Common mistakes when buying insurance

22 June 2006

Insurance is a form of risk management primarily used to hedge against the risk of a potential financial loss. It is defined as the equitable transfer of the risk of a potential loss, from one entity to another, in exchange for a premium and the duty of care. In India it is also one of the least understood financial instruments, commonly bought or sold for all the wrong reasons.

Though the insurance sector was opened to private players and placed under a regulator a few years back, it is unfortunate that increased competition has not dispelled the misconceptions. In fact, they may even have increased, as large numbers of wrong policies continue to be sold, something that can cause serious financial damage to policy buyers.

Let us look at some common myths and point out the most frequent mistakes people make when buying insurance.

Is insurance an investment?
Most of us feel satisfied paying our insurance premiums. We feel we are doing a great job saving for the long term while getting a deduction on income tax at the same time.

But have you ever worked out how much return you are actually getting from this so-called 'investment'? If you do, you will quickly realise that the returns from an insurance policy are pathetic except certain policies like ULIPs, where one takes an equity risk. The problem with the latter is that on the one hand, the insurance component is often so small that one is getting very little coverage. On the other, if the stock market goes down like it did recently, one could end up losing on all fronts.