August 22, 2011

Life Insurance - 5 Common Myths & Misconceptions.

In this series of myths and misconceptions, I am trying to highlight / demystify various false notions associated with Personal Finance. I’ve already covered quite extensively the fallacies linked to tax, credit cards and mutual funds. Here’s top 5 myths & misconceptions about Life Insurance:
Misconception #1: Insurance is a tax saving tool.
The biggest myth about life insurance is that it is considered a tax saving tool rather than risk management tool. People buy it for the sole purpose of saving tax. There is nothing wrong in considering tax benefits while applying for it but buying it solely for tax savings is wrong.
Misconception #2: Nominee is same as the legal heir.
Nominee is the person who’s entitled for the claim proceeds if the life assured dies and is meant to give valid discharge to the life insurance company. Put another way, nomination only indicates the person who’s authorized to receive the claim amount and need not be a legal heir of the life assured.
Thus, nominee doesn’t acquire the absolute right over the proceeds if he is not the legal heir or the beneficiary in the will or if he is only one of the legal heir or beneficiary. The other legal heirs or beneficiaries can contest the ownership of the claim proceeds.
Misconception #3: ULIPs are equity linked.
A common myth about ULIPs (Unit Linked Insurance Plans) is that they are linked only to equity markets.
The fact is that there are various fund options (differs from company to company) available in case of Ulips. However, we can broadly categorize them into three categories 100% equity fund, balanced fund and 100% debt fund. There are also other fund options available with varying degree of equity and debt.
You have the flexibility to choose a fund option based on your risk appetite and if you wish, you can switch to another fund option at a later stage.
Misconception #4: Life Insurance is more important than Personal Accident / Disability Insurance Absolutely wrong.
Risk coverage for personal accident and disability is much more important than life insurance. Before you go for life insurance, you should be adequately covered for personal accident and disability insurance. Why?
    1. While life insurance covers only death whether natural or accidental, personal accident also covers disability (both temporary and permanent) caused due to accident (besides accidental death) and disability insurance covers you for non-accidental disabilities arising out of various diseases / ailments.
    2. In terms of financial impact, suffering from life impacting disabilities is worse than dying.
    3. The probability of meeting an accident or suffering from a disability is much more than natural death, particularly for younger people.
    4. Finally, these general insurance covers are much cheaper than life insurance.
However, please note that these policies don’t cover you for hospitalization (for which separate risk covers are available) expenses but for loss of income arising due to disability.
Unfortunately, as of now, disability insurance also called 'Income Replacement' or 'Income Protection' insurance is not available in India.
The next best alternative to insure against the risk of sickness induced disability is critical illness insurance which differs from disability insurance in terms of coverage and benefits with some some overlaps.
Misconception #5: You should receive the money back when the life policy expires.
How much annual premium do you pay to get your motor comprehensive cover on your 4 lakh or 6 lakh car? Do you get that money back when your motor car policy expires? But you expect your money back while buying a life insurance policy. Isn’t it amazing? To know more of it, see: Most Amazing Fact about Life Insurance.