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Category Life Insurance

Lump sum or income benefits what is right for the client?

04 May 2006 Craig Harding

When it comes to insurance products, clients plan their insurance portfolios to provide benefits to provide enough money to replace whatever has been lost.

This applies to both short term and long term insurance and the benefit proceeds represent a proxy for the insured loss. 

In a perfect world clients would provide exactly the correct amount with exactly the correct timing.  However, in an uncertain world this can never be the case.  Clients provide too much or too little since the exact requirements are not known at the time of planning the portfolio but matching the timing should be somewhat simpler.

Using the approach, consider the use of disability products.  Why does a client typically purchase a disability product?

1. To replace income in the event client can no longer work, either temporarily or permanently, as the result of an illness or an accident; income to
a.  Meet regular ongoing expenses
b.  Pay capital debt

2.  To provide funding for possible additional costs associated with being disabled, either temporarily or permanently in the form of
a.  Once-off costs such as rehabilitation costs, home renovation costs
b.  Recurring cots such as medical expenses

3.  To meet legal obligations as might be included in a business contract such as a buy and sell agreement, contingent liability arrangement or key man arrangement.

In the case of once-off costs lump sum benefits are an appropriate solution, being a proxy for the costs to be incurred.  However, in the case of ongoing costs, lump sum benefits are inappropriate, a better proxy being income replacement.

In addition to many lump sum benefits paying out only in the event of a permanent condition, calculating the correct lump sum benefit to replace future recurring costs is problematic. Factors to take account of include life expectancy, interest rates and investment returns, and inflation.   Factors that are difficult to predict accurately, particularly at the time of planning a portfolio.

In addition, it is unlikely that insurers will grant sufficient lump sum benefits to meet even moderate income earner needs. Depending on assumptions, insuring R1 of income, with inflation protection to age 65, could require an investment as much as R298 for a 37 year old (i.e. 298 times the income you wish to insure).  Not only is this expensive but you are unlikely to get an insurer to grant this much lump sum disability cover since the LOA guideline indicates 120 times salary as a maximum.

The most appropriate solution therefore, for insuring a potential income loss, is an income replacement product. Income replacement products are a far better proxy for the potential loss a client may experience and provides protection in the case of both temporary AND permanent income losses, as well as catering for some inflation protection.  In other words, the risks of life expectancy, interest rates, investment returns and inflation, are left with the Life Company, with people who have the expertise to manage these risks.

Remember, you pay for what you get! Lump sum occupational disability products are cheap for a good reason. 

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