Life insurance sometimes feels a grudge purchase because we personally don’t stand to benefit from it. The idea of having to pay thousands of Rands towards something you can’t see, smell or even taste, can leave us feeling a little resentful at times (especially when money is tight). The icing on the ill-feeling cake is the fact that if you cancel your life policy, you don’t get anything back. Why is that? Why don’t life insurance policies carry some type of policy surrender value, that pays at least some of the premiums back to the policyholder?
To answer that question, we need take a step back 20 years
20 years ago, life insurance policies did carry cash and surrender values. In most cases, policies that were sold back then, had a specific end date (normally 65). If you reached the policy maturity date then the policy would end, and you would get the proceeds of the policy. If you died before the maturity date, then the life insurance proceeds would pay out to your beneficiaries.
What happened to life insurance policies with cash / surrender values?
Two problems existed with life insurance policies carrying cash values:
- The insurance was expensive
- The investment portion of the policy didn’t perform particularly well
Let’s look at the first problem and a hypothetical scenario:
Lindiwe takes out a life insurance policy at the age of 20. She covers herself for R1,000 000 and the policy ends when she turns 65. The premium for the policy is R300 per month and it carries a cash value, so at age 65, if Lindiwe hasn’t passed away, she can expect a pay-out of sorts (nothing guaranteed).
Of the R300 monthly premium that Lindiwe pays towards the policy, perhaps R50 of that is being used to finance the R1,000 000 life cover that is attached to the policy. The other R250 is going towards the investment / cash portion of her policy, because she is only 20. The problem is that as Lindiwe gets older, less and less of her premium is being invested, and more and more of the premium is being used to finance the life cover. At a point in the life of the policy, the whole premium will be used to fund the life cover and zero will be allocated to the investment portion.
So, in theory, Lindiwe doesn’t have the greatest investment product, neither does she have the cheapest life insurance product. She really has an awkward hybrid of life cover and something that will pay out at the end of the policy or if she surrenders the policy.
The second issue with life insurance policies 20 years ago is that the investment portion of the policies didn’t perform particularly well. The policy holder didn’t have the opportunity to pick a fund they wanted to invest in. For the most part they didn’t even know what funds the cash portion of their life policy premium were being invested into.
People would feel disgruntled when the policy matured, and the pay-out was far less than they anticipated.
Enter pure risk life cover
Life insurance policies needed to be re-engineered, and smart actuaries, along with bright marketing folk, decided to introduce a new life policy called “pure risk cover”. Rather than the awkward hybrid that was being offered, they would split up the insurance and investment portions of the policy and sell them individually
- If you want to insure your life, take out a life cover policy (no investment portion)
- If you want to invest, take out an investment policy (no life cover portion)
If Lindiwe wanted R1,000 000 life cover and the rate was R50 for the cover, it would be far more efficient to offer a life insurance policy that simply covered that risk, without an investment section added to it. That would leave Lindiwe free to take the R250 (that she was saving) and invest that into a pure investment product.
That’s why your life insurance policy doesn’t carry a cash or surrender value. It is a “pure risk” insurance policy, which means that 100% of your premiums are being used to finance the life cover.
It’s the cheapest and most efficient way for the life insurance company to provide you with cover.
The only problem is setting customer expectations. The customer feels like they are entitled to something back if they cancel the policy.
As a result, you are seeing more and more life insurance companies starting to market the fact that you will get “something back” after 5, 10 or even 15 years.
Remember that all they are doing is hiking up your premiums, in order to give you something back and make you feel a little better. No life insurance company can offer you the best possible rate of cover, if they are promising you a cash-back benefit.
You need to make sure you are comparing apples with apples.
The best advice would be the following:
If you want to take out life cover, take out a pure risk life insurance policy. Reside yourself to the fact that the couple of hundred Rand a month, that you are spending, is going towards insuring your life. Don’t think of it as an investment and if you cancel, don’t expect anything in return.
If you want to invest, then the same logic is true – find an investment company with very low admin fees and a good track record and invest into a “pure investment”.
Life insurance and investments are two different things and while it’s a tough pill to swallow, you shouldn’t expect anything from your life insurance policy, except that it pays out to your beneficiaries as you intended.
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Until next time.
The Wise About Life team