Think About Critical Illness InsuranceDon Shaughnessy
Critical illness insurance is a conceptually simple insurance product. If you are diagnosed with one of stroke, heart attack or cancer, the insurer will write a check to help you deal with the problems that have arisen. Of course there are some definitional things like what do you mean by stroke, heart attack or cancer and how long do I need to live after the diagnosis and things like that, but nonetheless pretty straightforward.
Where it gets more subtle is in the options.
Some are familiar. Waive the premiums if you are unable to work, say from an accident? You have likely seen this idea in a life insurance policy.
Another uncomplicated choice is the definition of a covered condition. Most carriers offer an extended definition that picks up about twenty other illnesses and “loss of independent existence.” Again fairly straightforward and most people opt for the expansive definitions.
Would you think it smart to pay for a “second event” something like cancer after a heart attack? Again you could discover the definitions and conditions, think about it and decide.
That is about where the easy part stops.
For the harder part, would you like coverage to 65 or 75, or maybe 75 with only 20 premiums due, or lifetime with premiums only to 100 (Nice deal if you can get that last one to work for you.) Maybe decreasing coverage or increasing premiums would work for you. It gets confusing. Too many options make it harder unless you know the future with certainty. Not common in my experience.
You should try to think about how much and when your money needs protecting against an unforeseen and urgent drain. If you don’t see problems after you retire, then to age 65 or 75 will likely work. If drawing down savings late in life would be a problem then lifetime may make more sense. Maybe more for a shorter time when you are younger and less later on.
The coverage should reflect how you see the risk. The premium is just a byproduct of that observation.
Now the challenge and how sales people address it. Return of premium.
The insurer offers you a choice. Pay more premium and get your money back if you don’t have a claim. There are several options for how to structure that.
Here’s how return of premium works. Suppose you are a 45 year old male in good health, with a good family history who would like $100,000 of coverage. You decide you would like to have coverage to age 75 with premiums for only 20 years. You also like the wider definitions, second condition and waiver of premium in disability. The premium is about $2,350 annually. If you have a claim you will receive $100,000 and the very most you could pay for that is 20 times $2,350 or $47,000. Not foolish. It could happen in the third year instead of the 23rd.
Then I offer you this choice. How about we GUARANTEE that you get a check from the insurer? If you will pay about $3,700 annually instead of $2,350 you will get one of three possible checks:
- You are diagnosed with a covered condition and the company pays $100,000
- You die before 75 and the company pays you whatever premiums you have paid. Maximum of $74,000
- You make it to 75 with no claim and the company gives you the premiums back. $74,000
Case 2 and case 3 might reduce the cost of owning the right to claim in 1. If you have a claim you win financially, but against that is the possibility of losing the premiums. People mostly don’t like losses. With the return of premium option and with no claim your cost for the possibility of collecting is the loss of investment income on the extra premium you voluntarily paid. You get the capital back but lose the income. You are essentially paying an extra $1,350 for a chance to get back $3,700.
Described this way, the return of premium option is about a 2.50% investment. In today’s world, reasonably attractive.
Other return of premium options for other policy structures could run into the 9% range. These are the ones that are making hard for the government to decide if it is taxable or not. But that is not really the point.
If you would refuse to buy the coverage at $2,350 because you think it is not a risk you care about, then consider the return of premium option. It may be a good enough deal that you can justify owning the coverage. Even as a long shot risk, it might not be too expensive.
If you accept that the risk is important, and could pay the $3,700 premium the question is should you buy return of premium and $100,000 coverage or should you buy more coverage ($157,500) for $3,700. You can get honest opinions on both sides of this debate. It does not matter who is right, but you need to think it through.
You may recall that there are two times when you can be insurance poor. A) When you are paying premiums that are too high for the problem you are trying to solve, or B) when you get the claim proceeds, if any, and they are too little for your needs. A good adviser can help you towards a proper balance between your needs and the premiums you must pay.
Coverage matters more than you might think. Even smallish amounts are useful. Recently on Twitter, David Bourke in Australia (@dbourkebfs) posted this sad and not so uncommon story.
Select an adviser who can help. It matters.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.