Taking the Grudge out of ‘Life’ Insurance

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Knowledge is power

The Life Insurance industry has tried very hard to shake off the stigma of the past. The products have improved, costs come down and the advice jacked up (thanks in part to much stricter regulation). It has also become highly competitive and diversified, making it almost impossible for the man in the street to make an informed choice, relying on a Trust Advisor to help them with that. The new regulations, the ‘Retail Distribution Review’ (RDR), is going to protect consumers even more, but it is also going to force lower income consumers to do it themselves via Call Centres or direct sellers, as Brokers, Advisors and Planners decline to do ‘small’ policies because the remuneration just doesn’t even cover the costs.

There is another issue, money is tight and everyone is shouting “Pick Me” trying to get their hands on your disposable income, insurance salesmen and investment specialists among them. Cutting through the bull that you’re bombarded with in SMSs, Social media ads and TV commercials that lure you in with statements like “all your premiums back if you don’t claim”, “cut out the middle man and save” or “get R1m life cover for R1 a day”. (All the claims are fundamentally flawed if you read the small print – but that’s another story). Life cover is one of the ultimate grudge purchases, but most of us do it because it is the responsible, grown up thing to do, and we just keep on doing it. This is an important decision, if you make the wrong choice you may not be able to change it if you’ve had any event ( even a relatively minor car accident) that will impact your insurability. Is it money well spent – and should it be for life?

Over the decades ‘life’ cover expanded to include disability cover – first as a lump sum then later for a temporary disability income. Dread disease cover is also a ‘newcomer’ and is still evolving. When you add all the bells and whistles, especially for the more expensive temporary disability and dread disease benefits the premiums can really add up – so how do you cut through all the sales talk and find out what you actually need? There are so many different variations of ‘life’ cover, even within a single provider – it makes sense arm yourself with some basic knowledge and questions so you don’t end up paying a fortune for something you can’t use or becomes completely unaffordable in your later life – when you have a far greater chance of needing it. It will be much better for you to put ‘spare’ disposable income into investment and not “risk mitigation” (and that includes medical aid).

One of the biggest obstacles is seeing through the ‘Pick Me’ vested interests of all the different players out there. It always boils down to money/fees or commission. Once you understand who gets paid for what, you might be able to ask more meaningful questions and get the right cover at the right price.

‘Life’ cover is paid out as commission over 2 years (2/3 then 1/3) as a percentage of the premium multiplied by the ‘term’ of the policy, with a smaller amount paid every year as your policy increases. Commission on investments on a Life platform (the big life insurance providers) are paid in a similar fashion. On “LISP” Platforms (Linked Investment Service provider like Investec, Glacier, Allan Gray) fees rather than commission is paid, and it is usually as a percentage of the ‘assets under management’ on a monthly basis. Accumulating ‘fees’ slowly every month rather than earning the upfront commission for the entire term of the policy takes much longer – years. Brokers who are used to upfront commissions often find it very difficult to change how they are remunerated without it severely impacting their cash flow. To add insult to injury, if your broker chooses to place you on an insurance platform for your investment, and you change your mind, stop it or even reduce your contribution, you’re going to be slammed with ‘early termination penalties’. Sure, it might be a good thing that these remuneration models are changing, but there is going to be fallout. The average age of advisors and brokers in the life industry is already over 50. A young graduate with, say, a BComm can immediately enter the job market on a salary of R25-R30k per month. As an advisor, it will take him or her several years to sustain that income, and if he takes ‘as-and-when’ commission only every month it will take a decade. The amount of compliance required for a R300 premium is the same as a R3,000 premium so those clients are going to be pushed into the order-taking “Low or no advice” arena, (not my term this is what the FSB calls it), of call centers and direct sellers.

The ‘term’ of a policy is an often overlooked variation on your life cover and not all providers have the capability in their offering, and because it impacts on a broker’s commission, they might not consider it for you. Life cover does not need to be for life.You just need it in case you die prematurely – before your children are off your hands, debt paid or until your retirement pot is ‘full’ – so why take it out for the whole of your life (they assume you’re going to live until you’re 110 and it is costed accordingly.) If you just need it for a bond, which is going to decrease every year, why have it for life on an appreciating capital amount, or even fixed amount? Taking out the cover for just the term of your bond (say 10 or 20 years), with a gradually deducing balance (matching your declining bond) is going to reduce your premium (but also reduce the commission to the broker…)

The “annual increase” is another thorny issue that you should wrap your head around. You might assume that if your benefit increases at inflation every year, then so does your premium – but if you look at your policy carefully… probably not. This is the ‘premium pattern’, and believe me not all patterns are pretty. A premium pattern that increases each year at the same rate as your benefit is called ‘level’ (horizontal). Be careful though… not all ‘level’ premiums are truly level/flat, most have a ‘little’ bend in them because their actuaries add a little age-risk every year. Over 20 years, if you want your benefit – say dread disease cover – to increase at inflation, after 20 years the benefit will be, say, 152% more (data from a real case study). In a true level product, the premium would also increase 152%. The ‘slightly bent’ level covers will increase the premium at 256% – not a train smash unless you’re on a fixed income like a pension. In order to get a leg up on the competition, the ‘age rated’ premium pattern was born. Basically, the premium starts lower than a level premium and increases by several percentage points – over and above the increase you want (say, inflation) over the term of the product. After about 7 years the premiums are about the same, but thereafter the curve bends upward exponentially – essentially compounding those increases. Not just slightly bent, really bent to almost become vertical in time. In the same case study I used above, after 20 years the premiums are between 1000% and 2000% higher. Try that on a fixed income!

Don’t over-insure disability. It is important that your financial advisor takes your Group Life cover into consideration before recommending temporary or permanent disability cover. If you have both and it goes over 100% of your income, they could well ‘repudiate’ (chuck out) some or all of your claim. That could be decades of wasted premiums you’re never going to see again. Unfortunately Group (company) Cover is seldom ideal, some of the small print on the claims criteria is often appalling. Temporary disability usually has a 3 month waiting period in company policies – it assumes that you have all your annual and sick leave. That is seldom the case and the company may put the employee on ‘unpaid leave’ until the benefit kicks in. This disability is at 75% of the salary for two reasons – they don’t want to ‘encourage’ people to pull a sickie instead of working, and the assumption that there are 25% less expenses when you’re not working. What? Doesn’t make sense to me. Temporary disability, the ability to have an income when you can’t work is probably the most important risk cover out there. If you’re in a car crash and die, it’s very sad and hopefully life cover will pay, but what if that same accident leaves you unable to work and still a liability to your family? You insure your car – why not the driver? Disability cover ends at retirement.

Dread disease cover is the only benefit that really has to be ‘for life’ – the older you get the greater the chance you’re going to need it. In order to be sustainable, the premium pattern really should only be level (preferably “true” level not “bendy” level). If you get suckered in by the lower premium in an ‘age-rated’ premium, you’d better hope your health holds out in 10 years’ time when you try and replace it with a level premium. If your preferred provider can’t offer you what you want – get the ‘best of both’ by putting your dread disease cover with someone who does. All providers are not created equal, and not all the plans with even the best providers are the same. Rather take out less cover with a premium product that pays out 100% immediately (not a smaller percent depending on how severe they reckon it is), reinstates for other ‘events’ and is ‘stand-alone’ (doesn’t reduce your life cover). It might be difficult to determine what you have from the quote, so ask your broker or advisor the question directly.

Action:  Make sure your family/friends can find out what cover you have quickly by getting organized. You are welcome to contact me for me for the (free) Red File Template to get you going. With dread disease claims, time is often the key to getting paid out quickly (or at all). Review your cover annually, often benefits are upgraded and you might not be informed. When you change jobs, speak to your advisor about the need for a ‘continuation option’ on your Group cover. Always fully disclose your medical conditions but don’t have a pity party – those self-diagnosed ailments you moan about to your friends.

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Author Dawn Ridler ©

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