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Risk Management via Insurance – Critical Illness Insurance



This is a guest post series by Brian Poncelet who is an independent certified financial planner (CFP) working in the financial services industry since 1994. Along with insurance, Brian Poncelet focuses on mortgage and retirement planning.

Overview of Critical Illness Insurance

Critical Illness (CI) insurance pays a lump sum benefit upon diagnosis of one of the covered conditions listed in the insurance policy. The benefit is tax free and receipt of this benefit does not affect the amount of disability benefits receivable. The funds from a CI insurance claim can be used by the insured as he/she wishes. There may be need to modify the home for wheel chair access due to stroke or to pay for accumulating expenses for cancer treatments not covered by our national health care system. On the other side, if a “mild heart attack” victim returns to work after only 4 weeks, she may chose to invest her money for the future or go an a cruise. There is no requirement on how the benefit is spent.

The History

Critical Illness Insurance was first developed in South Africa in 1983. Dr. Marius Barnard was the driving force behind the development of the product. He is the brother of Dr. Christian Barnard, the doctor who performed the first successful open heart transplant surgery.

Dr. Barnard saw a need for insurance that pays a “living benefit” to offset lost income and to pay for additional expenses incurred by those who survive a major illness. He found that while savings and investments were usually the first funds to erode in order to keep patients’ families afloat, in many cases homes or businesses had to be sold to pay off loans that could no longer be serviced.

“Traditional life insurance was no help here, as it is only payable on the death of the insured person. And increasingly, medical conditions that would have been a death sentence in the past, such as heart attack, stroke and cancer, were now responding well to enhanced treatment methods” said Dr Barnard. “It was very important for me to try to find a solution to help my patients.”

While insurers will pay a reduced sum of a life insurance policy upon diagnosis of a terminal illness, this still leaves a void in the insurance portfolio to care for loved ones or protect an estate upon death. Thus a new type of separate insurance coverage was born, Critical Illness Insurance

Policy Features

The first CI policies covered only 3 conditions, heart attack, stroke and cancer. Over time the list grew to include conditions that were of interest to the population such as multiple sclerosis and Alzheimer’s disease. While banks typically sell policies covering the 3 major conditions, individual and group policies will include up to 23 conditions or more.

Conditions currently covered in Canada include:

  • heart attack, stroke, cancer coronary artery bypass surgery, multiple sclerosis, kidney failure, paralysis, blindness, deafness, rheumatoid arthritis, benign brain tumour, loss of limbs, major organ transplant (or on waiting list), Alzheimer’s disease, Parkinson’s disease, motor neuron disease (a.k.a. ALS or Lou Gehrig’s disease), coma, loss of speech, severe burns, occupational HIV infection, late onset insulin dependent diabetes, aortic surgery, heart valve replacement, loss of independence.

CI policies are sold on an individual and group basis by insurance companies, banks and associations (such as CAA). The market offers CI insurance on a stand alone basis, as a rider on a life or disability policy or as an acceleration of a life insurance death benefit. The latter would reduce the life insurance amount by the amount of critical illness benefit paid.

Premiums for CI insurance may be non-cancelable or guaranteed renewable.

The policy plan types vary from 10 year term to level premiums to age 75 or for life. There may be an option to convert from term to permanent or from CI insurance to Long Term Care insurance (LTC).

Benefits are paid upon diagnosis and completion of a brief survival period as defined by each condition in the contract. Both full and partial benefits are available with most policies. The amount of benefit payment depends on the specific diagnosis and the related contract terms for that condition. For example, a policy for $100,000 may specify only a partial payment of $10,000 for conditions that are not considered immediately life threatening such as certain early stage cancers. The remaining $90,000 is then available for payment upon diagnosis of any of the other covered conditions including a spread of the original cancer. Upon full pay of the $100,000, the contract will terminate.

Who should buy CI Insurance ?

While we do have an attractive health care system in Canada, wait times are long. Critical Illness insurance offers the option to go to another country to seek treatment. The modification of your home to accommodate a wheel chair and medications used to combat the side affects of cancer treatments are only a few of the expenses that may not be covered by the provincial heath care plan. When I ask my clients how they would fund these types of expenses, many feel they would just dip into their savings accounts such as RRSPs.

To this I respond with the following example:

Cindy is 44, single and is 50% owner of a thriving interior decorating business. She has been on the recovery from a motor vehicle accident that left her paralyzed from the waist down. She has long-term disability insurance that replaces 60% of her income. Does she need critical illness insurance as well?

Due to her condition, Cindy needs to hire someone to help with her usual activities of daily living. She also needs to make some home and vehicle modifications and purchase a wheelchair. The total bill will cost $25,000. Her only source for that money is her RRSP. Because she is in a middle tax bracket she needs to take out $45,000 from her RRSP and pay the withdrawal taxes in order to net the $25,000 she requires.

The above highlights the personal affect on Cindy’s lifestyle and future retirement goals. What about her business saw a decline in revenues and lost accounts due to inability to service them. As she was unable to service the business debt, she was forced to sell her share of the business for less than its true value.

If Cindy had CI insurance she may not have had to withdraw funds from her RRSPs for personal use and she may have been able to hire someone to replace her key person status in the business during her recovery. In the event that she could never return to work, a CI policy put into place earlier may have provided the funds for the partner to buy her share of the business.

The average Canadian

While we cannot predict when or if we might be affected by a debility trauma such as a car accident we do not know that about 1in 3 Canadians will get cancer. There will be 75,000 Canadians who suffer from a heart attack (50% are under age 65) and 40,000 will have a stroke each (60% suffer a long term disability).

With early detection the survival rates for cancer is getting higher (five years). For woman with breast cancer it is 82% men with prostate cancer is 87%.

Morality vs. Morbidity

Mortality risk is the risk of dying, at any given time, when compared to other individuals of the same age or sex. Morbidity risk is the risk of a particular individual contracting a disease or other disabling condition at any given time, when compared to other individuals of the same age or sex.

Incidence of Disability and Death at Various Ages – source: Education Committee of Academy of Life Underwriting (2007)

Age Disabled greater than 90 days Disability vs. Death
32 8 per 1,000 8 to 1
37 9 per 1,000 8 to 1
42 11 per 1,000 6 to 1
47 13 per 1,000 5 to 1
52 17 per 1,000 4 to 1
57 21 per 1,000 3 to 1

When a person applies for a mortgage, the bank will generally offer life insurance but rarely talk about disability or critical illness insurance. Since there is a higher risk of disability than death, disability insurance is of great importance also in order to protect against an interruption in mortgage payments.

LTD versus CI insurance

Long Term Disability (LTD) Critical Illness Insurance (no partial payments plan)
Pays a portion of your lost income Lump sum payment
Payments cease once back to work Coverage terminates at first payout
Requires ongoing proof of loss of income to continue benefit payments One time claim adjudication
Payments cease upon return to work Coverage terminates at first payout
The policy continues, additional claims may be made Coverage terminates at first payout

One can clearly see that Critical Illness Insurance does not replace LTD or life insurance but is intended to complement the insurance portfolio.

In summary, most of us have either experienced a heart attack, stroke or cancer or we know someone who has. These potential expenses may affect your current life style and you future goals. I have addressed the potential financial costs but what may be less obvious is the emotional cost of dealing with a critical illness. It commonly understood that a patient with a positive outlook has a better chance of recovery. One can surmise that a patient, who is constantly worried about making the next mortgage payment, may not do as well.

We have now come to the end of the 3 part series.

Insurance is a valuable risk-financing tool. Few people have the reserves or funds necessary to take on the risk themselves and pay the total costs following a loss of life or disability. Using a line of credit or selling investments such as RRSPs to pay for the short fall in income only means someone’s financial future may well be sacrificed. The key is to dust off the benefit hand book, review what benefits are in place and add or enhance where necessary.

Insurance is the one thing you pay for but never really want to use. What if we called it DISASTER PREPAREDNESS because that is what it really is? In a perfect world nothing would happen to any one at any time. But it’s not a perfect world. Insurance allows one to get back in the game financially without having to start from the bottom.

When a disaster like cancer or a car accident that causes injury occurs, it usually is out of blue. When entrepreneurs go to the bank to get a loan for a business, it is common practice for the bank to require insurance as a condition for the loan. Why? Because if something happens to the borrower, the bank is protected. Maybe the banks know something about risk management. As my dad said your health is your most important asset.

Many thanks to Brian Poncelet for writing a detailed series on life, disability ,and critical illness insurance.





19 Comments, Comment or Ping

  1. Brian, say for example a healthy male in his 30′s, how would the premium cost for critical illness insurance compare to disability insurance? Would they be much less?

  2. Brian:

    Thanks for the series. You may want to address who would NOT qualify for CI in terms of a person’s medical history, genetics etc. CI is NOT an easy type of insurance to get given that I understand a lot of re-insurance companies have opted not to re-insure CI carriers so the underwriting has become quite strict.

    As I understand it, DI is really an income test for qualification while CI is a health test and CI insurers are very sensitive to anyone who may even show any signs of future illness to disqualify a person for coverage.

    For someone who may not be able to qualify for CI individually, is there a way to obtain it through a group plan? Thanks.

  3. 3. Cash Canuck

    If you don’t qualify. Take whatever the premiums would be and contribute them to an “emergency account”. If you never get a serious illness, you’ll develop quite a nest-egg.

    In addition, there are no restrictions on “qualifying illnesses” for your own savings. Heck, you could use it on a plumber and a hotel room if the pipes burst in the middle of winter.

    If you do qualify and you think you need it, I would get term and save the difference in an emergency account.

  4. CashCanuck, those are my thoughts also. For those frugal people out there with big cash reserves, they are basically “self insuring” themselves.

  5. Hi Ft,

    For your question: a healthy male in his 30’s, how would the premium cost for critical illness insurance compare to disability insurance? Would they be much less?

    You have to look at what they do for a living. A accountant will pay less for disability insurance than a roofer. But the cost for critical illness insurance will be the same.

    Also, if you get sick or hurt unless you have cancer heart attack etc. with ci you may not be covered like your disability policy. On the other hand if you had a heart attack even with a disability policy you may be back to work in four months!

    The two insurance policies are really different.

    regards,

    Brian

  6. Hi ThickenMyWallet,

    There is two reinsurance “players” Munich Re and Swiss Re for the the reinsurance on critical illness insurance. Swiss Re has pulled out of the Ci market for lots of reasons, but believe or not not because of the risks, (I have some clients who work at Swiss Re). Since Munich Re now is the only player. you will see very similar wording for all CI contracts out there. My understanding is for permanent CI contracts the payout is very high, hence the reason CI insurance is not cheap.

    For Ci insurance they do ask a lot of family history questions but generally it is easy to get. You can also get some gauranteed issued CI insurance as well. My thoughts is to apply and see if the insurance company comes up with an offer.

    You can have this set up as a group plan (no questions asked) for amounts of $25,000 and perhaps more.

    regards,

    Brian

  7. As I noted in the article I wrote on CI insurance on my blog:
    http://www.thetermguy.com/2008/04/08/drawbacks-to-critical-illness-insurance/
    there seems to be little real insurable need for this. In fact, in the above article Brian’s making the case for only $25,000 of critical illness insurance.

    Except that’s not what agents are selling. Agents like to sell amounts of $100,000 or$250,000. that’s way out of whack with what people actually need – if they even need it at all.

    Secondly, this stuff is being sold routinely into places where people don’t have proper disability insurance. Selling someone CI when they don’t have disability insurance with coverage like benefits to age 65 and indexing is, well, not good. But it’s happening. Because it’s easy to sell this stuff to consumers as a feel good lottery. It’s an emotional sale, not a financial sale in most cases.

    Never mind the fact that we don’t have to insure everything. Some things are so unlikely that we people don’t care about the risk. Other things – like a potential 25K loss may not be catastrophic enough to decide to insure. Some of us are actually OK with self insuring through savings or lines of credit for something like this. Balance the cost of the insurance against your other options, like a line of credit.

    Life insurance? You better have a ton of it for most of us. And the same with disability insurance – most folks I see are way under covered (coverage at work is generally not anywhere near good enough in most cases). Until both of those things are looked after, CI shouldn’t even be being discussed – and maybe not even then.

  8. I must have missed the term guys comment. So here goes.

    Criticiall Illness insurance is not of replacement of disability insurance, but can help compliment. Let me give an example. Heart attacks are serious events yet one could be discharged from the hospital in five days and back working within 90 days part time and full time within 180 days. A crticial illness policy would pay a lump sum 30 days after diagnosis a disability policy in many cases would not. After one is working full time the disability benefits would stop.

    Cancer is an other example how many you know have had cancer and survived? If the lump sum could pay off the mortgage get faster treatment in the US would that be good? Of course! In the case of cancer go to http://www.cancer.ca/ for lots of information about the amount of cases every year, the financial problems people face etc.

    If you are a numbers person getting a heart stroke or cancer is more likely to happen first long before death in many cases five or more years. Which means family finances can be destroyed. The term guy suggests using a line of credit, if you are self employed or employed or even resently unemployed what happens to paying the interest? Do you sell your RRSP’s or open accounts and pay tax to pay the interest?

    Another reason to consider getting a criticall illness policy is some policies offer “Best Doctors” http://www.bestdoctors.com/corp/index.html
    in a nutshell one can get a second opinion on a diagnosis this cost a lot a money every year if you just want this benefit for your self or family. There is some examples of people (including a friend of mine) who were misdiagnosed featured on a radio ad. Best Doctors helped them.

    If you look at premiums,l a 40 year male (as an example) for a $100,000 a permanent coverage would cost about $100 per month…not cheap! But lets say you could get 8% rate of return after 25 years ,you still would not have $100,000 tax free. At 5% after 32 years you would still be short, $100,000 tax free. The odds of something like cancer, heart attack stock happening over a lifetime is very high. Term in my opinion for this product is like renting.

    The bottom line is criticial illness is part of risk management like everything no one product solves all problems but to protect assets begin used up in an emergency is important. The key for many people is cash flow.

    Does it make sense to spend a percent or two proctect of one’s gross income to protect the other 98%?

    regards,

    Brian

  9. 9. cannon_fodder

    Brian,

    Interesting points. I will look into this and see what my work covers.

    Just for kicks, I decided to look at the comparison to you made between investing $100/month at 8% over 25 years vs. the premiums.

    Instead, what if I borrowed around $15,000 at 6.35% to invest in equities in a TFSA (let’s ignore the $5000 annual limit for now – we’ll imagine my wife and I split it and we do this using this year and next year’s contribution room). If we achieve 8% return we will have over $100,000 tax free after 25 years and our cash outlay would be around the $100/month over 25 years like your CI premium example.

    Of course, this latter method would allow us to use the money for anything we want should we be fortunate enough to not need it or could be used for either person rather than only the individual for whom this policy was written.

  10. Hi cannon_fodder,

    The 8% sounds good but the problem is the time you the money (which could be any time) the market has taken a dive..like 2008 now the returns say over ten or even twenty years might be say 5 or 6%! The best time to own the critical illness insurance policy is the same day you bought and your doctor sends you to get a MRI for the lump on your arm. The return on that would be excellent! But you don’t buy it (the insurance) because you think you are going to be sick the next day you buy it to protect the assets you will have to sell.

    Using a line of credit like the term guy talks about is crazy, he is assuming the person will be back to work right away. He does talk about the fact the disability may only pay 60% of the gross income…most people can’t take a 40% pay cut!

    As an example, if you are a manager at high stress job and you can’t put in your 60 hour work week (after you get sick) you can bet the company will try to get rid of you with a package, if it makes sense! Remember in this economy lots of people can get laid off at the same time so this could easily happen.

    regards,

    Brian

  11. Here is some more information why criticial illness insurance protects your money. I had to go to the hospital (yesterday Dr.’s orders) emergency. The bottom line is any more criticial illness I’d buy would now be rated (more expensive!) The lesson for anyone who reads this posts is get all the insurance coverage etc. you can afford! Why? If you health changes…it always changes as you get older you may not be able to buy it! If some said we can’t sell it to you or you don’t meet our guide lines how do you feel? If you have a family it’s very important!

    In the Toronto Star (I read while waiting in emergency!) Wait times for (in Ontario) chemo jump 10% for 2008. In other words the average wait time is 73 days! This compares to 67 days in 2007! Dr. Terry Sullivan president and CEO of Cancer Care Ontario recommends waiting no more than 28 days!! Read the rest of the story http://www.thestar.com/article/626083

    The bottom line is health care I believe will cost all of us more money if we want better faster help (say in the US). If some said for faster treatment cut us a check for $100,000 US to increase the odds of betting Cancer where does the money come from? A line of credit (like the term guy suggests) RRSPs? Open money?

    I think down the line there may be a Health Care Account like the one set up in the US last year. Where a taxpayer can put money aside in a tax sheltered account so he/she can use when the bills come in when they get sick.

    Note the TFSA is really like the ROTH IRA in the US. We are about 10 to 15 years behind. http://en.wikipedia.org/wiki/Roth_IRA

    Brian

  12. 12. Sayvari

    I think it i necessary to draw out the the purpose of CI Insurance and Mortgage Insurance, CI is basically to cover the health of the Mortgagor whereas the Mortgage Insurance (CMHC) is for the Mortgagee.

    Generally it is impressed upon by the Insurance agents that CI Insurance is necessary to pay off the mortgage, but CMHC shall cover that.

    With so many foreclosures coming up does it imply that the Banks are double dipping, from CMHC as well as from foreclosures, any ideas?

  13. Sayvari,

    CI (critical illness insurance) can be used for paying off the mortgage or any other use you feel makes sense. If you can get 8% on your investments and you don’t get a critical illness, like cancer, stroke, heart attack. MS, etc. for 26 years you don’t need it (based on a 40 year old male.. $100,000 tax-free permanent coverage). If you got hit by a bus, the benificeries would get the premiums paid.

    The CMHC statement I am not sure of, but I think the banks do not double dip. Best bet is to go to their web site http://www.cmhc-schl.gc.ca/en/index.cfm

    regards,

    Brian

  14. 14. Chris

    “The lesson for anyone who reads this posts is get all the insurance coverage etc. you can afford!”

    What? You should only be buying insurance on things that need to be insured! If you have extra money, buying more (unnecessary) insurance will certainly not give you the best return on your investment. Is there an “insurable need”? If not, do not buy insurance on something!

  15. 15. Biren

    Which is more important CI or Disability Insurance?

    Thanks

  16. Biren,

    Your question “Which is more important CI or Disability Insurance?”

    Both have their place. If you are self-employed disability will only cover your earned income. You can buy up to $2,000,000 with CI.

    If you get back problems disability insurance (a good policy) will pay CI will not.
    It’s like saying is a car or truck better? It depends on need. If you can afford it the best is both. Since everyone is different there may be other factors in play.

    cheers,

    Brian

  17. I thought I’d revist this…

    A comment from cannon_fodder …

    Instead, what if I borrowed around $15,000 at 6.35% to invest in equities in a TFSA (let’s ignore the $5000 annual limit for now – we’ll imagine my wife and I split it and we do this using this year and next year’s contribution room). If we achieve 8% return we will have over $100,000 tax free after 25 years and our cash outlay would be around the $100/month over 25 years like your CI premium example.

    My questions are since investing, say ten plus years, has anyone got 8% plus return after taxes? Anyone come across a family member, friend, etc., who has had Cancer, Stroke or Heart Attack during that time?

    The other thing is premiums would be returned to the beneficiary if death happened within 30 days. This is not for everybody. Not everyone can get this from the insurance company.

  18. HI FT.

    My wife went to a living benefits seminar here in Mississauga. Which covered topics like Critical Illness insurance.

    One of the speakers was Brian Goldman Emergency Physician at Mount Sinai Hospital in Toronto.

    He talked about the fact Canada’s population is aging rapidly. Out of pocket prescription drugs (new) is beyond the pocket-book of many of us. Five million Canadians can’t find a family doctor. His book is called Night Shift and is the Host of CBC Radio’s White Coat, Black Art.

    Another Doctor was Jean Leclerc who talked about the most common cancer for men …prostate Cancer. The value of and methods of early detection. (Which better Critical Illness insurance covers). This is timely since many men are trying to grow a mustache. See http://www.prostatecancer.ca/ for more information.

    Brian

  19. Here is an update.

    I have a client who had a serious illness. (Back at work within 3 weeks)

    Got paid a lump sum. Dave was kind enough to post his thoughts on video.

    See link below.

    http://www.youtube.com/watch?v=5VOZsO3_kZs

    Regards,

    Brian

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