How to avoid falling prey to life insurance mis-selling traps

It's the tax-saving season and for many individuals, it is a race against time to make smart investments before March 31 to claims deductions of up to Rs 1.5 lakh under section 80C.

Like tax-payers, it's also that time of year when bank relationship managers are in a hurry to meet their sales targets for third-party products, such as insurance policies and mutual funds. The January-March period is a crucial quarter for insurance companies, mutual funds, and their distributors.

Few basic checks can prevent mis-selling

At your end, you need to be cautious while making your tax-saver investment despite the rush to meet the March 31 deadline. For starters, ensure that you are not buying a unit-linked insurance policy (Ulip) when you want to invest in a mutual fund instead. With the plethora of advertisements from life insurance companies around the launch of small- and mid-cap funds to be attached to their Ulips, it is easy to get confused.

However, it's fairly simple to ascertain whether the product is a mutual fund or a Ulip. At the time of investing, you need to check the name of the entity in whose favour you are writing the cheque or authorising the auto-debit. If you are looking to invest in mutual funds, ensure that the name of entity is not suffixed with 'life insurance company' but 'mutual fund' or 'asset management company'.

This apart, Ulips come with a lock-in period of five years, while this is not the case with mutual funds. Equity-linked saving schemes (ELSS mutual funds) carry a lock-in period of three years. Finally, in case you realise that you have been mis-sold a product only later, you can always 'return' your policy and claim a premium refund within 15-30 days of receiving the policy documents.

It is not rare to hear of incidents of mis-selling, where unsuspecting individuals have been sold policies that they never needed. Here's a look at some of the most commonly-used sales pitches that you should avoid falling prey to.

'An endowment plan is like an FD with additional benefits'

The promise of a guaranteed income is a time-tested pitch that ensnares many an unsuspecting buyer. Insurance is no different.

The returns under guaranteed traditional policies range between 4 and 6 percent, and you have a better chance of earning higher returns if you were to invest in other debt instruments. In fact, insurance is not at all about income or return, but protection.

Financial planners recommend buying a large pure risk term cover to secure your dependents' financial future and investing through mutual funds for achieving various goals. Senior citizens should avoid guaranteed endowment plans altogether and even term plans for that matter, as they are unlikely to be drawing an income or supporting a family at that stage in their lives.

'This product offers unbeatable combination of life cover, tax benefits, and investments’

The oldest and most common sales pitch, particularly during the tax-saving months of January, February, and March, continues to appeal to a large section of Indians.

In a hurry to save on taxes under section 80C, which offers tax deductions of up to Rs 1.5 lakh on certain instruments including life insurance premiums, many end up buying policies they do not necessarily need. Many tax-payers go ahead and make tax-saver investments without first ascertaining whether existing tax breaks - on employees' provident fund (EPF) contribution, home loan principal repaid, children's school tuition fee etc - are adequate.

The solution to this recurring blunders? Do not treat tax planning as a separate exercise. It should be embedded into your overall financial planning process and not treated as an isolated activity.

Evaluate your existing investments and expenses in April – chances are that your EPF contribution and children’s tuition fees, both eligible for deduction under section 80C, will consume a large chunk or can even exhaust the entire Rs 1.5 lakh limit.

‘Stock market investments are risky, buy a guaranteed policy instead’

This is the most favoured insurance product category in the last two years due to high interest rates in the system. Many individuals find non-linked, non-participating, guaranteed endowment policies attractive due to the assured maturity proceeds that they offer.

This is in contrast with Ulips, where returns are market-linked along with participating policies. Although the latter, too, offer secure returns, they do not offer a fixed maturity amount as the final corpus depends on annual and terminal bonuses declared during the tenure.

However, guaranteed policies offer lower returns of around 5-7 percent.

Only high networth individuals (HNI) who do not have liquidity concerns and are looking for assured-return instruments that offer tax benefits could find value in these products. Maturity proceeds under life insurance policies are tax-free (provided Ulip annual premiums do not exceed Rs 2.5 lakh and endowment annual premiums do not cross the Rs 5 lakh per annum limit).

As an individual, you can avoid falling into these traps by reading the documents you are signing carefully. This will help you ascertain whether you are indeed investing in a fixed deposit, mutual fund, or are being surreptitiously sold a life insurance policy with a multi-year premium payment commitment instead.

More importantly, never ignore verification calls from insurance companies post policy issuance. Irrespective of what your bank official or agent might have told you, answer the questions to the best of your knowledge to nip the mis-selling nuisance in the bud.