"I already have your proposed insured amount in the bank, given that I want to shore up my savings, I'll pass up on this insurance." This was my recent conversation with a client when I mentioned there's a shortfall in coverage and proposed a term cover to fill the gap.
Frankly the only permutation that leaves us better off without purchasing the insurance is when nothing happens to us.
In this article, we look into the math to make sense of each option.
Case Study
Background
Let's assume Jane earns $100,000 a year and needs approximately $500,000 in critical illness (CI) coverage. Jane is 34 this year, non smoker and already has $250,000 of critical illness coverage bought when she first started work. She needs an additional $250,000 to make up her existing shortfall of her coverage needs.
In terms of how a critical illness need of $500,000 is derived, it follows the assumption that the average recovery period of critical illness is 5 years. This would likely be the period a person may be out of income because they may not be working due to critical illness.
*This case study is simplistic. Jane income will increase and so will her coverage needs over the years.
Below is an excerpt taken from a Straits Times article published on Apr 26, 2018
To read the full study visit the link here
In order for Jane to cover her shortfall of $250,000 till age 65 when she retires, Jane needs to pay $2,657.50 if she purchase a standalone critical illness term plan from one of the insurers. Let's assume Jane has $250,000 saved up in the bank. She has plans to purchase her own house and is reluctant to spend on purchasing insurance. After all, she has $250,000 in the bank should she need it.
What if Jane doesn't get CI?
If Jane purchase the insurance and nothing happens, she spends $82,382.50 on her additional coverage. Let's now assume Jane did not buy the insurance. Instead, she invests the $2,600 in the market and get an annualized return of 5% over the 31 year investment period. She would get a value of $193,177 at age 65.
What if Jane gets CI?
If Jane gets diagnosed with CI within the first 10 years, her return on her premiums paid is 10x or more. As she age, the multiplier on the rate of return gets lesser although it is still a significant multiplier.
However, if she did not purchase the insurance and she gets diagnosed with CI, her savings would result in a -$250,000 assuming she maxed out the full 5 years of recovery. Of course we can debate on things like maybe her expenses won't be as high as her salary etc. If I wish to play devil's advocate, I can also argue that her illness prolongs and it exceeds the 5 year recovery mark. 5 years of income is thus an arbitrary figure which is fairly reasonable to form a hypothesis.
What if Jane invested her lump sum and also the $2,600 she was supposed to use for insurance?
This would very much depend on another luck element. If the markets are good, Jane might have an additional $250,000 or potentially more to cushion the CI event. However, Jane can also fall ill during a market downturn and then she might not even have her original funds to stop work.
A critical illness insurance would have guaranteed that the $250,000 sum assured figure is there regardless of economic conditions.
What if Jane invested her lump sum and bought the insurance?
Assuming her lump sum grows at an annualized 5% rate of return till she's 65, Jane would have $1,130,000 for her retirement nest egg. While also having a protection figure of $250,000 assured because she bought the insurance.
Another relevant article: Why the idea that financial solutions are expensive is terribly flawed?
Factors Jane may not have considered
Remember one of Jane's goals is to purchase her house? If she went ahead with the purchase and emptied her savings in the process, her original $250,000 set aside for unforeseen needs is spent!
What's the odds a person would purchase insurance when they are feeling poor especially when they chose not to purchase insurance when they were feeling richer?
So when will Jane win without purchasing the insurance?
Jane would only be better off if these conditions are met.
She does not fall sick
She falls sick, invests the money and the market performs better than the insurance pay out. She liquidates what she needs to fund her lifestyle.
On the other hand, Jane would be worse off under these conditions.
She falls sick, did not buy the insurance and does not invest the money, so she uses the money for her recuperation and is left with no savings (cannot buy house).
She bought the house, did not buy the insurance, falls sick and has no money to rely on. So she has to continue working despite her discomfort or she needs to borrow money from her friends and family.
She falls sick, did not buy insurance, invested her money but lost the money and she still has to either not stop work or borrow money.
Is Jane better off with the insurance?
As long as Jane has set aside the $250,000 of insurance, Jane would have been free to purchase her house or invest the $250,000 for her retirement. Her financial well-being would not be dependent on whether she falls sick or whether she falls sicks during a bull market. As for the $2,600 she needs to spend, just take it as buying a lottery ticket you don't wish to strike which gives you a peace of mind.
After reading this article, you may have some questions or may want to find out more about critical illness protection through a conversation with me. You can reach me by dropping me a message.
Be sure to share the article if you feel this information is helpful. You will enable a lot more people to learn about critical illness coverage. About Janice I specialize in wealth management and retirement planning. Clients look for me primarily to outsource their retirement planning needs so that they can focus on other aspects of life that interests them. Many of whom are very good in earning their incomes in their respective professions and wish to ensure their monies continue to work harder while they focus on what they are good at. Refer to client testimonials here. I've helped many clients who are referred to me achieve tangible financial goals without compromising on their aspirations and many clients reach out to me in order to achieve their ideal retirement goals. You can reach me at 94313076 or my social media accounts on Facebook and Instagram. Disclaimer: The content created are based on my personal opinions and may not be representative to everyone or any organisation. If you have any doubts or queries pertaining to insurance or investment, please seek professional advice from a trusted adviser in an official setting. You may also reach out to me if you do not have a present adviser using the message box under 'Let's Talk'.
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