Using income protection as a Spartan shield

03 November 2014 Brad Toerien, FMI

The term income protection is often associated with disability. If your client cannot work due to an injury or illness, an income protection policy will pay their income until they are able to return to work or retire.

However, what about long-term disability or death? An income protection policy can play an important role in protecting your client’s future income against these risks as well. This means most individuals will be forced to re-think the cover they have in place.

Insufficient disability protection

Research by True South Actuaries and Consultants shows that 60% of cover sold in the South African insurance market is for life cover, 30% of cover sold is for disability cover, and 10% of cover sold is for critical illness cover, meaning that life cover sold is at double the rate of disability cover.

Logic dictates that disability cover sales should actually be double the level of life cover sales as individuals who are disabled are still part of the household. So, South Africans are under-insured for disability risk. In addition, only 17% of the disability benefits sold in 2011 related to income benefits while lump sum disability benefits accounted for a staggering 83% of disability benefit sales.

This is concerning as lump sum disability benefits only pay out for permanent disabilities, and provide no cover against temporary disabilities. And, while lump sum pay-outs are necessary for debt settlement, they are not suitable for replacing a future income stream, especially in light of inflation and investment risks. Similar problems apply to traditional lump sum life benefits.

Add this to a R11 trillion gap in the South African temporary disability cover market, and South Africans could find themselves in serious financial straits, without the necessary disability cover, and with cover that is most often paid out as an unwieldy lump sum. With increasing debt and little savings, self-insurance is not a viable option for most South Africans. What they need to do is structure their current portfolios in the right way – with benefits that pay out, for the most part, as income.

Client’s most important asset

Contrary to popular belief, the working individual’s greatest asset is not their house, bond, or car, or even the insurance policies used to protect those items. It is their ability to earn an income.

What would happen to your client’s family if they could no longer earn that income due to a disability or death? That is why protecting one’s ability to earn an income, rather than just against a particular risk, should be a primary financial priority.

Taking a different view

All risk products should work to protect your client’s ability to earn their future income. A properly constructed income protection plan will help protect your client against short-term risks, as well as safeguard their long-term capital value.

While the industry has traditionally offered lump sum solutions, income-based solutions are actually the best choice when it comes to replacing future income. For disability, these solutions should cover 100% of income as that is how much most individuals need to live. For life cover, they should offer beneficiaries the monthly income they would have received if the life insured was still alive. Whether considering disability or death, income replacement benefits are better suited to replacing future income because they remove timing, investment, inflation, and longevity risks by providing benefits that are the exact match for the asset being insured.

Advocating for an income-based approach to income protection does not mean dismissing lump sum pay-outs. To be truly effective, income protection should involve a combination of monthly income replacement benefits and a lump sum, to settle outstanding debt or cover major once-off expenses.

The time has come to look at income protection as essential insurance for your client’s most valuable asset and to structure their insurance portfolio accordingly.

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