This article was first published in the third quarter 2016 edition of Personal Finance magazine.
There is no thrill quite like looking at a big bank balance after your first salary payment. It signals the start of independence, financial freedom and spending power. The hope is that it will continue for many, many years.
When we start earning, we start accumulating: possessions, debts, wealth and dependants. This brings a responsibility. What happens if we are unable to earn in future? How will we provide? Long-term insurance steps in to fill this gap. Life assurance, disability assurance, dread-disease cover and income protection can all play a vital role in ensuring that we can afford to live and provide if we are unable to earn.
Assurance is not top of mind when the first salary arrives. Ryan Chegwidden, the technical head at Hollard Life, says that family is the biggest driver of life-cover purchases. Marriage or the birth of a child acts as a trigger to protect dependants should something happen to a breadwinner.
Despite this, statistics from the leading assurers show that there is a fairly good uptake of assurance policies among young adults.
Petrie Marx, a product development actuary at Sanlam Personal Finance, says about 20 percent of Sanlam’s life assurance business comes from people under the age of 30. Hollard Life sells 15 percent of new policies to clients under the age of 30 and Liberty just under 25 percent. Over the past three years, a third of Old Mutual policies were taken out by clients in their 30s, and more than 20 percent of new policyholders were in their 20s. At PPS, 10 percent of policyholders are under the age of 30.
But do we need assurance when we are young, healthy and at the beginning of our working lives? The short answer is yes, because there is at least one asset worth protecting.
Protect your earning potential
The biggest risk for a young person with no dependants is to be underinsured if you become disabled or severely ill and can no longer earn an income, Jaco Gouws, the manager of risk protection at Old Mutual, says. With 40-plus years of future salaries still to come, your greatest asset when you are in your 20s is your earning potential.
Even without annual increases, 40 years’ worth of salaries for a professional person should add up to well over R10 million. Unless you have saved this amount, you need to find a way to protect yourself against the risk that you lose the ability to earn that kind of money.
There are, unfortunately, many things that can go wrong, resulting in a loss of earning ability. You might have a car accident or suffer a debilitating illness. The consequences of these tragic events include death, permanent disability, temporary disability and extended time off work.
Statistics show the risk is real
No one, no matter how young and healthy, is exempt from health issues, Hesta van der Westhuizen, an advisory partner at Citadel Wealth Management, says. Old Mutual’s youngest death claimant in 2014 was a 19-year-old and the youngest disability claimant was a 22-year-old, Van der Westhuizen says.
Gareth Friedlander, the head of research and development at Discovery Life, says Discovery Life’s 2015 claims figures indicate that almost one in 10 people who claim for a severe illness is younger than 30 years of age.
Claims in the younger age group are mainly the result of unnatural causes, such as retrenchment and motor vehicle accidents, which can affect you no matter how healthy you think you are, Henk Meintjes, the head of risk product innovation at Liberty, says.
Juret Ferreira, the actuarial analyst for product development and pricing at PPS, confirms that most claims at young ages are accident-related or the result of crime.
Road accidents affect all road users: drivers, passengers, pedestrians and cyclists. Road users are at highest risk when they are in their 20s. This age group accounted for 28.5 percent of all passenger deaths in 2015 compared with 13.2 percent for those in their 40s. Accidents on the roads claimed the lives of more men in 2015 – 74 percent of all victims – than women.
If we consider that you can claim for death, severe illness or capital disability (life-changing events), Friedlander notes the following:
* Two in 100 people who are 25 years old today will experience a life-changing event before they reach 35;
* Six in 100 25-year-olds will experience a life-changing event before age 45; and
* Sixteen in 100 25-year-olds will experience a life-changing event before age 55.
These figures are for a high-earning, non-smoking man with a degree.
The risk might not be excessive, but it exists, and the problem, as Friedlander points out, is that no one knows in advance whether they will be one of the unlucky. This is the point of assurance.
Can you rely on your medical scheme or the Road Accident Fund (RAF) to pay your expenses and compensate you for loss of income?
A medical scheme should cover at least part of the expenses you incur if you become ill or have an accident, but it may not cover everything. A hospital plan is very unlikely to cover the full cost of treatment. Van der Westhuizen shares an example: a young student was diagnosed with testicular cancer, and even with a fully comprehensive medical scheme option, there was a shortfall of over R100 000. A further cost was incurred when the student missed too much of the academic year and had to repeat the year, which cost another R100 000.
In the event of a motor vehicle accident, a claim may be instituted against the RAF. Claims are limited for earnings loss to about R240 000, and only emergency medical expenses are allowed; additional medical expenses are limited. The average claim paid by the RAF for the year to the end of March 31, 2015 was R114 969.
Additional costs may be incurred for further treatment, such as rehabilitation and physical therapies, and to adapt your home. These expenses can run into hundreds of thousands of rands.
A basic motorised wheelchair will cost R30 000, while a more comfortable model will cost R80 000 to R90 000. Chairs should be replaced every three to five years. A sports wheelchair will cost upwards of R60 000. A basic adaptation of an automatic motor vehicle will cost about R11 000, and the figure for a manual vehicle is at least R60 000.
Covering the costs
You could, theoretically, cover the costs of an accident, illness or disability from your own savings. But savings take time to build up and a young person may not yet have accumulated enough. Assurance is usually the solution, Van der Westhuizen says.
How much and what kind of assurance you take out depends on your circumstances and needs. Ask yourself who is dependent on your income and, if something should happen, who would you be dependent on and could they afford to take care of you?
To protect your income, you need a form of disability assurance, and your medical expenses should be covered by a medical scheme. A serious illness such as cancer can result in medical expenses that may not be covered by a medical scheme and these can be covered by a dread-disease policy. Keep in mind that the impact of a severe disability or impairment that prevents you from earning an income is greatest at a younger age, because you are further away from retirement at the age of 65 or 70, Meintjes says.
The need for young adults to have life cover may not be so clear cut, particularly if they do not have dependants. Independent financial planner Evelyn Doubell says if you have no dependants to support, the question to ask is whether you have debts to pay off.
Don’t burden your beneficiaries
Doubell says you should consider whether anyone has stood surety for your debts and how that person could be affected if your estate was unable to pay them. Two common forms of debt among young professionals are car and student loans. A car could be sold to cover outstanding debt – although be careful of assuming that the full debt will be met.
A student loan – which could be a six-digit number – has no obvious counter-asset that could be sold in the event of death. Student loans are the main funder of tertiary education, Van der Westhuizen says, and are often secured by undertakings from parents to repay the loans in the event that their children cannot. These debts could be covered by the payout from a life assurance policy.
Young + healthy = cheap cover
There is a big advantage to taking out cover early in life: the price is low. Malan says a rule of thumb is that a 40-year-old can expect to pay double what a 30-year-old would pay, and a 50-year-old double what the 40-year-old would pay.
Individual premium rates for an underwritten policy will be affected by your gender, occupation, whether or not you smoke and the amount of cover requested. Information from five life assurers for a hypothetical standard life demonstrated that cover is cheaper when you are young and healthy, because your propensity to claim is low (see Crunching the numbers.)
You are also less likely to have a loading or exclusion. Meintjes says you are twice as likely to have a loading or exclusion applied once you are over 40, compared with when you are younger than 30. Loadings can add 50 to 100 percent to the premium.
Watch out for premium patterns that make assurance look cheaper than it actually is. Premium patterns are the way premiums are paid over the life of the policy. There are two kinds of patterns: level and age-rated.
On a level premium pattern, the policy is priced so that premiums do not increase over the duration of the policy (if your sum insured doesn’t change), Meintjes says. In the above examples, a level premium pattern is assumed.
Age-rated premium patterns take into account the likelihood of claims increasing when you are older, with premiums increasing each year by higher amounts as you age. Age-rated premium patterns show a lower premium at a younger age. The risk with an age-rated premium pattern is affordability, because increases occur at an exponential rate and can become unsustainable, despite lower premiums at inception. You can switch from an age-rated premium pattern to a level premium pattern, but if you started paying an age-rated premium of R100, instead of a level premium of R150, you will need to catch up the additional premiums you would have paid on a level premium pattern.
Chegwidden says the choice of premium pattern is critical. When buying a policy, you must know what the premiums will be in five, 10 and 15 years’ time.
Decisions, decisions …
There are two basic decisions when you take out assurance: how much cover is needed for what purpose, and how to pay for that cover over the life of the policy. It’s a two-step process, Suzanne Stevens, the executive director for marketing at BrightRock, says. Think it through carefully; it’s a complex decision for a consumer, particularly if it is your first assurance purchase.
Beware of making assumptions such as these:
1. Rates will come down
Be careful of assuming that assurance rates, which affect premiums, will come down, Marx says. Rates move in cycles and, although cover has become cheaper in some cases over the past few years, it may not always be so.
2. Adding an escalation benefit will give sufficient cover in future
Escalation benefits can be a good thing, as they allow your cover to keep up in real (after-inflation) terms. However, your actual assurance needs increase and decrease over time, and an escalation benefit won’t necessarily ensure all your needs are covered. For example, as your dependants age, you will need less cover. Malan cautions against taking cover and then just adding an inflation escalator onto it, because this doesn’t address your particular needs and how they are likely to change over time.
3. You can always take cover later in life
Many people who apply for cover later in their lives may find that they are required to pay a premium loading as a result of medical conditions that have been diagnosed, Ferreira says. If you have been diagnosed with a condition that is almost certainly going to lead to a claim, that condition will be excluded from the cover provided by the policy and you will not be able to submit any claims when you are on sick leave or are disabled as a result of that specific condition. If you have cover in place before you develop a condition, this condition will be covered and a claim would be met.
Applying for cover while you are healthy is much more important than comparing the premium you are asked to pay with premiums being paid by consumers who bought cover before (or after) you, Ferreira says.
Flexible products are a must
When you take out long-term assurance in your 20s, your product must be flexible and change as your life, lifestyle and needs change. Ask, before signing, what effect a change in occupation, a move overseas, or a sabbatical will have on your policy. All of these are becoming more common, and they will affect disability cover if it is occupation-based.
Marx cautions that disability income protection can be very specific. Contractually, it protects you from not being able to do what you do – a particular job – and there may be clauses that disallow a claim if you are not doing the job for which you are covered.
As far as a sabbatical goes, pay attention to what is insured, Chegwidden says. Income protection is designed to protect your income. If you are on sabbatical and not earning an income, you don’t have anything to insure. Some assurers allow you to keep your cover in place if you are on sabbatical, but won’t allow claims for loss of income in this period. Chegwidden says it may be an option to cover only impairment at this time, but this will need to be discussed with your assurer. Impairment assurance is based on your ability to perform certain functions (eating, for example). Impairment cover usually pays out a percentage of a benefit, which would be lower than a comprehensive disability claim payment.
A flexible product that covers your needs should eliminate waste and increase affordability. Products have become more needs-based and flexible, and allow cover to be added and removed as needs change. Products can also precisely match the need for the cover, to the exact amount, Stevens says.
Retirement savings vs life cover
You need both to save for retirement and have life assurance, author and financial coach Jillian Howard says. But, to save for retirement, you need to earn an income. If you become disabled and have not adequately insured your income, you will not be able to save, Ferreira says.
You have to balance wealth creation with wealth protection, Stevens says. Your wealth creation can be completely destroyed if you have no protection and something happens.
The proper thing to do is to start saving for retirement as early as possible, Van der Westhuizen says. But it would be appropriate to cover your income-earning ability, at the very least.
Invest only according to your need
Even if cover is cheap, buy it only if there is a need, and if that need is not already being met by group cover, which you may have if you are formally employed. Don’t overspend on cover you don’t need, Jan-Carel Botha, the director of Purpose Wealth and the 2012 Financial Planner of the Year, says.
Make sure you have covered your income and earning ability with disability assurance, and take out life cover for any debt. Adjust this cover as you pay off debt, or if you become responsible for dependants. Dread diseases can strike early, and although the chance of becoming ill in your 20s is low, if you have high risk factors (members of your family have suffered an illness, for example) consider dread disease cover to make up any shortfall in medical scheme benefits.