Life Insurance: Understanding Some Myths & Realities

Life insurance is one of the least understood elements of financial planning. There are dozens of kinds of policies, and the legal jargon can make a novice uncomfortable. It’s hard to shop by comparison because companies use different names for their policies, and if you ask three different agents how much insurance you need, you are likely get different answers. As a result, people either buy too much insurance or not enough. Moreover, we often don’t buy smartly. Experts advise individuals to spend a fair bit of time to review their coverage and their policies. In this direction, here are some myths you should clear before buying your next policy:

Myth 1

Everyone alive needs life insurance: Not everyone needs life insurance; yet people often hold on to policies because it makes them feel more secure or more responsible. The number one reason for purchasing life insurance is to protect loved ones who depend on your income; the insurance replacing your lost earnings if something happened to you. If you are single with no dependents, you can probably skip life insurance and put your money to better use. Moreover, if you and your partner each earn enough to be self-sufficient and you don’t have children, you are better off building your nest egg than buying insurance.

Myth 2

My company insurance is adequate: This is often untrue. For instance, if you are between jobs or if the company goes through a bad phase and does not pay the premium, you could be in a fix. So, make sure you have your own insurance as safety.

Myth 3

My credit card insurance is adequate: Your life insurance should be a contract between you and the insurance company. Any other mode is risky. Have you heard of anybody who says, “My husband died in an accident and I got Rs 20 lakh from his credit card insurance cover”?

Myth 4

Money-back policies return all the money I invest and hence it’s better: For most of us, the cheaper kind - term insurance - is actually the better choice. Term life insurance is ‘pure’ insurance with no investment add-on. As long as you pay your premium, you will have coverage. You buy term insurance for the duration of time for which you will need life insurance - typically until the children are out of college, or if you are the sole breadwinner, until you retire. Level term insurance is the best because the premiums don’t increase during the term of the policy, which can be from five to 30 years. You can always shorten the term - just stop paying the premiums and the policy will lapse. 

Permanent insurance comes in lots of flavours, as for example whole life, universal, etc. and is seven to eight times more expensive than term. A ‘money-back’ policy combines life insurance with an investment that builds up cash value. You can tap this money by borrowing or surrendering (cashing in) the policy. Although it may sound appealing to get something back for all the premiums you pay, the extra administrative costs and fees whittle away at your rate of return. In general, life insurance policies make poor investments. Most of us are better off buying cheaper term insurance and investing on our own, preferably through equity-based mutual funds.  

Myth 5

I am single and don’t have dependents, so I don’t need coverage: Even single persons need at least enough life insurance to cover the costs of personal debts, medical, and other bills. If you are uninsured, you may leave a legacy of unpaid expenses for your family to deal with.

Myth 6

My CA told me I am adequately covered: Adequate ‘premium’ for Section 80C cannot be confused with adequate life cover. To ensure that your insurance cover is adequate, contact an insurance advisor.

Myth 7 

Only the breadwinner requires insurance: It is estimated that a non-working spouse contributes a significant portion to the household budget. For this reason it is important to buy life insurance for everyone in the household whose absence would cause financial hardship. 

Myth 8

Insurance should cover only likely disasters: Till the Mumbai deluge happened, few had flood insurance. In a similar vein, insurance is meant to protect you from financial catastrophe - disasters from which you could not easily recover on your own. 

It’s no fun to think about all the bad things that can happen or to write those big cheques every year. But once it’s done, you can rest easier knowing that you are well and properly covered. The key concept to understand is that you shouldn’t leave life insurance out of your budget unless you have enough assets to cover expenses after you are gone. Tackling popular myths is a good start.