The ben­e­fit of in­come

In­come pro­tec­tion spe­cial­ists FMI has re­cently an­nounced the launch of its new Life ben­e­fit. In what is be­ing hailed as a first for South Africa, the Life ben­e­fit will pro­vide both a lump sum pay­ment and an on- go­ing in­come ben­e­fit on the death of the Lif

RISKSA Magazine - - CONTENTS - Do­minic Uys

FMI mar­ket­ing ac­tu­ary, Paul McKillen ex­plains that there are many the­o­ries why in­come pro­tec­tion ben­e­fits might be bet­ter than lump sum ben­e­fits on death. “When it comes to disability many people buy a com­bi­na­tion of lump sum ben­e­fits to set­tle on- off debts, and in­come pro­tec­tion ben­e­fits to pro­tect their fu­ture in­come stream. The same logic should ap­ply when people buy life cover. Part of the rea­son why people buy life cover is to pro­tect their de­pen­dants in the event that they can no longer earn an in­come and sup­port them into the fu­ture,” he says. “For in­stance, the client may want to pro­vide for his spouse for a pe­riod of 20 or 30 years. That same client might also want to pro­vide for his chil­dren to make sure they re­ceive a sound ed­u­ca­tion and are taken care of un­til they be­come fi­nan­cially in­de­pen­dent, or reach a cer­tain age. There­fore, part of the client’s life cover plan­ning is prepa­ra­tion to re­place the in­come stream he would have earned, for the ben­e­fit of his de­pen­dants and their dif­fer­ent cir­cum­stances,” McKillen continues. FMI sees the disability and the life mar­kets as be­ing sim­i­lar in terms of need. In both cases, the client is in­sur­ing against the risk of no longer be­ing able to earn an in­come. While the cover may be for dif­fer­ent risk events, the out­come is es­sen­tially the same.

Tim­ing is ev­ery­thing

While there have been a num­ber of in­sur­ers who have of­fered some man­ner of in­come ben­e­fit in the past, FMI still con­sid­ers its prod­uct unique in a life cover mar­ket that tra­di­tion­ally of­fers only lump sum cover. There are a num­ber of rea­sons for the com­pany’s claim. McKillen points out that FMI took ad­van­tage of a re­cent ma­jor change in the in­dus­try, “In the past, and up un­til March of next year, pre­mi­ums on disability prod­ucts have been tax- ex­empt while the life cover mar­ket had no such ad­van­tage. Any in­come ben­e­fit that was paid out for life cover was de­fined as an an­nu­ity and this ben­e­fit was taxed. The client didn't en­joy the ad­van­tage of any kind of pre­mium de­duc­tion so es­sen­tially they were pay­ing the full price pre­mium and re­ceiv­ing less of the ben­e­fit,” he says. This made in­come- based life ben­e­fits tax-in­ef­fi­cient. From March 2015, how­ever, the pro­ceeds from all life poli­cies will pay out taxfree, re­gard­less of whether they are lump sum or in­come ben­e­fits. “This means that you will get more value for your pre­mium. That is the sort of par­a­digm shift that has opened up this mar­ket,” McKillen ex­plains. The other rea­son that the rest of the life in­sur­ance in­dus­try may have been slow to adopt this ap­proach is a more dif­fi­cult one, ac­cord­ing to McKillen. “The fact is that in­sur­ers

don't have much data re­gard­ing longevity, which means that pric­ing a ben­e­fit that pays out an in­come for life is dif­fi­cult. This may be part of the rea­son why in­sur­ers have shied away from this so­lu­tion in the past,” says McKillen. In con­trast, lump sums have been much eas­ier to price. “When­ever your client dies, you pay the re­quired amount, and your re­spon­si­bil­ity to the client is met with­out the need to fac­tor in un­knowns, like how long the client will live or how fu­ture eco­nomic fac­tors will af­fect the ul­ti­mate cost of the ben­e­fit,” McKillen continues. “We are not the first to pro­vide an in­come ben­e­fit, but what we have done is to ex­pand that uni­verse. What you could buy in the past was a very limited sub­set of the range of cus­tomis­able op­tions that we are now of­fer­ing clients. In this re­gard, we are def­i­nitely ahead of the pack,” he says.

Choos­ing lump sum or in­come

McKillen is quick to point out that lump sum and in­come pro­tec­tion cover are not mu­tu­ally exclusive op­tions. “It is still very much up to the needs of the in­di­vid­ual client. Lump sum ben­e­fits will al­ways be the best op­tion if there are home loans or large li­a­bil­i­ties to be set­tled. And there is no point in us­ing an in­come ben­e­fit when you ac­tu­ally re­quire a few mil­lion in cash right away,” he ex­plains. How­ever, when part of the client’s re­quire­ments is to pro­vide for their spouse, chil­dren, or other de­pen­dants, an in­come ben­e­fit can be most ben­e­fi­cial. There are also cer­tain busi­ness ap­pli­ca­tions where it would be more ben­e­fi­cial for the busi­ness to re­ceive con­tin­u­ing in­come rather than a lump sum, and an in­come ben­e­fit would be bet­ter suited to that. “I would say that there is a def­i­nite space on al­most all our clients’ portfolios for some kind of an in­come ben­e­fit,” McKillen adds. The so­lu­tion ac­cord­ing to McKillen, will al­most al­ways be a com­bi­na­tion of the two op­tions.

The ben­e­fit of in­come

McKillen ar­gues that there are sub­stan­tial ad­van­tages to tak­ing out a life in­come pol­icy. The first of these oc­curs when set­ting up the cover in the first place. “As soon as you try to use a lump sum to cover your fu­ture in­come li­a­bil­i­ties, you need to cal­cu­late how much lump sum cover you are go­ing to have to pro­vide your ben­e­fi­cia­ries with to meet those costs. This cal­cu­la­tion re­quires nu­mer­ous as­sump­tions about fu­ture in­fla­tion, in­vest­ment re­turns, and longevity,” he starts. With a monthly in­come ben­e­fit, the client de­cides how much they want their ben­e­fi­cia­ries to re­ceive ev­ery month. This can ei­ther be for a set time or for the rest of the ben­e­fi­cia­ries’ lives. “We can work that out with­out in­tro­duc­ing the un­cer­tainty of con­vert­ing that in­come stream into a lump sum amount,” McKillen adds. “Us­ing a lump sum to pro­vide for de­pen­dants also in­tro­duces risks to the ben­e­fi­cia­ries at the time of the pay- out as they now need to rein­vest that lump sum on the terms avail­able in the mar­ket at the time. “They will also have to man­age longevity and in­fla­tion risks them­selves. In ef­fect, a lump sum pay out trans­fers risk from the in­surer to the ben­e­fi­ciary. With an in­come ben­e­fit, up­front, there is a much more in­tu­itive match be­tween the client’s needs and the so­lu­tion that the cover pro­vides,” McKillen ex­plains. Ac­cord­ing to McKillen, many clients do not un­der­stand the risks in­volved in life cover plan­ning. “With good fi­nan­cial ad­vice there is no doubt that these risks can be man­aged, but what we’re say­ing is that an in­come ben­e­fit pre­sents a much lower risk and a much neater so­lu­tion. Es­pe­cially when op­posed to rolling the dice with lump sum where the life in­sured takes on a num­ber of se­ri­ous risks,” he says. FMI’s Life prod­uct is still quite new, hav­ing only been in­tro­duced in April this year, “This is def­i­nitely what we call phase one, so we cer­tainly have the in­ten­tion to evolve this prod­uct an­nu­ally go­ing for­ward. We've al­ready had some very good feed­back from the mar­ket about op­tions and fea­tures that are not in­cluded in our ini­tial prod­uct but that are re­ally good ideas. As time goes on, we will be able to bet­ter de­fine our pric­ing mod­els and I think, will be able to of­fer more op­tions to the mar­ket. I can­not pre­dict the fu­ture but I sus­pect that this prod­uct will evolve sub­stan­tially over the next five years,” McKillen states. What is not likely to change, ac­cord­ing to McKillen, is FMI’s phi­los­o­phy on the sub­ject. “We be­lieve that if you face an in­come- based li­a­bil­ity then you should be look­ing for an in­come- based so­lu­tion,” he con­cludes.

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