Get to grips with disability cover

2013-05-12 10:00

Maya Fisher-French looks into why most South Africans spend more on life insurance when disability has greater financial benefits

The True South Disability Market Study, which was commissioned by income-protection specialists FMI, found that about 60% of insurance sold was life cover, compared with 30% for disability and 10% critical-illness cover.

As morbid as it seems, a household is better off financially if the earner dies than if he or she is unable to earn an income but is still incurring living and medical expenses.

Based on these costs, the study found that life cover needs to replace only about 68% of the earner’s current income compared with disability cover, which needs to be about 97% of current income.

Without adequate cover, those who become disabled may be forced to drop their living standards or could even face total financial ruin.

In the case of the earner without a family to support, life cover is largely irrelevant, while disability cover is a necessity.

What is driving our decisions?

The fact that more life cover is sold is not really surprising when one thinks about why people take out insurance in the first place. Most insurance is “forced” on people when they buy a home or take on credit.

To minimise costs, people usually select pure life cover. Perhaps if consumers actually made the conscious decision to buy insurance to cover their actual needs, this ratio would change.

The way insurance is marketed also drives behaviour towards life cover.

It usually focuses on the emotional issues of leaving enough money for your family rather than making sure you have income if you cannot work.

Financial adviser Gregg Sneddon says he finds that people generally have a pragmatic approach to disability.

According to the Association of Savings and Investments SA, out of an estimated 12.4?million income earners each year, 160?000 would die and 52?000 people became permanently disabled. Disability, therefore, represents a risk of 0.4%.

“With these statistics, most people take the chance,” says Sneddon, who believes the lack of transparency in the insurance industry is mostly to blame for underselling disability cover, where people historically have had poor claim experiences around disability payouts because of “technicalities”.

When it comes to life cover, a death is straightforward. The decision to declare someone disabled, however, is a lot more subjective.

The study also found that when people did have disability cover, they tended to have the wrong mix, with an overemphasis on permanent disability. This was in the form of a lump sum payment rather than temporary disability cover and income protection.

Statistically, you are more likely to face a temporary disability than a permanent disability. In the case of permanent disability, one can wait as long as two years before lodging a claim. This delay does put the earner at a significant financial risk while waiting for the permanent cover to pay out.

Moreover, there is a heavy skew in favour of lump sum benefits rather than a regular income benefit. The study equates this to being shipwrecked and landing on an island where there is a large container full of food on day one, which they must live off for many years, compared with preordering a regular delivery of fresh food.

The study estimates that a consumer would have to buy about 32% to 41% more lump sum cover to provide the same guaranteed level of income cover. It also found that, in many cases, disability income was cheaper than the equivalent lump sum benefit.

From a behavioural economics perspective, it can also be far riskier to suddenly have access to a very large amount of money, which is supposed to generate an income for the rest of your life. One also has to make sure that one invests it correctly in order to provide a decent income.

Any mistake in the investment choice would result in running out of money.

What is clear from the study is that most South Africans, who do have some form of long-term insurance, do not understand exactly how they are covered and when that cover would actually pay out, let alone whether or not their cover is optimal in terms of the amount of money they are spending.

It is worth spending some time analysing your cover and making sure you know exactly what your money is buying you.


Temporary disability cover

1 To provide an income from the date of disability until benefitsof the permanent disability kick in. The amount should replace the individual’s current income, less of any other benefits.

Permanent lump sum cover

2 To provide for one-off expenses that might be required.

The amount depends on the individual’s needs, such as outstanding debts or major lifestyle changes, as a result of the disability.

Permanent income cover

3 To provide an income for the individual until retirement age. The cover starts from the date that benefits that had been provided under temporary disability terminate.

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