A Primer on Life Insurance: What you need and why

by Sinenhlanhla Nzama - Investec Life Head of Product Actuary

A primer of life insurance: what you need and whyEverything is okay until it isn't. When we're in good health with a stable income and a fulfilling professional career, it's tempting to think that nothing could possibly go wrong. But if Covid-19 has taught us anything, it's that a lot can go wrong quickly. We simply can't predict when a life-changing event like cancer, disability, let alone a disease we haven't seen yet like Covid-19, will affect our ability to earn an income and provide for our dependents.

Perhaps most visible in the affluent and high net worth market, having the right life insurance in place can protect your wealth from creditors and estate duties, preserve your lifestyle when faced with a severe illness or disability, and give you access to critical care when you need it most.

The ability to keep servicing your debts and meeting your responsibilities without having to downscale your standard of living is an essential part of planning for the future.

Our research consistently shows that one person is rarely just one person. Which is to say, a major illness doesn't only affect the person who has it but changes the dynamics of financial support in the family. Even among younger professionals who haven't yet started an immediate family, 40% still financially support their parents or siblings. As their life stages change and they start their immediate families, they may become double or triple providers, supporting parents, siblings and their own children.

Rather than being a single product, life insurance is a combination of benefits – it's not only about the death benefits that pay out when you die, but also about the living benefits that support you through illness or disability. There's some overlap, but each product pays out when specific events or conditions happen in your life. You also don't need to take out every product all at once, or even at all. Among the basket of insurance costs, actual life cover alone is often the most affordable.

Life cover: Protects those you leave behind

Life cover is the simplest product to understand. It pays out to your nominated beneficiary when you die, usually a family member. This helps your family settle debts, replace the income they've lost, pay estate duty costs and capital gains tax, and settle executor fees. Most financial planners suggest life cover of between 12 and 20 times your annual salary, but this depends on your life stage and how many people rely on you for financial support.

Severe illness cover: Helps you manage a life-changing diagnosis

Severe illness cover is a living benefit that pays out a lump sum when you're diagnosed with a condition like cancer, stroke or a heart attack. It's easy to dismiss this kind of cover because many assume their medical aid will cover all their expenses. But most medical aids have carefully defined sub-limits, after which you're required to co-pay.

Depending on the plan you're on, you may also need to self-fund certain types of advanced or progressive treatments that aren't part of a prescribed minimum benefit. You may also need time off work to recover; just because you're out of the office doesn't mean your expenses stop. Severe illness cover gives you the capital boost you need to cover these situations. You're usually paid out a percentage of your cover value based on the severity of your condition.

Disability cover: A lump sum payment for additional support

If you're ill or have an injury that results in you being deemed permanently disabled, disability cover gives you a lump sum pay out to help you adjust to a new way of living. You can use it to settle your debts or make adjustments to your home so you can get around more easily. Disabilities related to all major anatomical systems are covered and, like severe illness cover, the pay-out is generally based on the severity of the disability.

Income protection: Paying you an income when you're unable to earn

Arguably the most critical living benefit is income protection. If you're off work or can't perform your occupational duties because of a temporary or permanent illness or injury, income protection will pay up to 100% of your net of tax income. It will effectively pay you a salary until you turn 65 (or 70, if you choose), replacing a potential lifetime's worth of earnings. Income protection kicks in after a waiting period, usually one month or three months.

Choose your insurer carefully

The way life insurance is structured varies greatly between insurers, so it's important to understand what you're buying. In an effort to reduce your upfront premiums, many insurers may require longer waiting periods until you can claim or offer reduced benefits in the small print.

They may also combine your life insurance and your living benefits into a single “accelerated” benefit, which means your life cover is reduced when you claim for a severe illness or disability. If your life cover is R2 million, for example, and you claim R1.5 million from your severe illness cover for a cancer diagnosis, the remaining death benefit to your family is just R500 000.

Other insurers may promise paybacks and cash incentives the longer you keep your policy active. Essentially, these are structured so that part of your premium is pre-funding part of these cash incentives. This has upsides and downsides.

On the upside, you're being forced to indirectly save each month, with a cashback portion paid to you at certain intervals. On the downside, your premiums may be higher than they need to be. And if you cancel your policy because you can't afford the premiums, you could lose both your life insurance and the cash accumulated to date

Particularly for the high net worth individual, proper financial planning is essential. If policies are not structured optimally, you or those you leave behind may face unexpected tax liabilities or complications when claiming.

For example, many high net worth clients may use debt financing to acquire assets that are highly valuable but not very liquid. This can mean cash shortfalls soon after death to cover estate costs and settle debts, which can destroy wealth if assets (particularly property and offshore investments) need to be sold in a rush.

Arguably the best kind of life insurance is efficient, relevant and flexible enough to adjust to your life stage, health outcomes and way of working. Some people are entrepreneurs who need cover that accounts for an earning cycle that may be sporadic or concentrated into particular times of the year. Some people run their own practices or consultancy firms that must keep running if they're off sick and can't come into the office for a few months.

Instead of a taking a policy that bases your cover and premium on the data set of a generic population group, look for cover that's more personalised. You want insurance that looks at you as an individual and covers you appropriately without over- or under-insuring you. This will keep your premiums sustainable while still offering you generous protection to safeguard your health, wealth and legacy.

This article was published on the Investec Website on 17 June 2020.

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