How to buy the right life insurance policy

Life insurance policies are widely used to safeguard your family's financial future. A good life insurance policy not only supports your family's monetary requirements but can also aid in achieving long-term financial objectives such as funding higher education, children’s marriage, retirement, or even home purchase. Additionally, life insurance serves as a tool for tax savings.

Premiums paid towards life insurance policies are also eligible for tax deductions under Section 80C, while the maturity proceeds are tax-exempt under Section 10 (10d) of the Income Tax Act. This applies provided that the premium amount does not exceed 10% of the sum assured annually during the premium payment period for policies issued after April 1, 2012.

The increasing number of insurance companies has led to a wide array of complex life insurance plans in the market. This diversity can make it challenging to select the most suitable plan for your family. By answering these five questions, you can ensure you choose the right life insurance plan without any regrets:

1. Why do you want to buy a life insurance policy? 

This is the most crucial question to ask when purchasing life insurance. Although all life insurance plans offer tax benefits and life coverage, each plan is designed by insurance companies to address specific financial needs.

For instance, pure-term plans only protect your earning capacity and do not return any money if you outlive the policy term.

On the other hand, endowment plans, whole life plans, and money-back insurance plans serve the dual purpose of long-term savings and investments while providing life coverage for your family.

Moreover, you can choose a plan that aligns with your long-term financial goals, such as funding your children’s higher education or marriage. Some plans also offer pension benefits and can be used for retirement planning.

Single premium plans allow you to save a lump sum amount, often competing with long-term bank fixed deposits.

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Finally, unit-linked insurance plans (ULIPs) invest the premium in the stock market, potentially yielding higher returns over the long term compared to traditional insurance plans.

2. How much insurance premium can you afford to pay each month?

Life insurance plans are not only designed to meet specific financial goals but are also tailored to fit your savings or investment capacity. If you have a limited budget but still want to secure your family’s financial future, you should consider a pure-term insurance plan. These are straightforward insurance products that offer the highest sum assured for each rupee of premium paid. In the unfortunate event of your demise, your nominee will receive a substantial lump-sum amount.

Term plans typically last until you reach retirement age or 60 years old, and there are no benefits if you outlive the policy term. If you find pure-term plans unappealing, you might consider the return of premium term policies. As the name suggests, these plans refund all the premiums paid during the policy term if the policyholder survives the term.

The drawback is that the premium return feature comes with a slight reduction in life cover compared to a pure-term plan.

Conversely, if you can afford a higher premium, you can opt for endowment or whole-life plans that combine long-term savings, retirement planning, and life cover in a single policy. These plans can be integrated into your financial planning and serve as an alternative to investments in fixed-income instruments like bank fixed deposits or debt mutual funds.

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3. What are your long-term financial goals?

Ultimately, life insurance policies are a way to save and secure your family's financial future, so they should align with your long-term financial objectives. For example, if you are already saving and investing through mutual funds, stocks, bank FDs, and provident funds but want to ensure your earnings or salary are covered, you should opt for term plans with a sum assured of at least 10 times your current take-home pay.

However, if you are a middle-aged professional uncomfortable with the volatility of equity markets or the hassle of selecting the right bank FD, endowment plans can meet your needs.

Some examples of endowment plans are LIC’s Bima Jyoti, Jeevan Anand, and Jeevan Lakshya. You can choose a specific endowment plan with a particular tenure to save for a specific financial goal in your life. Most endowment plans also offer a single premium payment option, which can be used to make financial gifts to your children or grandchildren, providing them with recurring or lump sum income once they reach adulthood.

4. What is your investment horizon?

Life insurance products other than term plans are long-term savings and investment vehicles, but their policy terms are not open-ended. All savings-cum-insurance plans have a lock-in period during which the maturity benefits are paid only after you have paid the premiums for a certain number of years. This period can range from just two years to 30 years, depending on the plan and policy tenure you select. Generally, the best returns are offered by plans with the longest lock-in periods.

Therefore, consider buying endowment, whole life, or money-back plans only if you can wait 15 years or more for the maturity benefits.

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The longest-running plans are whole-life plans like LIC Jeevan Umang, which pays out benefits until the policyholder turns 100 years old. These whole life plans can also be used to leave a significant lump sum for the next generation. Those with a shorter investment horizon can opt for endowment or money-back plans such as LIC Dhan Rekha.

5. What is the claim settlement ratio of the insurance company?

Once you have decided on the type of insurance policy to purchase for your family, the claim settlement ratio should be a key factor in selecting the insurance company. The claim settlement ratio is the percentage of claims settled or approved by the insurer compared to the total number of claims filed by policyholders in a given year.

A higher claim settlement ratio tells you that the insurance company is more efficient and reliable in settling claims.

The Insurance Regulatory and Development Authority (IRDA) regularly publishes data on the claim settlement ratios of various insurance companies. Use this information to select the most dependable insurance company for your family. All else being equal, you should opt for a product from an insurance company with a higher claim settlement ratio.

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

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