Over the years people buy life insurance policies and keep paying the premiums. As long as they are able to pay the premiums or they do not have to look at policies to get some money to meet certain requirements they will not have any worry about their policies. But fact of the matter is that there are few things which could create trouble for them in the future if they have not structured their life insurance portfolio optimally.
High life insurance premium payments affecting cash flows
Once I met a person named Joy Joseph who was finding it difficult to meet his income and expenses. His problem was that his total premium payments constituted a big portion of his total payments. While working his financial plan, I found that he needed to save additionally for meeting his goals but he was infact having shortage of funds month on month. The returns that could be expected from the life insurance policies were also low. I suggested surrendering a few life insurance policies. My suggestion was aimed at helping him to generate monthly surplus so that he can save the required amount towards his goals.
How will you know if your premium payments have exceeded desirable level? The answer is that while reviewing the policies you should check if your total life insurance premium payments exceed 50% of your savings requirements or 15% of your income. If so happens, you should considering reducing your exposure to investments through life insurance. You may ask what is particular about these percentages. The answer is that these are something I learned through my experience over a period of time.
High life insurance investment allocation affecting returns
Anil kumar an NRI, had about 30 policies which included policies from Indian and international insurance companies. As most of his savings went into life insurance policies his overall returns were very low. His investments do not seem to earn reasonable returns as to meet his goals. He could not afford to save additionally in other investment products. He later surrendered a few policies and bought a residential plot at his home town. You will not disagree that the returns from real estate is much higher than return from insurance investments. He allocated the property to his retirement goal. When he returns he can sell it and use the proceeds to generate regular retirement income.
Traditional life insurance policies have low risk but returns are also low. Traditional life insurance policies on an average gives about 6%p.a returns and within that for money back policies the returns could be even less than 4%p.a. In case of ULIP policies the yield after adjusting for various costs on an average could be about 10% only. So it is important that you should check your overall investment returns considering investments through life insurance, mutual funds, fixed deposits, stocks, bonds etc. In case the returns are lower than what you can expect as pr your risk tolerance level, you should restructure your investments. As long as your investments in life insurance are less than 30% of your total investments, you need not worry about your policies.
In the above case his life insurance requirement was calculated and for the shortage of cover he bought term life insurance policy.
Higher allocation to life insurance savings affect liquidity
Few years back, I met a Thanigai moni who had about 100 ULIPs and 34 traditional policies over a period of time. He was a business man in rural Tamil Nadu. When business was doing well he subscribed to whatever policy agents were suggesting thinking that they are like fixed deposits. Agents made him think like that. They told him that he has to pay premiums for 3 years and after that he can get back the money with high returns. His annual premium payment required was more than Rs. 1 crore. A few years later when his business went down, he was in need of money. He realized that he is in a trap. He found that the fund value of the ULIPs was less than the premiums paid and the traditional policies if surrendered would fetch him very low amount.
If you put majority of your savings in life insurance policies, you can end up in liquidity issues. Life insurance promotes thrift savings or forced savings. The benefits will be very low if stopped in between. So you are forced to save till end. If you are not forced to save you will stop the savings after sometime, take off the money and spend it. But the flip side is that if you save more in life insurance policies, you could end up in a situation where you will not have money to meet short to medium term needs.
Low cover defies the purpose of life insurance
Life insurance is meant to protect the family from the financial loss arising out of the untimely demise of the bread winner. The death of the income earner could derail the life goals, could push the family into debt trap and could bring down the standard of living of the family. Hari is earning a salary of Rs.30,000 per month. He saves Rs.9000 towards his goals and pays about Rs.1000 towards living expenses. He has a home loan of Rs.10 lacs outstanding for which the EMI is about Rs.11,000. His wife is not working. He has 2 kids. If he meets untimely death, how will his wife be able to make all these payments? She has to surrender the house to the bank as she will not be able to repay the EMIs. She will not be able to save for the goals like education of kids or even live in the same way they were living. If you have seen the film “Kadha Thudarumbol” then you will understand the plight of such a lady.
If Hari has required life insurance cover he could avoid such a worst situation. There is an easy method to get approximate life insurance requirement. He should calculate how much is required to put as a bank fixed deposit so that a portion will grow enough to meet the life goals, and the other portion will pay monthly interest good enough to meet living expenses of the family. Add to that his current liabilities. From that deduct the current insurance cover and value of assets. The resultant figure is the total additional life insurance requirement. While reviewing life insurance it is essential to find out the life insurance cover actually required and structures the life insurance portfolio accordingly.
I have seen many people buying life insurance policies as means to save their money. They often do not think through the purpose for which they are buying. For e.g. when a children’s education policy is bought, the buyer should check the maturity payment dates. If the maturity payments dates are not matching with the college years then the policy will not serve the purpose for which it is taken. Most often in India the majority of the amount is required at the time of college entry. But most insurance policies pay majority of the maturity benefits in the last year of college. This will also do not help to pay the goal cost at the time of requirement.
Mismatch between goal date and life insurance maturity dates
Narayanan’s daughter was 10 years old, when he bought a Marriage Endowment/ Education Annuity plan from LIC to save towards his daughter’s marriage. The policy was a good policy in terms of the return and cover it provided. The term of the policy was 20 years. Narayanan was ignorant about the importance of the term to select. The agent told him about the high bonus and also that if minimum 3 premiums are paid, then he will get benefits. Narayanan religiously paid premiums every year till his daughter reached 24 years of age. Her marriage was fixed. When he went to withdraw the investment he was told that it will mature after 6 years only and if he surrenders it then, he will get a very low benefit only. It was a shock to him. So while you review your insurance policies you should check if there is mismatch between the goal dates and policy maturity payment dates. If the policy matures before the goal date, you can manage it without many problems. You just need to reinvest the maturity benefits according to the time horizon available till the goal. If the goal is to occur after 3 years from the policy maturity date, you can invest the maturity proceeds in a balanced mutual fund or if the time horizon available is less than 3 years, you can keep it as a bank fixed deposit. But if the goal is before the maturity date then you will have a big trouble waiting for you.
Life insurance policies help to protect the family from the financial losses due to untimely death as well as help to save towards life goals. But every policy has a purpose. So you need to select the right policy for your need. You should also be aware of your total life insurance cover requirement.
Certain agents tend to give wrong information regarding the returns the policy holder can get. They often tell that the premium has to be paid for 3 years or 5 years only. What they mention is the minimum number of annual premiums to be paid to be eligible for surrender value or to keep the policy in force. In reality they are also ignorant about the returns that can be expected from a policy and also the harm in advising minimum premium payment period. When you deal with an agent or a broker make sure that he has a process to assess your life insurance requirement and suggests a suitable policy. You should make double check to make sure if you can expect the returns as suggested by the agent or broker.