Before taking out life cover, it is important to be absolutely clear on the reasons for putting the cover in place. To achieve its intended purpose in your overall financial plan, life cover must be appropriately quantified and structured in terms of ownership, beneficiary nomination, premium payment, premium patterns and quantum of cover, amongst other things.
In this article, we explore a number of factors that should be considered.
The many functions of life cover
Life cover can be effectively employed to provide security for your home loan, make capital provision for a family member in the event of your passing, provide for the income needs of your spouse and children, settle unsecured debt in your estate, or provide liquidity in your estate so that assets intended for your heirs don’t need to be realised. On this note, many people tend to lose sight of the fact that life insurance is primarily an estate planning tool and that it plays an integral role in the overall structuring of your estate. The manner in which you employ life cover affects the way the proceeds will be taxed in the event of your death which, in turn, can affect estate liquidity and the financial provision you intend to make for your loved ones. As such, it is important to be absolutely clear as to the role you wish the life cover to play in your portfolio.
Quantifying your life cover
It is possible that your life cover is designed to serve multiple purposes in your portfolio and calculating the correct quantum of cover is important to ensure that each of these purposes is adequately met. If you’re taking out bond cover, you will naturally need to ensure that the quantum of life cover matches your home loan. As your home loan reduces over time, it is important to review your life cover to ensure that you are not paying for more cover than you need. On the other hand, if you would like to employ sufficient life cover to provide an income for your spouse, you will need to determine the level of income they would require and for how long, and then capitalise that amount using certain assumptions in terms of inflation and investment growth. Again, it is likely that you would need to review and adjust this cover as your net worth increases and your reliance on life insurance reduces.
Revealing your health status
When applying for life cover, you will need to fill in a comprehensive questionnaire relating to your health – and this information will be used by the insurer to underwrite the risk that you present to them. Having all the facts at their disposal allows the underwriters to quantify the risk you present and to adjust your premiums in accordance with that risk. It is therefore important to fully disclose any information about any medical or lifestyle condition that could impact the underwriting decision. Failure to disclose material information about a condition means that, although you could end up paying lower premiums for your cover, you could be penalised at the claims stage if the insurer discovers that you omitted material information from your application form. Our advice is to err on the side of caution by disclosing as much information as possible even if you don’t think it is relevant. The underwriters know what to look for in terms of materiality, so rather err on the side of transparency.
Taking your group life cover into account
Group life cover and personal insurance are not mutually exclusive and, in fact, can work in synergy to create a risk protection strategy that fully addresses your needs. Generally speaking, group life cover provides more favourable underwriting outcomes at more cost-effective premiums, so the starting point when developing a risk strategy is to maximise the group life cover available to you. That said, your group life cover is not based on your actual risk cover needs but rather on a multiple of your annual income, such as one, two or three times your annual income. Once you’ve maximised the group life cover available to you, you can then use personal life insurance to address any shortfalls you may have in your portfolio. When applying for personal life insurance, keep in mind that you will be individually underwritten and, as a result, this cover is likely to be more expensive than your group life cover which is normal.
Nominating your beneficiaries
Correctly nominating your beneficiaries is an important part of the structuring process because getting your nominations wrong can scupper your plans and cost you money. For instance, if your life insurance is designed to create liquidity in your estate, it is advisable to nominate your estate as the beneficiary to the policy as this will ensure that the proceeds are paid directly into your deceased estate. However, keep in mind that the proceeds of domestic life policies are considered deemed property in an estate and will therefore be taken into account when calculating estate duty. If the net value of your deceased estate is dutiable, you may need to adjust the quantum of your life cover to account for the additional tax.
On the other hand, if your life cover is intended to provide financially for your spouse, it would make sense to nominate your spouse as the beneficiary, bearing in mind that in terms of Section 4(q) of the Estate Duty Act, the value of all property bequeathed to your surviving spouse will not be taken into account when calculating estate duty, and this includes the proceeds of domestic life policies.
Where the proceeds of your policy are intended for inheritance by minor heirs, nominating a testamentary trust as the beneficiary would ensure that the proceeds are not held by the Guardian’s Fund until your heirs reach the age of majority.
Understanding your premium pattern
When structuring your life cover, give careful thought to how your premiums will escalate over time as this can affect future affordability. If you choose an age-rated premium pattern, your premiums will increase each year in line with the additional risk you present to the insurance company as a result of your increased age. Typically, these premiums generally start off lower and then escalate each year in line with your age. On the other hand, a level premium structure is not linked to your age and generally remains constant over time. So, while this premium pattern may be more expensive up front, it is likely to become more affordable over time, and easier to budget for into the future.
Assessing your need for living benefits
When considering life cover, give thought to your need for living benefits such as income protection, capital disability and dread disease cover. Insurance is typically much cheaper to secure while you are young and healthy and, if you’re earning an income, an income protection benefit is likely a necessity. When putting your life cover and living benefits in place, keep in mind that you can structure them as either standalone or accelerated benefits, depending on your requirements. If you structure your disability or dread disease cover as accelerated benefits, this will have the effect of reducing your life cover. On the other hand, standalone benefits, while more expensive, can be taken out separately from life cover and will not reduce your life cover in the event of a claim.
Optimising the use of loyalty and rewards programmes
Some life insurance companies have loyalty and rewards programmes attached to them which come at an additional cost. While the benefits appear attractive, it is important to do a careful cost-benefit analysis to ensure that you’re getting full value from the programme. Many such programmes only really provide value if you’re fully engaged in all aspects of the programme and make optimal use of the rewards, points and miles gained in the process. If you’re not the type of person to engage in mechanisms of such programmes, rather opt out than pay extra money for something you’re not going to benefit from in the longer term.