Living benefits: Protecting the value of your future earnings

The real value of disability insurance only becomes apparent when crisis strikes. Sadly, many of people approach risk as something that will never happen to them and, as a result, underestimate their need for disability cover. Generally speaking, the security of one’s financial future depends on one’s ability to physically work and produce an income. If the process of generating an income is temporarily interrupted or permanently stalled, most economically active people would not have sufficient accumulated wealth to replace the lost income. As such, disability insurance is designed to address the financial exposure a person faces in the event of permanent or temporary disability, albeit that disability cover is a technical minefield.

In general, disability cover can either take the form of lump sum disability cover, also known as capital disability, or income protection, which is designed to replace lost income. In many instances, it makes sense to take out a combination of both, although this will largely depend on your particularly set of circumstances. When determining the need for disability cover, it is important to understand what your financial position – and that of your loved ones – would be if you became incapable of generating an income, either temporarily or permanently. In the process, keep in mind that your income has multiple purposes: it is used to cover your living expenses, save short-to medium-term financial goals, service your debt, and fund for your retirement. It may also be used to provide financial assistance towards your aged parent’s retirement, or fund for your children’s tertiary education. As a result, finding an appropriate balance between lump sum insurance and an income protection benefit involves a careful analysis of your earnings, your dependants, lifestyle expenses, debt, and your current level of retirement funding, keeping in mind the insured’s needs at claims stage.

The primary function of an income protection benefit is to protect your future earnings, and most insurers allow you to select the percentage of your salary that you would like to cover, up to a maximum of 100% of your net taxable income. While some people take out two or more income protection policies as additional protection, it is important to bear in mind that income protection is designed to protect against a quantifiable loss, being your income or a portion thereof. If you become disabled and claim against multiple policies, you will not be reimbursed for more your gross income net of tax, regardless of the number of policies you have in place, although some insurance providers have indicated that they do not aggregate and will pay out regardless of whether there are other policies in place. However, this could still pose a risk at claims stage and may result in you paying for benefits that you do not necessarily need.

Income protection benefits are dependent on the nature of your occupation, with some occupations being too high risk or unorthodox to insure. By way of example, a surgeon may not continue to operate without the use of one of his hands, while a salesperson would be able to continue working. If a surgeon loses the use of a foot, he may be able to continue performing surgery, whereas a professional soccer player would not be able to continue working.

In order to take out an income protection benefit, you will need to be employed, have a qualifying occupation and be medically insurable. If you are formally employed and enjoy group benefits, it is likely that your group cover includes an income protection benefit. The advantage of group life cover is that it makes long-term insurance cover accessible and available to those who may otherwise not be able to obtain cover in their personal capacities. Further, many group life policies include a continuation option which allows you to purchase the same level of cover with limited underwriting in the event of resignation, retrenchment or dismissal.  For business owners and entrepreneurs, securing an income protection benefit will be an imperative because, without sick leave to fall back on, even a temporary inability to generate an income can have a catastrophic effect on your business and future profitability. Having said that, many business owners – specifically those who operate in the gig economy, have multiple streams of income, or engage in unorthodox occupations – struggle to obtain income protection, although a handful of insurers have taken bold steps to provide income protection benefits to those with high-risk occupations, such as oil rig divers, as well as to those not yet earning an income, such as students.

While income protection cover is generally more expensive than taking out lump sum disability cover, it is important to remember that this type of cover is occupation-based and is priced according to the risk that an individual presents to an insurer. It also takes into account other factors such as your age, gender, smoking status and medical underwriting. You can elect to include waiting periods on your policy which can also serve to reduce your monthly premium, although it is then important to ensure that you have sufficient emergency funding in place to tide you over during the waiting period. Ideally, your income protection benefit should be linked to inflation to ensure that the value of your monthly payout keeps pace with the cost of living and does not lose its purchasing power over time.

In the event that you do not qualify for an income protection benefit you can elect to insure yourself through a lump sum disability benefit. Alternatively, you may elect to protect your future income, or a portion thereof, using an income protection benefit while using lump sum disability to fund for other expenses such as debt, retirement or lifestyle modification costs. For instance, you may want to take out lump sum cover which would be sufficient to pay off your home loan and provide for an income during your retirement years, meaning you will need to calculate the amount of money you need live on for the rest of your life and then capitalise that amount in the form of a lump sum benefit. Lump sum insurance is, however, not without risks. For instance, if your permanent disability has no effect on your life expectancy, you may be faced with the risk of outliving your capital. Further, variables such as inflation, interest rates and investment returns can also affect how long your capital will last. Importantly, lump sum disability insurance only pays out in the event of a permanent disability with no provision made should you suffer from a temporary disability. In the absence of a temporary income protector, you will then need to ensure you have access to sufficient capital to fund your living expenses if you have a temporary loss of earnings.

It is never easy to anticipate the additional costs that a permanent disability will generate as this will largely depend on the nature of the illness or disability. However, when calculating your lump sum needs, it is always advisable to make provision for costs such as vehicle modification, home renovations, appliances and prosthetics which may not be covered by your medical aid, ongoing rehabilitation and treatment, travelling expenses, and alternative therapies.

Most importantly, make sure that you revisit your disability cover on an annual basis to ensure that it remains appropriate to your life stage and your needs. In general, protecting against the risk of disability involves a combination of insurance and invested wealth to ensure that you remain self-sufficient for the remainder of your life should tragedy strike. Some forward-thinking insurers have made it possible to play around with the mix of income protection and lump sum cover on one’s policy as one moves through various life stages without the need for further medical underwriting. As you accumulate more wealth, you may find that your need for disability cover reduces in line with your ability to self-fund your future costs of living. Further, changes to your income, health status and lifestyle may necessitate that your cover is re-assessed and adapted to your needs. Either way, don’t dismiss the opportunity to thoroughly assess your disability protection and the important role it plays in your overall portfolio.

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