Life insurance is a key component of a financial plan. If chosen well, it protects the financial well-being of a family in case of any unfortunate event. However, if it has been bought for the wrong reasons then the same policy can become a drain on your finances and savings.
Recently I met a prospective client who has 6 Life Insurance policies with a total Sum Assured of Rs 11 Lakhs. Most of the them are Endowment policies. The total premium paid by him is around Rs 32,000 pa. Some policies were bought with the prime reason to save taxes. Now, he is of the view that some of the policies are not worth enough to hold and want to get rid of them.
The psychological barrier of losing the money, is stopping many policyholders to exit from these kind of policies. It is better to exit from the unwanted policies instead of compounding the mistake. There are plethora of financial products available. Choose a better product(s) and achieve your financial goals.
So, how to know if you have unwanted insurance?
Low Cover: The quantum of cover depends on various factors. But one thumb rule can be, the total insurance cover should be atleast 40 times the annual premium paid. If your policies do not offer you this kind of minimum cover then you are paying too much for the cover.
High premium: Another thumb rule is, the premiums should not account for more than 5 – 8% of your annual income. I have seen clients using 40 % of their savings just to pay Life insurance premiums.
Tenure: If your policy matures before you retire then it won’t be of much help when you need it most. The insurance policy should cover the entire span of your working life.
Returns: Most of the endowment and money-back policies offer you roughly 6% returns. Typically, a 20 year traditional plan (money-back or endowment) will break even around 8th year of the policy term. If you are not content with this kind of returns then you can identify them as unwanted policies.
Time value of money: Do not blindly go by projected illustrations given by your agents or advisors. A traditional policy may look attractive today by looking at the projected maturity corpus. But, always factor inflation into the calculation. For example: You may be offered a maturity value of Rs 50 Lakhs in 20 years. At 6% inflation the today’s value of it will be reduced to Rs 15.6 Lakh.
Does it fit your financial plan? If you have a stable and rising income then money back policy is not required. At the same time, if you are not content with low returns then endowment policies are not suitable. Unit Linked Insurance Policies (ULIPs) may not be suitable for old age individuals.
What are the available options?
1) Let the policy lapse: This is best suitable if you had paid premiums for 1 or 2 years only. If the policy is a total mismatch to your requirements, it is better to let it lapse eventhough you stand to lose the paid premiums. It is like junking a bad performing stock and investing in a better one. If you discontinue the policy then you will stand to lose the tax benefits availed in the previous year(s). In case of ULIPs (issued after Sep 2010), if discontinued in first 2 years then the sum assured will be paid after the lock-in period of 5 years with minimum guaranteed return of 4%.
2) Surrender the policy: You can surrender the policy if you had paid the premium for two / three years.
You can get guaranteed surrender value which is roughly 30% of premiums paid excluding the first year premium. The life cover will cease to exist. Recently IRDA has come up with new regulations on minimum surrender values for new traditional policies. The surrender value must be atleast 30% of the total premiums paid. After the 4th year it would be 50% and it can go upto 90% of the premiums paid in the final policy years. IRDA has also put cap on surrender charges levied on ULIPs.
3) Make it a Paid-up policy: It is a better alternative to surrendering your insurance policy. You can turn a policy into a paid up one if you had paid the premiums for three years.If you just stop paying premiums then the policy will be automatically converted into REDUCED PAID UP policy.
The Life cover on endowment or money back policies will be reduced proportionately to the number of years for which the policy was in force.
For example: If you have an endowment policy with a cover of Rs 10 Lakh for 20 years and convert it into a paid up policy after 5 years then the reduced sum assured will be Rs 2.5 Lakh.
So, you will have a life cover for Rs 2.5 Lakh for the next 15 years. There is no need to pay any premiums during this tenure. The future bonuses will not be accrued. The reduced sum assured along with the accrued bonuses (if any for 5 years) will be paid on maturity or on death of the insured.
I believe that the paid-up option is the best way to exit an insurance policy. The policy holder will get rid off unwanted insurance and at the same time he/she will continue to enjoy the life insurance cover. Don’t forget to inform your dependents or nominee about the policy status.
4) If you have insurance policy which is due to mature in next 2 or 3 years then it is advisable to continue with it for full term.
Before you decide to junk your policy, check if you have sufficient life insurance coverage at a reasonable cost. It is advisable to take Term insurance with sufficient coverage. Life insurance is a risk mitigating product, do not consider it for savings or investment.
( You may visit my article on “Best Online Term insurance plans- a comparison“ for more information on Term insurance). Do you hold any bad insurance? Please share your thoughts.
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