Income protection & lump sum disability cover the right combination!

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1 For intermediaries June 2015 Solutions for Graduates protection & lump sum disability cover the right combination! This flash fact is aimed at positioning the value of an income protection benefit (i.e. a combination of a Sickness Benefit and an Extended Disability Benefit) in combination with a lump sum disability benefit as the cornerstone of a graduate s financial plan. The flash fact consists of two parts that can be summarised as follows: Understanding lump sum disability and income protection benefits Importance of disability insurance Type of disability cover being sold Characteristics of lump sum disability and income protection benefits Challenges of lump sum disability benefits Features of income protection benefits Why income protection and a lump sum disability benefit are a better combination The lump sum disability option The income protection option The comprehensive disability option Comparing the intrinsic value of the three options The claims perspective ce Sanlam is a Licensed Financial Services Provider.

2 1. Importance of disability insurance Protecting the earning ability of a graduate should always form the basis of a comprehensive financial plan irrespective of whether they are formally or selfemployed. This would ensure financial security and peace of mind after a temporary and/or permanent disability event. 38% of true need for permanent disability cover is actually covered 2. What type of disability cover is being sold? Disability cover in the form of an income and/or a lump sum usually satisfies this need. However, the March 2013 True South Consultants and Actuaries report shows that the actual need for disability cover has been grossly under-insured. Sales are also overly skewed towards lump sum disability benefits.... 7% to 25% of the true need for temporary disability cover is actually covered 2

3 3. Let s look at the characteristics of lump sum disability and income protection benefits: Lump Sum Adjust lifestyle, One-off expenditures, e.g. debt, Specific needs, e.g. education, Cover until date of retirement Replace income Service debt/monthly obligations Cover until date of retirement Permanence must be established More diffiult to claim Fewer claimable events No possibility of multiple disability claims Permanent & temporary disability Easier to claim Shorter waiting periods More claimable events Multiple claims 4. The challenges of lump sum disability benefits can be summarised as follows: Permanence must be established no lump sum disability benefit will be paid until the life insurer is satisfied that the condition is permanent. Managing the lump sum expertise is needed to invest a lump sum to provide the benefit over the remaining lifetime of the client and this usually comes at a cost. Under-insurance reducing the cover to make the payment amount more affordable often leads to a client being under-insured. Managing client expectations clients often do not understand the claims criteria, and might want to claim for temporary disability conditions or conditions that do not satisfy the lump sum disability definition. 5. Features of an income protection benefit An income benefit allows debt obligations to be serviced, thereby indirectly protecting a client s credit rating. Standard of living is maintained. can be inflation-proofed. is a better match to the client s need. There is protection against both temporary and permanent disability. The longevity risk is not passed on to the client but retained by the life insurer. It is clear that income and lump sum benefits are different and satisfy different needs. A lump sum disability benefit should therefore never be used in isolation to cover an income need. 3

4 protection and lump sum disability cover are a better combination Lump sum disability cover on its own does not comprehensively satisfy the income protection need and leaves a client exposed. A better combination is an income solution as the foundation, together with a lump sum benefit. To illustrate this point, we used the client details below to work through the various disability options: Client details Gender Male Age 35 anb Smoker status Non-smoker p.m. R Quallification Graduate Occupation Accountant Disability benefit Regular occupation Taper benefit? No Benefit cease age 65 anb Guarantee period 5 years Premium pattern Standard age-rated Cover growth 5% Sickness Benefit 1 month waiting period Extended Disability Benefit 24 months waiting period 4

5 1. The lump sum disability option The graph represents the lump sum disability amounts the above client may qualify for. The Age bar allows the client to qualify for a lump sum disability amount based on a multiple of monthly salary according to age, i.e. R x 240 = R The payment for this cover amount is R944 p.m. The bar is a present value of the client s current monthly income and is based on 75% (based on Sanlam s latest income sliding scale percentage table) of pre-tax income growing at 5% and discounted at 8%, equalling R The payment for this cover amount is R721 p.m. However, affordability is always a concern, hence the Reality option, which makes the premium more attractive but means the client is under-insured. R x 40% = R The payment for this cover amount is R300 p.m. Cover amount R9,000,000 R8,000,000 R7,000,000 R6,000,000 R5,000,000 R4,000,000 R3,000,000 R2,000,000 R1,000,000 R R944 p.m. Age R721 p.m. R300 p.m. 40% However, the cover is not comprehensive as the client is under-insured and the benefit only pays once permanence has been established. 2. The income protection option In this scenario, instead of using lump sum disability as the base, we used income protection as the base. The graduate client qualifies for Sanlam s unique Sickness Benefit and an Extended Disability Benefit. The cover amounts are calculated as follows: Sickness Benefit: R x 75% = R p.m. Extended Disability Benefit: R x 75% = R p.m. The total cost for this cover is R219 p.m. (Sickness Benefit = R75 p.m. and the Extended Disability Benefit = R144 p.m.) The client now enjoys comprehensive cover for both temporary and permanent disability. Monthly income R30,000 R25,000 R20,000 R15,000 R10,000 R5,000 R R75 p.m. Sickness Benefit R219 R144 p.m. Extended Protector However, a lump sum may be required to fund any lifestyle adjustments and any other one-off expenses. 5

6 3. The comprehensive disability option To further complement the above income disability option, while not breaching any aggregation rules, a lump sum disability amount of up to twice annual income could be included to accommodate any one-off expenses, e.g. lifestyle adjustments, R x 12 x 2 = R The payment for this cover amount is R112 p.m. The total payment payable for this solution is R331 p.m. The client now enjoys comprehensive cover for both temporary and permanent disability conditions, as well as any lump sum disability needs. Monthly income R30,000 R25,000 R20,000 R15,000 R10,000 R5,000 R R75 p.m. Sickness Benefit R331 R112 p.m. R R144 p.m. Extended Protector 4. Comparing the intrinsic value of the three options Now let s look at the present value (PV) of the future benefit at claim stage, assuming that the client becomes permanently disabled in month one. The graph shows that the income benefit solution offers more than twice the value of the lump sum solution. There is absolute value when income protection benefits form the foundation of the financial plan. PV of Future Benefit R8,000,000 R6,000,000 R4,000,000 R2,000,000 R- Now Lump sum disability option protection option Comprehensive disability option 5. Claims lump sum disability vs income protection benefits As a starting point, the lump sum disability client base of a life insurer is by far greater than the income protection client base. That said, the graph shows that far more income protection type claims are paid versus lump sum disability claims almost three times more in The claims process and applicable requirements for the Sickness Benefit are also far less stringent than the lump sum disability claims requirements. Number of claims paid 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Sickness benefit/ protector claims Lump sum disability claims It s a win, win, win situation V /2015 Given the above, it is clear that an income protection benefit, together with a lump sum disability benefit, offers a client value for money, comprehensive cover and absolute peace of mind. Proper financial planning will always help to ring-fence your client. The client has peace of mind as the longevity risk is retained by the life insurer, which means the future income will always be guaranteed. 6