annum under some ‘life insurance cum investment scheme’. I would suggest close that policy, but a term insurance with a premium of around Rs. 12,000 and invest 38,000 in PPF / tax free bonds. I can assure you will get higher cover and higher rate of return in this combination.

Now that concept of what is life insurance and why you need life insurance is clear lets discuss which policy, where, When, how and how much.

When you have dependants: Life insurance is required only when you have dependents. So if you are a bachelor and your parents are not dependent on you it does not make sense to buy a life insurance cover. People will tell you that it makes sense to start insurance policy early as you lock in at lower premium. You will end up sending money down the drain for many more years without any utility. In those years it’s better to invest and full advantage of power of compounding. Anyway due to increased life expectancy, better records, cheaper channels etc. life insurance premium have fallen substantially and if you are having an old policy it might make sense to buy a new policy and surrender the old policy.

Pure term insurance: First of all, as I mentioned earlier go for only “pure term insurance”. Do not mix investment and insurance. If you keep that separate you would not only get better cover but also higher return.
Term of Life insurance: Generally life insurance term should be limited to your working life or till people are dependent on you. Generally people retire at 60 and hence beyond 60 there is no need of life insurance. Beyond 60 your dependent kids should be independent enough. For your dependent wife and yourself you should have enough savings to take care of the retirement years. In fact after retirement, when you are not earning, the premium payment, however small, is a total waste. So do not get lured by insurance companies that offer life insurance up to age of 90. If you are having such a policy, you would be forcing your now independent kids to look forward to your death.
Fine print check: Check for exclusions like terrorist activity, nuclear activity etc. Ensure such exclusions are not there. Considering the neighbors we have and their activity like 26/11 you never know.  Suicide exclusion upto 2 years is a fair clause (Anyway I hope this is not a consideration for you).

Online term insurance policy: Buy online term insurance policy as generally it’s cheaper because the insurance company is saving cost on agent commission, channel cost etc. An insurance agent might tell you that claim payment record in these policies is bad, but do not believe them. Anyway unlike medical insurance, car insurance etc., denying life insurance payment is difficult for an insurance company as it’s a definitive event and is not open to interpretations of so called experts. One should go to sites like policy bazaar to compare policies and select one for oneself. Then go to company website to apply. Stick to bigger companies which have been in operations for a while like Bajaj Allianz, HDFC, ICICI, SBI etc. I would advise not to go for aggressive newcomers like Religare, Reliance etc. just to save 200-300 rupee in premium. State run insurance companies are good but generally for online term insurance policy they are not competitive enough. Generally for a Rs. 1 crore policy for a 32 year old male, the premium would be around Rs. 12,000 inclusive of taxes.
Medical test is good: Many insurance companies advertise that ‘medical test not required’. I would suggest it’s better to undergo medical test. If you have anything to hide I would suggest that you spend more on doctors, physicians and gyms. Medical test not only give information to insurance company but also to you and would help you improve your life style. Also when you undergo medical test it becomes very difficult for insurance company to later claim that you have hidden something from them while taking policy. Most of the policy donot provide for this excuse beyond 2 years. It’s important you check that in your policy.

Insured value: You are insuring against loss of income due to your death and you hope by this insurance your dependents won’t have to compromise on their current lifestyle. Hence it’s important for you to know what is your current annual expenditure (cost to maintaining the current lifestyle). As today rate of return on tax free bonds and FDs are around 9%, I would suggest that your cover should be enough to provide annual interest equivalent of your annual lifestyle cost @9%. So if your annual expenditure is say Rs. 12 lakhs, then your term policy should be around Rs. 1.35 crores. If you do not know your annual expenditure (which shows how irresponsible you are in your personal financial management, and I would suggest you calculate it today) and do not even have the will power to calculate it, you can use the thumb rule that your insured value should be around 10 times of your net annual income. So if your net annual income is Rs. 15 lakhs then your insurance cover should be around Rs. 1.50 crores.  In most cases both methods would give similar results, but method 1 is a better method. We have presuming 20% savings on income. If you are doing better than that, good job, keep it up. If you are doing less than that, you need to tighten your belt and seek help of professional financial planner. Remember it’s important that you are not under covered. However, it’s equally important that you are not over covered. If you are over covered not only you are putting extra money down the drain every year, you are also creating threat to your life!

Last but not the least you should properly inform your dependents the life insurance cover you have, where the policy document is kept, what is the process of claiming it etc. You won’t be there to claim it and insurance company would not pay on its own. Do you want your family to live a miserable life after you just because you forgot to tell them where you have kept the policy document?

I hope this was helpful. Feel free to write your comments and ask for clarifications, if required.

1 comment:

nidhi marothia said...

really useful for people who mix up insurance with investment.......