Over-insurance - the silent assassin?

As a rule, South Africans are underinsured. The often cited True South Insurance Gap Study suggests that, relative to the financial risks consumers face, their life insurance coverage lags behind by at least R24 trillion. This translates into a shortfall of two thirds of the requirement for a 40-year-old.

That does not mean that over-insurance is not an issue for our industry. We would argue that it is in fact a systemic problem, built into the structures of existing life insurance products, and in fact, often the driver of underinsurance earlier on in a client’s life, when exposure is highest.

Debunking over insurance

What exactly is over-insurance? Simply put, it is when the sum insured exceeds the actual financial loss a client would incur in the case of an insured event.

The concept is closely linked to the requirement of an insurable interest, derived from English insurance law, where a client must be able to prove the financial loss they would suffer as a result of an insured event.

Insurance, it is argued, does not exist to enrich clients but to place them in the same financial position as they would have been had the insured event never occurred. While this concept is not legislated, it is applied in industry practice and insurers do check for over-insurance.

Fighting the price war

The price sensitivity of clients at earlier ages has led to a price war, and the insurance industry has sought to reduce the initial cost of cover. This has been achieved by the separation of risk and investment products, and by the use of age-rated premium funding patterns, allowing clients to pay less initially – increasing their premium and their coverage over time.

Unfortunately, this approach exacerbates the problem of under-insurance at younger ages, where people buy less cover than they need initially, and of over-insurance in later years.
The True South Study found that in older earners, especially over the age of 55 years, significant over-insurance exists as the financial need is far lower given that earners have fewer pay cheques and fewer financial liabilities to protect. Yet the level of clients’ coverage is far higher than at younger ages.

Implications for clients

What are the implications for clients? Claim stage aggregation can create a significant disconnect between the premiums the client has paid to date for their coverage relative to the pay-out they actually receive.

But the problem goes deeper than that. Because life insurance products are priced for life, and structured to grow over time, the cost of future cover is built into clients’ insurance premiums from inception.

The promise of future cover - that a client may or may not ever enjoy, regardless of whether it over insures them - can contribute between 30% and 40% of a client’s premium, from inception date.

As premiums increase over time and clients’ financial need reduces, the closer they are to retirement age, clients often end up buying down. In the process they sacrifice a significant portion of the premiums they have already paid towards the promise of this inflated cover at later ages.

Policy reviews

Insurance structures must be revisited to create the proper balance or alignment between clients’ financial needs at each different point over the policy term, and the level of insurance provided. The result for clients will be cover that is more appropriate, more affordable and more sustainable.

For financial advisers, it is likely to remove the advice hazards of under- and over-insurance, ensuring the relevance and suitability of the financial advice they provide. The reality is that clients can unlock significant savings or buy substantially more cover at the outset, when it is needed most.