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Exit options

Do not lose heart for having purchased an unsuitable life insurance policy.

It is a common refrain that life insurance policies are never bought but sold. Which means that most of these policies are bought without looking into the options available. Till recently most life insurance policies were bought for the wrong reason: as a tax-saving instrument (any regular reader of our “Portfolio Doctor” section would have noticed this phenomenon). As a result there is a huge mismatch between what these policies were bought for and what they should have been bought for.

The complications don’t stop here. Unlike other savings instruments, life insurance policies are longterm investments. It’s difficult to wriggle out of them without taking a financial body blow. But taking a body blow may be better than a slow bleed that a wrong policy may cause.

Says Aneesh Khanna, associate vice-president and head of products, Kotak Life: “Insurance policies are long term in nature. If one has made a poor choice, there is a 15-day ‘free-look’ during which the policy can be returned.” The free-look period is extended to a month by some insurers. But it is effective only if you spot the lemon quick, which most people don’t and end up keeping it.

The easiest insurance policy to end is a term plan. It can be terminated any time you like since it carries no money-back or return obligations.

For other types of policies, which majority people have, there are three exit options available: let the policy lapse, surrender it or make it paid-up (which means continuing with the policy without having to pay premiums; the flip side being you will get a lesser money and cover at maturity). These options come into play after you have missed the free-look option to get out of the insurance plan. All three have their share of pros and cons (see graphics). Says Pier-Paolo Dipaola, deputy CEO, SBI Life Insurance: “Understand the difference before exiting any participatory insurance plan as they work best only if you run them through their tenure.”

Terminating a policy before its maturity also has income tax implications. For instance, if a policy is terminated before the completion of three years you stand to lose on the tax exemption you enjoyed on the premiums paid earlier.

Therefore, it will be wise to understand what you stand to lose monetarily when you opt out of insurance. Before coming to a decision figure out the paid-up value and surrender value on your policy. These are usually mentioned in the premium statements. If you decide to convert your policy to paid-up, be sure of the cover you are left with. If you decide to surrender your policy, calculate the premiums you have paid and the surrender value to get an idea of your losses.

Lastly, re-evaluate your future life insurance requirements and choose a policy that suits your age and financial profile, so that you don’t repeat the mistakes you committed when you took the first policy.