July 10, 2010
By Staff Reporter
In the first of our "How to manage life assurance" series, we look at why you need life assurance. Life assurance enables you to face the risks of life with greater confidence in the knowledge that, if anything happens healthwise to prevent you from earning an income, you and your dependants will be able to maintain your standard of living.
Ask most people what their greatest asset is and most will immediately think of the big-ticket items they have purchased, such as their house or car. The more financially savvy will think instead of their investments and retirement savings. Younger individuals who have not yet accumulated many assets may even believe that they have no "great" asset.
All are wrong, Andrew Warren, the marketing executive of Liberty Retail, says.
If you dig beneath the surface, you will realise that all the assets you own, and those you hope to own in the future, had to be purchased and, except for the few of us that inherited large sums of money, we generally have to work to earn the income we use to purchase our assets. Without income, it would be impossible to amass the material wealth and tangible assets we desire now and in the future.
So the greatest asset you own is not your house, car or retirement fund but your ability to earn the income that funds those things. It is the earning potential locked up inside you - and the value of that asset is realised with every pay cheque, bonus and promotion - that leads to your greater wealth.
On this basis, younger people are immensely wealthy; they have their whole working careers ahead of them and, as such, hold a tremendous store of future potential income. As time passes, they convert that potential into actual income, which funds their living expenses, pays off their student loans and allows them to buy their first car.
As their debts are cleared and the car is paid off, they start to save and invest some of their income to generate financial assets that will grow with time so that eventually, when their working career is over, it will be these saved-up financial assets that will sustain them in retirement.
Like all assets, your future potential income must be protected. Premature death, disability or illness may prevent you from realising the full value of your earning potential.
If you are older and close to retirement age, you will probably have achieved most of your earning potential. If you are severely injured in an accident and have made adequate provision for your retirement, you will probably be able to survive financially without having to work again.
But if you are young and are badly injured in an accident and consequently are unable to work, you will still have to support yourself and any dependants you may have now or in the future. No one will simply give you the money.
In other words, the disability you have sustained, if permanent, could limit your future earning potential.
There is only one way for most people to counter the loss of potential future earnings: by having life assurance against the risks of life, be they an accident or a debilitating disease. Life assurance companies offer a range of products that can ensure that your full potential is reached, no matter what may befall you along the way.
Your income asset or your potential future income is greatest when you are starting out in life, because your potential for earning an income is over a longer period. When you start off in life, you tend to have a very large amount of future potential income and a very small amount of financial capital.
Hedge against disaster
Warren says taking out life assurance should not depend on how healthy you are or how risky your lifestyle is. However, health and lifestyle do affect how accessible life insurance is and how expensive it is for you to buy.
Having good health and a safe, healthy lifestyle does not mean that you do not need life assurance. You can never foresee what may happen tomorrow.
Instead, the need for life assurance depends on how large your future potential income is or, to put it another way, how much you or your dependants stand to lose financially in the future should a disruptive event occur.
Events are random, and it is the magnitude of the impact of those events that determines need. You cannot say for sure when an event may occur, or if it may occur at all. Insurance is a great way to hedge your future potential income and make it safe so that you can invest to achieve your life's goals successfully.
So your future potential income asset is the foundation of everything, including the planned accumulation of wealth.
Most of us are under-assured
You are most likely to be under-assured and need to have a financial health check-up soon to ensure that you and your dependants are properly protected against the unexpected.
Two years ago, True South Actuaries & Consultants undertook research that showed that the vast majority of South Africans are under-insured against risks such as death and disability. The research found the average household earns R60 000 a year (R5 000 a month). At the time of the research the average amount by which the average household should have been assured against death was between R431 000 (if your dependants tightened their belts and did away with all luxuries) and R531 000 (if you wanted to preserve your dependants' standard of living). But actual life cover averaged a mere R239 000. These are the lump-sum amounts that would be needed to generate a monthly income to sustain your dependants. So, if you are Mr or Ms Average and the main breadwinner in your family, and you die or are disabled today, your family would have to cut its living standards by up to half. The annual cost for the average household to get its life cover up to the ideal level would be between R1 330 and R2 322 a year. The total amount that South Africans would have to spend to be properly assured is R34 trillion. Their cover is about R10 trillion short (or R5.6 trillion if their dependants tightened their belts).
To have sufficient life assurance to maintain your current standard of living, you should be paying premiums of about 3.9 percent of what you spend each month on living expenses. To meet a belt-tightening budget, you would have to pay premiums amounting to about 2.2 percent of what you spend each month on living expenses. Again, this is if you are Mr or Ms Average.
The three main risks to your ability to earn an income
1 Dying too soon
This is the risk of death, robbing your dependants of the asset of your future potential income, especially significant if death occurs early in life when your potential earning asset is large but you have little in actual accumulated assets.
Dependants may include your parents who have not planned properly for their retirement.
When you are younger you are likely to use debt to finance assets, particularly for big-ticket items such as a home. Loss of income plus debt could condemn your dependants to poverty and the loss of your home.
To cover both your unrealised income potential and your debt you need life assurance against premature death.
2 Reduced ability to work
A health event can compromise your ability to work or lower the size of your future potential income asset. You may suffer an event that affects your income potential but does not necessarily lead to disability. For example, you may have a non-fatal heart attack that places "workstyle" constraints on you in the future, such as no longer being able to work as hard or take on as much work stress and pressure as was possible in the past, thereby possibly resulting over time in fewer promotions or, if you are self-employed, worse business results.
For this you need dread disease life assurance.
3 Becoming disabled
A health event can prevent you from working altogether and result in you losing your entire future potential income asset from the date of the disability event until death.
A total loss of income has the same financial consequences for your family as your death, except you survive to experience the lost income with your family members.
To cover yourself and your dependants, you need disability and/or impairment assurance.
In most cases, the amount of assurance you need in simple terms is the difference between your earning potential plus debt and your accumulated investible assets.
  
 
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