Avoid These 6 Common Life Insurance Mistakes
Buying life insurance can be a confusing experience because of all the options out there. Should you go for an old-school LIC policy, or go for one of the insurance policies offered by banks and modern NBFCs? Are long-term life insurance policies preferable or short-term life insurance plans?
Then there’s one of the biggest life insurance problems: should you be honest about pre-existing problems, family health history, and vices?
Despite insurance being one of the oldest forms of investment, people are still confused about the types of life insurance, dos and don’ts when buying life insurance, and the advantages and disadvantages of life insurance. This leads to them making very grave life insurance mistakes that either leave their families vulnerable or prove to be a waste of valuable investment capital.
If you are in the market for a life insurance policy, avoid these 6 fairly common life insurance mistakes.
Life insurance mistake#1
Selecting the wrong policy term: Some people will buy an insurance policy with a term extending for a hundred years and more. Now, this might sound like a good way to offer financial support to your dependents for decades after your death. Theoretically, it makes sense, but you must consider how you’ll be paying a drastically higher premium now for a payout that will drastically diminish in value, so far into the future.
Similarly buying a policy with too short a term will not offer financial support to your family for a useful enough duration after you are no longer available to support them. It is tempting, because you will get a low premium for a policy with a shorter coverage term, but you’re defeating the purpose of buying insurance in the first place.
Life insurance mistake#2
Not buying a term plan/ not reading the fine print: There are two types of life insurance policies. Modern term plans offer a sum assured in case of the policyholder’s death and also pay back a certain amount in case the policyholder outlives the policy term. On the other hand, traditional life insurance policies work like medical insurance. If the policyholder survives the policy term, then the sum is assured and all the capital is lost. This was also the reason why, historically, people purchased very long-term policies.
Avoid the risk of losing capital by buying a term plan. Read the terms and conditions, payout amounts, and all other details with utmost care. Ensure that you do get back a certain pre assured sum if you survive the policy term. Otherwise, both you and your dependents lose out.
Similarly, read the details and choose your payout mode for the sum assured carefully. Your dependents might not be confident with finances and investing, in which case a staggering payout is preferable. If you feel like they would invest a lump sum wisely, then opt for a lump sum payout. Whatever you choose, it should be after careful deliberation.
Life insurance mistake#3
Not shopping around:
Always compare factors such as
- Premium amount
- Sum assured in case of policyholder’s death
- Payout upon completion of the policy term
Do not get carried away by any other bundled features and benefits. Keep your focus on these factors and compare rates on an online insurance marketplace like IIFL Insurance.
Life insurance mistake#4
Lying about medical conditions and medical history: If you are a smoker, have some sort of pre-existing medical condition, or have a family history of chronic illnesses, know that there is no point in hiding it. In fact, hiding it is very likely to result in you losing out on your sum assured when the time comes because you won’t be able to hide stuff from the hospital, and all your medical records will go to the insurance company. Avoid giving them just reason to reject your claim citing withheld information.
Life insurance mistake#5
Falling for the premium return tactic and other gimmicks: Keep your focus trained on your insurance requirements at all times. Some life insurance policies will have the option of earning back your premium at the end of the premium payment term or the policy term. However such policies will typically have a much higher premium payable upfront, which cannot really be justified. This is just baiting.
There are a lot of benefits out there including loan access, but keep your focus strictly on the points discussed under mistake #3, and you should be able to navigate your way to the best life insurance plan easily.
Add ons may or may not be worth it. Use this quick questionnaire to evaluate them:
- Is this cover actually essential?
- Does it overlap with any other insurance that I already own?
- Would it be more cost-effective to buy this add-on standalone (or only when necessary?)
- Would it be more cost-effective to buy this add-on as part of another type of insurance?
- Is this add-on relevant to the entire policy term?
Focussing on only life insurance as an investment plan
Life insurance policies – even the ones that invest part of your capital – cannot begin to compare with a lot of other investment options, in terms of the returns that they are able to deliver.
For example, ULIPs (unit-linked insurance plans) give you market exposure, but without the risk management and capital management expertise that a mutual fund house gives you, or the flexibility to pull out your capital only on peaks as you would have if you invested directly in stocks or mutual funds.
Other insurance plans might be risk-free but low risk typically means low potential returns. It is ideal to have a mixed portfolio with fixed income investments (even if they have low returns) and some investments that allow access to potentially higher returns (so long as you have the risk appetite). This is called portfolio diversification.
Takeaway
Select insurance plans after sufficient research and shopping around; and whatever you do, don’t fall for gimmicks. Insurance is a safe mode of investing with modest returns (when chosen right) and is a must-have means to long-term financial security, but cannot be the only investment type in hand if your goal is wealth generation.
