Once upon a time, life assurance cover against life’s untimely risks was quite simple. You selected an amount of cover, probably increasing with inflation, and you paid a guaranteed premium for about 20 years, if not for life.
The main reason you chose the policy of one company over another was effectively a result of which assurance sales person knocked on your door first.
But in recent years, risk life assurance has got a lot more competitive and, because risk life assurance is often a grudge buy, life assurance companies have to provide prospective policyholders with a number of different premium patterns from which to choose.
Paul Zondagh of True South Actuaries and Consultants says most life assurance companies offer premium structures that vary between having cheap initial premiums but which then have sharp increases into the future and having higher initial premiums with lower increases in the future. It means you now must not only make a choice between different providers, you also need to select a pattern of premium increases that will best match your needs and circumstances, current and future.
He says that generally, while your assured amount will increase annually in line with inflation, for example, the level of your premium increases can vary considerably.
“As a general rule, the lower the initial premium available from a provider, the higher the annual increases will be in the future.”
This puts the onus on you to choose carefully.
Zondagh says that while increased choice is generally beneficial for you, there is a risk that you may be tempted to select the cheapest initial premium for your desired risk assurance cover level, without having proper regard for the future premium increases required under a particular policy.
“The wrong choice might be very costly if you simply pick the lowest initial premium,” he says.
The True South research shows that, depending on your age, your premiums can escalate very rapidly to levels of unaffordability.
For example, in an extreme example from Life Company B, for a 25-year-old woman the additional cost of the cheapest initial premium as opposed to a higher initial premium will see the policyholder paying an additional 74 percent in today’s rand values over the lifetime of the policy.
Zondagh says that in most instances a small initial premium saving becomes significantly more expensive when viewed over the lifetime of a policy. The extent varies by provider. For example, with Company B, which has very aggressive premium increase patterns, the extra cost of premiums varies between 11 and 74 percent, compared with Company D, with less aggressive premium increase patterns, where the premium increase cost varies between six and 36 percent, depending on the age of the policyholder.
Zondagh says there is a general tendency for the lifetime costs of the various premium patterns to converge at higher entry ages. He says the research shows that unless you have a relatively short time horizon – for example, if the cover is required only for a specific purpose for a specific number of years – the initial saving by picking a lower starting premium, with more aggressive future increases, may be an unsound financial decision.
How the research was conducted
In undertaking its research on the consequences of low initial life assurance premiums, True South Actuaries and Consultants obtained 126 quotes, using different premium patterns, from four of the major providers of risk assurance cover under the Long-Term Insurance Act.
The quotes provided for cover on the whole of life (until the policyholder dies), lump-sum disability cover (up to age 65) and income continuation cover (up to age 65) for a number of hypothetical insured lives, split between male and female, with entry ages of 25, 30, 35, 40, 50 and 60.
They focused primarily on how the different premium pattern options available from a provider compare with each other (for each hypothetical assured life).
Quotes were requested from the four life assurance companies, categorised as Companies A, B, C and D, with each company’s premiums quoted in the research report.
The information was used to provide comparable information:
* Of the premium progression (increase) of each company’s structure choices over the first 20 years of the policy for entry ages 25, 30, 35 and 40.
* To show the future crossover points between low and high initial premium options where the low initial premium option becomes more expensive than the high initial premium option in today’s rand values.
* To show the percentage of your income that will be absorbed by future premium increases.
True South used a range of assumptions applied across all quotes in analysing the figures, taking account of things such as inflation, particularly income inflation.
You need a qualified adviser to guide you
The variations in premium options and their complexity are significant reasons why you should get sound financial advice before taking out a risk life assurance policy.
The results of the True South research into premium structures offered by life assurance companies emphasise the value of proper financial advice to get the correct amount of life assurance at the right price.
The complexity of risk life assurance also raises warning signals if you are buying assurance from a company that sells directly to the public. These companies tend to have the cheapest initial premiums and sometimes have unacceptable exclusions – conditions that will limit the payment of benefits when they are needed.
Getting sound advice will ensure that you make a fully informed decision that also achieves a balance between current and future affordability of premiums.
When buying risk life assurance, your adviser should:
* Assess your full financial situation by doing a financial needs analysis. This will tell you what financial shortfalls your dependants would have if you were to die or no longer able to earn a living and how to prioritise your various needs. (In the third part of this series, Personal Finance will explain the risks you and your dependants face and what types of assurance you need to cover the different risks.)
* Having assessed how much life assurance you need, and what for, your adviser should then help you to calculate whether you can afford the premiums for the necessary cover, taking account of all your financial needs. For example, by paying off faster a debt such as your home loan, you will be building an asset, meaning you will require less life assurance. In a way, by doing this you will be assuring yourself.
* Assess various quotations from a single life assurance company if the adviser is an agent of a particular assurance company, or from a number of companies if the adviser is independent. The quotes and assessments should include:
- The starting premiums of the various options and their estimated escalation over time;
- The total amount in present rand values that you will spend on each option over the lifetime of the policy; and
- The impact on your earnings. If your income is increasing at an average of one to two percent above inflation every year while your assurance premiums are increasing at a faster rate, you could eventually be unable to afford the premium. However, further down the line you may not need the cover or as much cover – but you may need more.
* Assess the structure of the product. You need to know things such as:
- The flexibility of the product. For example, can you alter the assured amounts and premiums, either up or down, as your assurance needs change? And if so, what conditions and costs apply? You must also know whether you will need to have a health check-up if you increase the total cover and what effect this could have on your premiums and your assurability.
- Exclusions. You need to know and understand under what conditions a risk policy will pay out. There may be an exclusion, meaning you will not be covered if you have certain health conditions or even for certain hobbies if they are high risk.
- Conditions. You may need to inform the life company of a change of job and/or type of job or even change of employer, failing which no benefit will be paid because of a change in your risk profile. You will also probably have to inform the assurance company if you start smoking, as this will impact on your policy, as will stopping smoking.
- Premium guarantees. Some policies have a guarantee that the premium will remain level for a certain period and only after that period will |it escalate. However, often you may be told that a premium is “level” whereas it will still increase at the inflation rate, or more likely at a rate above inflation if the assured benefit is keeping in line with inflation. The reason the premium goes up quicker than the inflation-linked benefit is that you are getting older and becoming a greater risk.
Health warnings
1. No two people have the same assurance needs, and each needs to be properly assessed.
2. Never attempt, by sins of commission or omission, to mislead a life assurance company so that you can get a lower premium. This could include keeping silent on a risky hobby or a slight heart attack you had 10 years ago. A life assurance company is entitled to assess your risk to it and to set your premiums and any exclusions based on that assessment. If the company finds out something about you and you have misled it, it is entitled to repudiate any claim, meaning your dependants could be left destitute.