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.
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
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.