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South Africans are under-insured for disability in general, with a staggering 60% of the necessary disability cover not in place, according to a survey by True South Actuaries & Consultants which was conducted in March this year. Income earners everywhere are hard hit when disability strikes, and yet the mix of life insurance products sold remains far from appropriate.
Lump sum disability or income protection?
The survey reveals that Lump Sum Disability cover is being oversold in comparison with much needed Income Protection cover. Although Lump Sum Disability is good cover to have, it might not be the best choice, and probably shouldn’t be the only one.
It is well-known that lump sum payments could be difficult for individuals to manage, especially considering they’ll have to make it last for what would have been their entire working career. Lump sum pay-outs further place major inflation, interest, and longevity risk on the disabled individual, while insurance companies are geared to bear these risks, and should be the ones carrying them.
Furthermore, the focus is mainly on Permanent Disability cover, while Temporary Disability cover is much more likely to occur (the vast majority of disability claims last for less than 90 days), yet most people focus on Permanent Disability cover when taking out a policy, and very few consider insuring their monthly income.
Many South Africans are self-employed
Self-employment in South Africa is at its highest level since 2009, according to the Absa Group, and there are currently 1.2 million self-employed business people in the country.
Even a few weeks of absence from work could result in serious financial problems for the households of these individuals, and therefore they are the ones most likely to need Income Protection insurance. Since they don’t have the luxury of falling back on sick pay like employed individuals, they should especially consider cover of the temporary kind.
What should individuals know about income protection?
Many people are actually not familiar with Income Protection. The more well-known Life Cover, Lump Sum Disability and Impairment Cover and Illness Benefits are considered sufficient by most. But whether one has children or other dependants or not, if illness would mean that you couldn’t pay your bills, Income Protection insurance should be seriously considered.
This type of cover pays the individual a fixed monthly income while they’re unable to work due to a disability, illness or accident. Their ability to pay the household bills (and possibly medical bills resulting from the illness or injury) therefore remains intact.
An insured can claim if they become disabled through bodily injury or illness, to the extent that he/ she is continuously unable to fulfil a substantial and material part of the duties of the regular occupation he/she engaged in immediately before the disability, resulting in a loss of some or all of their income.
Calculating the replacement income
The insured should get the monthly income from his/her regular occupation, averaged over the 12 months before the claim event took place. If the life insured has a fluctuating income, the average monthly income will be calculated over the 36 months before the claim event took place.
For a life insured in formal employment, the calculation will use the cost-to-company income, consisting of gross taxable income including the cost of benefits paid for by their employer that forms part of their remuneration package and is reflected in the employer’s financial statements.
For professional lives insured in practice, the gross professional income for professionals who charge a fee for services will be equal to the sum of professional fees and net income from trading activities, after deducting business overhead expenses.
The matter of aggregation
Aggregation in the context of Income Protection Cover means taking various sources of income into account as a whole.
In principle, an Income Protector product requires (by existing tax dispensation) that an insurance company must aggregate to compensate for loss of income only. In terms of risk management, an insurer also doesn’t want an insured to be better off by claiming. Covering actual income loss is what gives Income Protection Cover its favourable tax treatment, with contributions deductible from taxable income.
Each case would, however, have to be assessed on its own merits and must be interpreted carefully.
Let’s look at a practical example:
After Mr X becomes disabled, he buys a franchise. In general, a question would arise about whether the insurer will take into account the income he earns from owning the franchise, and whether the monthly amount paid to Mr X would therefore be reduced in accordance.
Petrie Marx, Product Actuary at Sanlam Personal Finance, explains what would happen within the Sanlam Group’s Income Protection offering:
“Passive income (investment income, dividends, interest or rental income) is not aggregated, and seeing that buying a franchise is very much like an investment, income earned from it would be like investment income. We would therefore not need to aggregate.
Even if a client takes his hobby more seriously after disability and becomes a famous artist or writer earning more than ever before, we would not aggregate.
The guideline we follow is that income still earned in an insured’s wider profession/field of employment must be aggregated. It has to be noted that this definition is wider than the own/regular occupation. An example would be if a surgeon had to lose his thumb and gets the “own occupation” payout. If he continues in the medical field, for example as a general practitioner, we have to aggregate that income in his Income Protector. But it is important to note that Sanlam does not require that the insured continues in a reasonable alternative occupation.
Therefore, if Mr X buys the franchise, and especially if his role there is rather passive and not related to his original field of business, we wouldn’t want to aggregate, as it is more like investment income.
However, if Mr X used to be a small business owner, or even a franchise owner in the first place, the income he earns from buying the franchise will probably be aggregated, depending on the nature of the businesses and the degree of involvement.”
While the importance of sufficient disability cover is not something anyone would contest, the layperson knows very little of all the various types available. One could even argue that only a very small percentage of people actually know they can insure their income – something at least every self-employed person should consider, and a benefit every client should have access to.
* This report was prepared by André Krause, National Manager: Distribution at Glacier by Sanlam