The Ultimate Guide To Long Term Insurance In South Africa

Insurance. Is it a grudge purchase or is it a non-negotiable necessity? There are very strong schools of thought on both sides of the spectrum and arguments can be made both for and against taking out insurance to cover your risks. Seeing that this is a topic that can get quite complex to understand and something that is by no doubt being miss sold in the financial industry, I decided to create a mini series on YouTube where I will explain exactly how long-term insurance works, when and what you need to consider when taking it out and when it might actually not be necessary. It is quite a meaty topic to cover and I do not want to leave any important info out so I will break it down into multiple videos in a series titled The Ultimate Guide to Long-Term Insurance for South Africans. The first video, the one you are watching now, will cover all of the fundamental aspects of long-term insurance that you first need to understand and then each subsequent video thereafter will cover each type of long-term insurance product individually which will include life cover, funeral cover, income protection, disability cover and critical illness cover. Now working as a financial planner in the industry, I see how many people are sometimes being smoked by sleazy salespeople and how some firms and providers have become predatory on uninformed South Africans by forcing products and policies on people who don't actually need them. So in my attempt to change the financial planning profession for the better, I will use the platforms at my disposal to provide non-BS financial education to the general public. I will therefore also be sharing three red flags that you need to look out for when dealing with SaaS brokers in this space. So if you are in the process of taking out long-term insurance or you already have some policies in place, I would highly encourage you to invest some time to watch all of the videos in this series so that you can make informed financial decisions and also to be able to tell when you might be taken for a ride. And with that said, let's get right into it. So insurance is essentially a method by which we protect ourselves and our assets against various types of risks. We buy insurance policies from insurance companies by making regular contributions to the insurer who then adds all of these contributions to a pool from which losses are paid. It is therefore a method that aims to shift the risk from one person to a group. For example, let's say you owe 1 million Rand on your home loan which you want to pay off if you become disabled. When you take out insurance, you don't EFT the insurance company the full 1 million Rand and then when you become disabled they pay you back. No, you pay a much smaller monthly premium, let's say 500 Rand, which then gets pooled by thousands of other clients who also pay 500 Rand. This pool of funds then builds up from which all successful disability claims then get paid. So if you do not yet have enough assets to self-insure you for all the risks that exist, meaning you don't have 1 million Rand just lying around that you can use to pay off your bond in the case of disability, then the risk of you becoming disabled can be mitigated by paying a much more affordable monthly premium. Now there is absolutely no guarantee that you will become disabled and receive the payout, so yes, you might end up paying all of these premiums your entire life without seeing anything in return. So you need to weigh up the magnitude of the risk that you could be facing with the affordability of the premium. If you're not able or willing to pay the premium, then you need to accept the risk and the potential consequences thereof on yourself. So essentially the main reason for buying insurance is to protect your wealth and secure your financial future. You may have the best crafted investment plan in the world but if no provision has been made for unforeseen events like disability or your house burning down and one of these events do occur, your investment plan can be turned into ashes. Many people are unable to ever recover financially from these types of losses, so before you can start your journey towards building wealth, you first need to make provision for protecting it. Now when taking out insurance, you have to apply and get approved. It is by no means guaranteed. The insurance company will assess your level of risk and then based on a couple of factors like your age, gender, BMI, smoking status, qualification and occupation, calculate the premium that you will need to pay. High income earners can afford better healthcare, are more health conscious and typically live in more secure areas, so they will usually pay less. Uneducated or low income earners poses more of a risk to insurance company and will therefore be charged a higher premium. In the same way, it can be argued that a smoker poses more of a risk than a non-smoker and a person who spends a large part of their working day involved in manual labor is much more likely to suffer a health event or an As an example, a 50 year old that drinks, smokes, does skydiving for a living and that has multiple pre-existing diseases will pay much more for insurance than a 25 year old healthy medical doctor because the 50 year old poses a much higher risk of making a claim. Insurance companies are not charities. They are businesses that are there to make money and this is how their business models work. They need to follow strict criteria to reduce their risks based on statistical probabilities otherwise they will all cease to exist and the main way that they mitigate this risk is through a process called underwriting which consists of two parts, financial underwriting and medical underwriting. Financial underwriting limits the amount of insurance cover that you can take out based on your occupation and income. For example, if you earn 30 000 rand per month after tax, you can only take out income protection to the value of 30 000 rand per month. Likewise, if you earn 5 000 rand per month, it is very unlikely that the insurance company will approve life cover amount of 15 million rand. Medical underwriting limits the amount of insurance cover you can take out based on your past and present health status. As part of the insurance application, you will need to answer detailed medical questions where based on the answers given, you may need to go for further medical examinations and blood tests. The insurance company will typically arrange for a nurse to visit you at your place of choice and if further medical records are required, they will ask you to provide your treating physician's contact details. The cost for all of this is usually covered by the insurance company. Now, if you have pre-existing conditions when applying for long-term insurance such as mental illness, cancer, fractures or maybe some skin issues, then the insurance company may apply what is called a loading to your policy. This means that they will still cover that condition but you will need to pay a little bit extra for your insurance. If the condition poses too high of a risk for the insurer, then they might also apply an exclusion which means that they will not cover any claims for that particular condition at all. And if you pose many different risks all at once, the insurance company may also reject your application in its entirety and classify you as insurable. This is why you will sometimes hear that it is cheaper to take out insurance when you are younger because if you took out insurance without any loadings or exclusions and then later on develop these conditions, your existing cover will remain in place without any issues but if you then add cover to your policy or you move to another insurance company, the loadings and exclusions can be applied in full to the new cover amount. Now, this is very important and red flag number one. If your financial advisor or broker advises you to jump between different insurance companies every two or three years, I would question their motive very seriously. As you can tell from the medical underwriting explanation, this might not be in your best interest as you'll be older and perhaps have contracted some sort of medical condition in that time, which means your insurance will also be much more expensive. Unless there's a very good reason to move and you fully understand why, then I'd say it is usually best to just stay where you are. Now, some insurers will require you to inform them if you make certain changes to your lifestyle after you took out insurance and others will not. For example, if you change occupation, take up hazardous activities or start smoking, some insurance companies may want your risk to be reassessed and your premiums amended, whereas others will say, you know what, you have been underwritten when you initially took out the policy and therefore do not need to inform them of any changes. It is very important for you to know how your insurance provider works, so best to always check how your insurance may be influenced before making big lifestyle changes. Now, getting a loading or exclusion sucks and the insurance company will only know what you tell them, so why not just lie or conveniently forget that you have a medical condition? Well, you are required both legally and ethically to deal with the insurer in an honest and transparent manner. By law, an insurer is in its full right to reject or reduce a claim if any material information was misinterpreted that could have affected the insurer's assessment of risk. For example, if you forget to mention in your application that you suffer from a heart disease, this would have had a massive impact on the level of risk taken on by the insurer and subsequently the premium you would have paid. If you then die as a result of a health-related incident, the insurer will be in its full legal right to refuse to pay out your claim because, you know, you did not contribute towards the risk pool as you should have done had you been honest and transparent. So, if you lie or you do not properly disclose all of your information, you really can't be mad at the insurance company for not honouring your claim. As with most things in life, be honest, otherwise it might bite you later on. And likewise, if you do not pay your monthly premiums on time, your policy may lapse and your insurance get cancelled, which means the insurance company will not pay out because you violated the contractual terms. However, they cannot refuse cover or cancel existing coverage based on reasons such as a person's race, sexual orientation, marital status or religion. Right, so when taking out risk cover, you can select to either have the cover amount increase every year or to remain level. When deciding between these two options, the first question to ask is whether the need will increase or remain the same over time. For example, a need to cover unforeseen medical expenses in the case of critical illness or to provide dependents with an income should the main breadwinner pass away is likely to increase over time and should thus be covered with a benefit that also increases. A home loan, on the other hand, is likely to decrease over time and therefore does not necessarily require increasing cover. If you do decide to take out escalating cover, you need to choose a percentage by which the cover will increase, which typically includes a fixed percentage such as 5%, 7.5% or 10% or one that is linked to the South African Consumer Price Index aka inflation, which will usually range between 4% and 6% per year. And now for probably one of the most important components of long-term insurance, premium patents. This is vital to understand, so please pay attention. When your benefit cover amount increases, let's say by 5% per year, the premium that you will pay will also increase by that same percentage, aka 5%. But this is not all. When you take out long-term insurance, you also need to select between a level or an age-rated premium patent, which will, in addition to this cover increase percentage that we just spoke about, also increase your premium amount. In other words, the premium patent refers to the premium increase patent that is selected separately to the cover increase patent. A level premium patent starts out higher than the other premium patents, but because the premium is not increasing every year to make up for the lower initial premium, these premium patents are often much more cost effective over the long run. This ensures that the premiums remain affordable when you need it most in life, because statistically, the older you are, the higher likelihood that you will need to make a claim. A level premium patent gives you much more control over your budget and cash flow as your policy premiums remain much more predictable. An age-rated premium patent, on the other hand, increases every year at a rate based on your age. Remember, when you are young and healthy, your risk to the insurer is much lower than when you are old and sickly. These premium patents are therefore much cheaper in the beginning of the policy, but they become much more expensive every year with each increase, and as a result, it becomes much more expensive to keep these policies active over the life of the policy, and unfortunately, oftentimes lead to people being forced to cancel their long-term insurance policies later on in life, when they actually need it the most, because they simply cannot afford it anymore. Alright, so how do you choose between the two premium patents? Age-rated premium patents could potentially work well if the need that you are ensuring is short to medium term. For example, if you need to take out life cover on a car loan that you will pay off over six years, or you want to provide for your children until they leave the house, then it would make sense to go for a cheaper premium patent, as you will save some money in the short term. This is usually the case with most loans, but if you want to ensure a risk that is long-term, like income protection or critical illness cover, then it would be best to rather take out a level premium patent to ensure long-term sustainability. Insurers are legally obliged to show you the premium patent projections over at least the next 20 years, so when taking out long-term insurance, ask for a comparison between level and age-rated patents to see how the future increases compare. In my experience, age-rated premiums are usually cheaper for the first 10 to 15 years, but then it becomes a lot more expensive after that. So the second red flag to watch out for is when brokers from competitor companies present like-for-like quotations on your current benefits, but then they select an age-rated premium patent when you currently have a level premium patent. So it might seem that you will be paying less now if you move to the other company, but be very careful, as you might be coughing premiums 10 years later, at which point it may be too expensive to move back to a level premium patent again. Alright, so it is important to understand how your yearly premium increases are calculated. Let's say, for example, you take out life cover with a 5% cover escalation and level premium patent. The premium will still increase every year, because the cover increases by 5% and you will need to pay more for that additional cover. The premium itself will not increase if the benefit amount does not increase. At each policy anniversary, some insurance will allow you to opt out of the benefit increase, which means that if you are on a level premium and there's also no cover amount increase, your premium that you will pay will stay the same in However, if you decided not to increase your cover amount, but you are on an age-rated premium patent, then your premium will still increase. And if your cover increases by 5% and you are also on an age-rated premium patent, then your premium will increase by both. That is why you will sometimes see that your insurance premiums are increasing by like 12% to 15% per year, and why I say you must be careful of age-rated premium patents for cover that should last for the long term. Now, a portion of the premium that you will pay every month will be allocated to the policy costs and the balance will then be added to the risk pool from which all the claims are paid. These policy costs include number one, administration costs, which are charged by the insurer for the administration of the policy. For example, collecting premiums, handling queries, processing claims, building fancy offices, etc. Number two is the policy issue costs, which includes the cost of the medical underwriting that you need to go through in the beginning. And then finally, number three is commission, which is paid by the insurance company to the financial advisor or broker for their role in the recommendation and implementation of the policy. The maximum percentage of commission that is payable is regulated by law and can either be taken upfront or on an ongoing basis. So, the third red flag to be aware of is when advisors or brokers tell you that advice is free. That is a straight up lie. You may not be paying them a fee directly for the advice, as you would a doctor or a lawyer, but they do get paid commission by the insurance company and that commission is built into the monthly premium that you continue to pay for the rest of the policy term. Now, in principle, there is no problem with earning commission for the work that was done, but because most advisors prefer to take upfront commission, which is usually 12 times the monthly premium payable when a new policy is issued, this oftentimes drives bad behavior in the industry, where clients get churned between different companies so that the advisor can earn new commission each time. And again, it may not be in your best interest to move from a one provider to the next, because there might be some medical underwriting issues. Some advisors intentionally decide not to take any commission at all and rather just charges a flat fee directly to the client for the work that was done, as this often results in the policy being 15 to 30 percent cheaper, which, when projected over many decades, could lead to substantial savings for the client over the long term. So again, if you are approached by a financial advisor who wants to move you to another company, make sure you understand all of the T's and C's and ask enough questions. By law, the advisor will need to get you to sign what is called a replacement advice record, which you need to please read through thoroughly, as it will disclose all of the actual and potential financial implications, costs and consequences of replacing your policy. This is important because this is the future of your insurance cover that we're talking about here. Alright, so now you know what to look out for when taking out long-term insurance, and I hope that this video will help you make better informed financial decisions. As mentioned earlier, I will create separate videos on life cover, funeral cover, income protection, disability cover and critical illness cover, which you can binge watch after this one. I will add them to this playlist once they become available. If you have any specific questions on long-term insurance, feel free to throw them in the comments so that we can all learn from each other. Cheers!