What Your Life Advisor Don't Tell You?

Agents will hard sell policies that offer them the highest commission, but a simple term plan is your best option.

Thomas is cursing himself. His new financial advisor has just told him that his three year old insurance policy would count among one of the dumbest things he has ever done in his life. The insurance plan didn’t suit him and the insurance cover is also inadequate, financial geek told him. He also asked Thomas to dump the plan, get whatever money he can from the insurance company and take a new plan. Thomas couldn’t understand what the fuss was all about. “I didn’t think much before buying the policy. A friend suggested an agent, who came to the office and selected the plan for me. All I did was sign on the dotted line,” he says.

According to his financial advisor, the practice of blindly signing on the dotted line is not an uncommon practice when it comes to buying an insurance plan. “Often I find that people have multiple policies with small insurance covers. Since they count the number of insurance policies they have, but not the cover they don’t know that they are severely underinsured, he says.” “If something happens to them their family won’t be able to maintain the lifestyle with the insurance covers from these policies,” adds the financial advisor.

According to him and other financial advisors, all you need to know is the basic premise behind the idea of buying an insurance cover and rudimentary details of how various insurance products work to stay clear of the trap of buying the wrong products.

How much cover should you buy?
Mostly insurance agents or advisors have the last say on the insurance cover. According to experts the insurance cover is dictated by the choice of policies and premium amount than the need for adequate insurance cover. ”Most insurance advisors sell a plan which gives them a good commission. Mostly these plans have a saving element along with the life cover and they are generally expensive,” says an insurance advisor with LIC. What a customer should do is to do some number crunching to find out how much cover/s he needs.

The basic idea behind insurance is simple. If something happens to you your family should maintain the same lifestyle from the proceeds from the insurance policy. To make this happen, your family should get an amount which should generate enough income for sustenance. One way to find this out is to calculate how much of your salary is consumed by your family. For example your take home is Rs.20,000. Deduct your personal expenses, savings, and investments from it to find our how much you spend on your family. Suppose the amount is Rs.10,000. Your insurance cover should be Rs.20 Lac to generate an annual income of Rs.1.2lac (Assuming the rate of return to be 6%).

They come in all hues
Now since you know your cover, it is time to take a look at different insurance products (their name would change with each company but the basic principle would remain the same) your insurance agent is going to sell you.

Unit linked insurance plans:
Apart from insurance cover ULIPs offer different investment options with varying degree of risk.

Endowment Plans:
These too have a saving element along with insurance cover. However, they don’t offer you any investment options. Your insurance company would invest money in a conservative fashion.

Money Back Plans:
They also have a saving element in the premium and offer periodic payments at regular intervals.

Whole Life Plans:
As the name suggests, you have to pay the premium your whole life or up to your seventies.

Term Plans:
You would be extremely fortunate if your insurance agent mentions these. They are the cheapest, pure insurance cover.

So which is the best?
According to financial geeks, you should ideally buy a term plan. Most of them don’t approve of mixing investment with insurance, as they don’t think much of the investment skills of insurance companies. (That rules our ULIPs, endowment and money back plans). You are better off investing money in mutual fund. Also, ULIPs don’t score much on transparency. They also don’t favor whole life plans because you have pay premium even after retirement. Finally, the best way is to keep it simple; for insurance needs, only look at term plans.

How much Life Insurance should you have?

Insurance is still perceived as an attractive tax saving tool or an instrument, which gives long-term tax-free returns.

But what it actually does is to mitigate risks and offer financial protection to a family in the event of an untimely death of the breadwinner.

Here are a few points that individuals need to reflect on and conclude on the amount he needs to cover his life for:

1. Where are you placed in your life?

There cannot be a single plan or formula that can work for everyone even in the same age bracket. Circumstances under which individuals find themselves should dictate the need for life insurance. But, your need for insurance varies with the stages of life. If you are young and single with no dependants, the need is low.

On the other hand, if you have recently celebrated your third wedding anniversary, bought your own house availing a housing loan and expecting your first child, with a non-working spouse, then your need soars.

Please keep in mind that as you grow older, the premium you need to pay increases for the same amount of cover, so it augurs well for you to avail of a policy at a younger age for the longest possible term. If you are the middle-age bracket with children who are making their debut in the job market, then planning for your retirement should be a priority.

2. What is your financial situation?

You are lucky if you are a sole inheritor of a large portfolio of shares with a farmhouse thrown in. Your personal wealth should keep your family in good cheer in case of your untimely death. But, if a good education and good values are all you have inherited, then taking stock of your financial health is imperative.

Be brutally honest with yourself and draw your personal balance sheet. On the asset side list your possessions: house, shares, small savings, other investments, jewellery, insurance policies, and bank balance. On the liabilities side, list any loans or other overdrafts facilities and debts that you have availed. If your liability side is much heavier then you need a huge policy to cover the gaping hole on the asset side. Your family will have to bear the brunt of repayment of these loans in case of your death.

3. How stable is your income?

Insurance is a long-term contract. Generally a life insurance policy requires a commitment to pay the premium every year for 15-20 years, depending on the term which has been chosen by you. Unlike other investments, if you renege on your commitment, your policy can lapse and your life cover compromised. The surrender value of such policy is low, which translates into a lose-lose situation for you. So think long hard before you buy a policy and cut a high-value cheque. It is an amount which you need to shell out year after year. Your career may hit a rough spot and the premium amount will cut a hole in your wallet.

4. What's your fitness level?

If your idea of fun is hitting the treadmill and doing 500 stomach crunches first thing in the morning then you can rest a bit easy. Good health is a great blessing which most of us take for granted. But be careful if the idea of standing on the bathroom scales gives you the jitters. A couch potato with a family history of lifestyle-related disease such as high blood pressure or diabetes has to face the fact that the probability of him contracting any of those disease is high.

In such an event, it is imperative that you cover yourself with medical insurance and advantage of all available critical illness riders, while you can. Unfortunately, once you contract any of those diseases then it goes against you at the time of availing a cover. Insurance companies frown upon pre-existing illnesses and when you buy a cover it will be loaded with an extra premium or denied altogether.

As a thumb rule, the amount of cover which you buy for yourself in the event of your untimely death should be enough to and cover all the expenses of your family and maintain the lifestyle for the rest of their life.

How much insurance should you have?

Typically, people end up having either far more or far less insurance than they actually need. Here are some thumb rules for how much insurance you need:

Dependents: The more dependants you have, the higher the insurance you will need; a child's education or spouse's retirement expenses will need to be considered separately

Debt cover: Any loan you have taken should be covered to the extent of the loan

Maintaining income/ expense levels: Have an assessment of what percentage of your current income will be required for your family to maintain present lifestyle and also have some savings. If you think it is Rs 4 lakh (Rs 400,000) a year, you could have an insurance of about Rs 50 lakh (Rs 5 million), which will earn 10 per cent returns a year (Rs 5 lakh -- Rs 500,000 -- a year) and take care of inflation too.

Judicious mix: Term insurance is a cheap way to insure, though it does not earn returns if you survive. Endowment policies and ULIPs are investment schemes with high premia.