Long-term insurance: Mind the gap

2013-12-08 14:00

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It’s key to always assess your long-term insurance requirements, writes Neesa Moodley-Isaacs

A recent survey by the life assurance industry revealed a startling gap of R24?trillion between the amount of life and disability cover that people have taken in South Africa and what they actually need.

However, before you panic, you need to make a careful assessment of your long-term insurance requirements.

Financial coach Gregg Sneddon says the bottom line is that you need to consider your life assurance requirements versus your financial budget.

“I tell my clients that they need to consider to what extent they might be able to count on family or extended family for support in a time of crisis.”

Sneddon points out that insurance is a grudge purchase and most people want to spend as little as possible on it.

“You want to insure against risks that you can’t afford to or don’t want to take, so it is important to identify what those risks are and to also note that those risks will change over time,” he cautions.

For example, if you are single with no dependants, you only require disability cover and no life insurance. But later in life, when you marry and have children that are dependent on you, your life assurance requirements will become significant.

The third insurance-gap study was commissioned by industry body the Association for Savings and Investment SA (Asisa) and was carried out by True South Actuaries & Consultants and the Unisa Bureau of Market Research.

According to the study, the national life assurance shortfall now stands at R9.3 trillion, while the disability cover shortfall is R14.7 trillion. This translates to an average life-cover shortfall of R700 000 and a disability-cover shortfall of R1.1 million per average income earner.

Schalk Malan, executive director at BrightRock, lists the following reasons for the gap in life assurance cover:

»?People are simply unaware of their insurance needs. Instead of looking at a lump sum amount as a large sum of money, you need to look at how that figure will translate into a monthly income for your dependants and how long it will last, taking into account inflation.

»?Affordability concerns. You may be aware of the need for more insurance cover, but simply unable to afford it.

»?Sustainability concerns. You might avoid taking out insurance entirely on the premise that you might not be able to afford it in the future.

»?Inefficient product design. Insurance products need to be designed so that you get more cover for lower premiums.

Peter Dempsey, the deputy chief executive of Asisa, says the majority of families will be forced to drastically cut their living expenses if an earner of the household dies or becomes disabled.

He further points out that it may come as a shock to South Africans that the group most critically underinsured is the one with people who earn more than R150 000 a year.

According to the study, the average insurance shortfall for this group means that if an earner dies, a household earning more than R150 000 a year would need to source an additional R10 000 a month or R20 000 a month if an earner is disabled.

While earners in the lowest income bracket, with an average gross annual income of R9 000, are likely to have a disability-cover shortfall, the government disability grant is effective at replacing lost income in this category.

“The only group likely to have sufficient life and disability cover is the one with high-income earners older than 50. This is because this group has generally benefited from group life and disability cover through years of membership of an employer’s pension fund,” Sneddon says.

He says that while he agrees South Africans are underinsured, he feels that those who are insured are more likely to be overinsured than not.

“The downside is that, for example, if you are overinsured for disability cover, the extra premiums that you paid are forfeited at claims stage. Often I find that clients have cover both through their employer and independent cover that they have taken out, outside of the work environment,” he says.

Malan suggests a possible solution to increase the uptake of life assurance is a drastic change to the traditional life assurance model. For example, BrightRock offers term life cover as opposed to whole-of-life cover.

This means that instead of buying a life assurance policy at the age of 25 that will provide you with cover for the rest of your life, you could buy a 20-year life assurance policy. That policy is also not a simple lump sum, but has various allocations for your different financial needs.

For example, you could buy a 20-year R1 million life policy at the age of 25, which includes a R400 000 allocation to cover your home loan in the event of your death.

However, at the age of 45, your home loan will be paid off and you can then change the allocation within your policy for a different need, or reduce your life cover and channel the savings towards a retirement annuity.

“As an example, the initial premium on a traditional whole-of-life cover of R1 million would be R211 a month. But the initial premium on a 20-year cover of R1 million would be R153. That’s an initial saving of 39%,” Malan points out.

How much is enough?

When you sit down to calculate how much life assurance and disability cover you actually need, Sneddon advises that you consider the following:

» Life assurance

•?What is the financial risk at death? If you are the sole breadwinner and have a spouse with two kids, as well as some debt, you would probably want your spouse to be able to settle the debt and then be able to replace your income for the next “n” years while the kids are still at home. It is reasonable to expect to generate 5% on capital for at least 30 years, so you either increase the amount of cover to match your needs, or reduce the term and consider the consequences (you could draw 10% for 11 to 12 years before the capital is depleted).

•?Balance the need or desire for cover with your ability to afford it. There is no point to taking out life assurance worth R10 million if you can’t afford it. You need to be pragmatic. Some cover is better than nothing.

•?When reassessing and changing your life assurance, make sure that you update your will at the same time.

» Disability cover

•?Consider the financial risk at the event – both for the immediate short term and for the rest of your life. In terms of disability cover, income-replacement cover is probably the most reliable form of insurance.

•?Remember too that you can only replace 75% of your income. This is international best practice, although some companies seem to have increased

their limits.

•?Take the cover that you can afford/need. If you are a salaried employee, you don’t need a seven-day waiting period on your income-replacement cover. As a rule, the longer the waiting period you take, the cheaper the premium.

•?Remember to watch out for overinsurance. You can buy as much as you like, but come the claim stage, the insurers will aggregate your income (from all sources) and only pay the shortfall.

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