The hidden risks of life insurance policies

Economist Azar Jammine did a little bit of investigative work recently, reviewing a life insurance policy. What he found was rather astonishing: it would pay more for the policy owner to die now because, in about a decade, the premiums paid would amount to more than the value of the policyholder’s life in terms of the policy – the sum insured.

Jammine, director and chief economist at Econometrix, tells Personal Finance that, in the case of this policy taken out in 2002, this is because the cost of the monthly debit order increases each month, yet the amount someone has insured their life for doesn’t.

Denise Gabriels, Lead Ombud at the Life Insurance Division in the National Financial Ombud Scheme, said that her office had received some complaints that mirror this issue. Between the late 1980s to early 2000s, insurance in the form of Universal Life policies, which were sold, which Gabriels said were based on a guaranteed period during which time premiums didn’t go up, and then they would, either yearly or through an immediate steep increase.

Gabriels added that, as the risk of dying increases, so does the cost of life cover.

In cases where policies are “age-rated, the premiums will go up while the cover amount could well stay the same, Wayne Mostert, MD of ASI Wealth, explained. In certain policies, especially permanent ones like whole-life or investment-linked life cover, it’s possible to reach a point where you’ve paid more in premiums than the value you’d get out, he told Personal Finance.

Izak van der Westhuizen, chief financial officer at BrightRock, pointed out that the younger you are, the healthier you tend to be, so your premiums will be lower because of a lower risk of claiming. Mostert added, “Locking in a good rate in your 20s or 30s can save you a lot of money over time. Also, life has a funny way of throwing big responsibilities at us when we least expect it.”

Only those who die young, it seems, are worth anything (and also good, based on one of Billy Joel’s better-known songs).

Taking all of this into consideration, it may seem like life policies become worthless as you age, hinting at it being a better idea to invest in unit trusts. Yet, they are still an important part of a financial toolkit.

Mostert said this concept, of taking the amount you would’ve spent on premiums and investing it in a unit trust or savings account, may seem good on the surface.

“But there’s a catch: investment alone doesn’t replace your income if you pass away unexpectedly. You might have some growth over the years, but if you died next week, your family would have only what you’ve saved – not the R1 million or more that a life policy might have paid,” Mostert said.

Van der Westhuizen added that, while there is a chance something might not happen to you, “you’re paying the premium in case it does, much like with a short-term insurance policy. Your car might never get stolen or damaged, but you pay the premium in case it does.”

Greg Smith, who is both co-founder and co-CEO of Dis-Chem Life, says: “Without adequate cover, the financial ripple effects can be devastating. Families often struggle to afford essentials like daily living expenses, school fees or even maintaining their home. In contrast, having appropriate cover in place can provide a buffer of financial stability in times of crisis.”

Mostert also noted that some other uses for life insurance are in business settings to protect partnerships or key staff members, such as enabling them to buy out the rest of the business. “Some people even use it as security, or collateral, when applying for a bond. So yes, it goes beyond just death cover,” he says.

However, death, like taxes, is inevitable. Pointing to US-based medical research centre National Institutes of Health data, which shows that 20% of deaths among South Africans aged 35 to 64 are caused by chronic diseases linked to lifestyle conditions, Smith said that the risk of death wasn’t theoretical.

Mostert added that many life policies in South Africa offer optional dread disease cover. “This pays out if you’re diagnosed with a serious illness like cancer, a heart attack, or a stroke. The money is usually paid as a lump sum and can be used for anything: from medical bills to helping you take time off work or even going on a bucket list trip if that’s what you need,” he explained.

There’s also disability cover, which replaces your income if you can no longer work due to illness or injury, for example, said Mostert.

Van der Westhuizen says a comprehensive life insurance policy should include income protection (temporary and permanent disability cover), critical illness cover, and death cover. “Different types of cover protect different things, so a well-structured policy should include all of them,” it said.

Worth noting is that, by law, insurers must hold a certain amount of capital to honour their claim obligations to all their clients, Van der Westhuizen says. “To comply with these capital requirements, insurers must use certain investment vehicles. Our regulators strictly govern and enforce these requirements and the rules around how these funds are invested to ensure their protection.”

Above all else, read the fine print and speak to a financial advisor is a message that always comes through clearly from Personal Finance’s experts.

PERSONAL FINANCE