Key Objective of life insurance is to protect future income due to untimely death of the breadwinner. Similarly In case of health insurance the objective is to cover the cost of hospitalization. But in India usually life insurance is bought and sold as a tax saving instrument or as an investment product. When insurance intermediary claims to help you save your tax, the real objective is to earn handsome commission on your premium.
Other day, when somebody asked me that because it is proposed in the new direct tax code (DTC) that the limit of deductions towards premium of life insurance, health insurance and children tuition fee will be Rs 50,000 and as he is already paying more that Rs 50,000 towards his children school fee, should he surrender his life insurance policy? I thought, is it really a reason for people to continue or surrender their life insurance policy.
Usually people buy insurance without a real understating of why they do so. In my financial planning practice, when I ask people the reason for buying multiple life insurance policies before they approach me, some common answers received are, that it was recommended by a colleague, they learnt about it through a TV commercial as best tax-saving instrument or bought it under obligation from friend or relative. Study confirms that life insurance policies bought just for tax planning and without keeping any financial goal in mind are surrendered before its due maturity.
The key objective of insurance is to manage financial risk. Different kind of risks can be personal risks like premature death, poor health and old age without having sufficient income or property and liability risk. There are various forms of insurance to manage these risks, and the objective of all is to protect people against unexpected loss. Most common type of insurance are life insurance, health insurance, critical insurance, personal accident and property insurance like motor or home insurance.
Premium towards your life insurance and health insurance policies qualify for deductions under Section 80C and 80 D of Income Tax Act, respectively, but that should never be the objective of buying insurance policy. If tax-saving is your objective, then there are much better schemes that provide you higher liquidity and returns. Insurance policies are not good investment options as they fail to create wealth due higher cost involved in them.
Since the objective of life insurance is to provide financial support to the family in case of untimely death of the life assured and therefore, life insurance should be bought on the life of the bread winner and not on the life of spouse or children. If spouse is also an earning member and is contributing to household expenses then he/she may buy life insurance policy on his or her life. Money received through life insurance claim can be used for repaying the debt, can be invested to manage household expenses of your family members and to achieve your other financial goals like children education and marriage. Pure term insurance policies best serve this purpose.
Term insurance plans do not offer you any maturity benefit, but these are the best plan as they offer high death benefit against the small premium you pay. There are also other type of life insurance plans like endowment plan and unit-linked insurance plan (Ulip). Endowment and Ulips are basically combination of insurance and investment.
Insurance company invest the premium in different assets like stocks, bonds or government securities after deduction of insurance charges referred as mortality charges and other charges towards marketing and administrative expenses. In a Ulip, there is a transparency about these charges, but in an endowment plan, there is no transparency about these charges. But in any case a part of your premium is used for investment after adjusting these charges, and therefore, your returns from your policy will depend on these charges and performance of underlying asset in your policy.
Before buying a life insurance policy you must do the proper insurance-need-analysis. To determine the sum assured under your life insurance policy, you can calculate the present value of your future expanses like household expenses, children school fee, cost of higher education, children’s marriage, and various other financial goals you have in your mind. The inflation and future returns should be considered, assuming that insurance proceeds will be invested in some savings scheme. You should also add your loan outstanding to analyse the need of life insurance cover.
Objective of health insurance is to cover health care expenses which include doctor’s fee, room and ICU charges, medicines, pathology and other expensive diagnostic tests during hospitalisation. Though, it is difficult to ascertain that which problem may strike your health in future, yet sum insured under a health insurance policy can be determined by the factors like your lifestyle, occupation, cost of health care in the city you live and your affordability to the premium. You must check the features like sub-limits under your health insurance policy, network hospital of the insurer, terms of renewability and exclusions under your policy.
To conclude, I say that insurance policy must be bought with proper planning and keeping long-term objective. Insurance is a complicated product and you need time to understand it. If you are in hurry of submiting your investment proof for claiming deduction in your income, I suggest not buying insurance policy. Take some time to analyse your insurance need and under the products well before you enter in a long term contract.