A policeman grabbed collar of a person just about when he was about to jump from a river bridge into the river. The policemen asked him who he was and why he wanted to commit suicide. The person answered that he was an insurance advisor and then went on to explain the reason for him to commit suicide. Within ten minute the crowd, which had gathered there, was shocked to see both jumping into the river. This is the convincing power of an insurance advisor.
Many of us are forced into buying insurance products which we do not really need. We get to hear number of horror stories of misspelling by insurance advisors with such convincing power. 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 misspelling.
Need for buying the life insurance for whom, when and how much
The basic purpose of buying life insurance is to provide for financial security of the people who are financially dependent on you to meet their financial needs. 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. Likewise the sole purpose of buying life insurance should never be tax saving. Availability of tax benefits is an incidental benefit which may accrues to you when you buy life insurance but it can never be the main benefit. The main benefit would always be the financial protection of your near ones who are financially dependent on you. For saving income tax there are many other products which are more tax efficient and fetch you better returns in the long run as compared to any insurance product.
During my consultancy days, majority of clients would tell the amount of the premium they were paying when asked amount the quantum of life insurance they had. Majority of the people are not able to assess the quantum of their life insurance needs. One needs to buy adequate insurance. In my opinion one needs to have life insurance of minimum equal to 12-15 days of annual income. The insurance need of a person at the beginning of the career would be a higher multiple of the annual income as the income would gradually increase. So if you are young opt for at least 15 times of your annual income as the amount of life insurance cover needs.
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Basic categories of life Insurance Products:
The life insurance products can be divided into two broad categories.
Terms plans : Under the this category come all the variants of term insurance plans. Under the term plan the person who is named as nominee/beneficiary gets the amount of sum insured in case of death of the insured person. However in case the insured survives the term of the life insurance policy no body gets any money. So the term plan basically covers the pure risk of life and thus is very cheap as compared to other life insurance products. Under the pure term plan category insurance companies have introduced many variants under which the payment on the death of the insured is staggered over a few years in stead of the same being paid instantly on the death. You can buy the term insurance either online or offline through help of an insurance advisor. Since no commission is payable in respect of the online term insurance product, these are very cheap as compared to the offline variant. 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 with the insurance Company. So in case you are confident of your dependent being able to make the claim without much difficulty go 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/nominees get the sum assured with accrued bonus in case insured person dies during the tenure of the insurance plan. In case the insured person survives the tenure of the insurance under the policy, he get the sum assured with bonus accrued on the policy in case 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 the investment products. 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 becomes eventually payable after death of the insured as and when if happens.
The premium paying term for these products may not necessarily extend for the whole tenure of the policy. The premium may be payable upfront by way of one time payment in case of single premium policy. The other variants may have premium paying term periodically 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 oxymoron. In case you buy life insurance product for investment, you get neither enough for your purpose. 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. 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 insurance product fetches you very low return which generally far lower than the alternatively available in 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 lower than what you can get from pure debt products like government securities. As the majority of the 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 can not 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 back received will serve as regular income for the person. As average person is 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 life insurance policies, is not more than 5-6%. 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 polices 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 one 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.
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(The author is a CA, CS and CFP. He can be reached at jainbalwant at gmail.com and @jainbalwant)By Balwant Jain (CA, CS and CFP)The author is a CA, CS and CFP. Presently working as Company Secretary of Bombay Oxygen Corporation Limited. Views are personal., He can be reached at email@example.com and @jainbalwant