In our lead story last week, Neil Krige, the former chairman of the Life Offices' Association (LOA), frankly admitted that the life assurance industry has done itself a great disservice with its benefit illustration agreement (BIA). Krige, an actuary and an academic, is one of the most ethical people I know.
Although, as Krige argued, most investors have received above-inflation returns, the problem with the BIA is that it has convinced many policyholders that they should have received more.
The BIA is a forecast of how your investment may perform given certain rates of return. It is not a guarantee. The BIA was initiated when South Africa had high rates of inflation, and its forecasts were based on investment growth of 15 or 12 percent a year.
But the inflation rate has dropped, and so have investment returns. The situation has been exacerbated by the volatile investment markets of the past few years, which have even resulted in invest-ors receiving negative returns.
As a result, Personal Finance has received hundreds of letters from readers complaining that life assurance companies are not meeting their "promises".
The life industry knows it has a problem. Earlier this year, the industry tried to convince the media that we have an obligation to clear up the confusion.
But this has not stopped the life industry continuing to use something that it knows is misleading, albeit with forecasts based on lower growth rates.
Even when you ask for your policy's value before it matures, many life offices refuse to give you the actual value but only its possible value at maturity, based on the BIA. This is unacceptable.
There are three things you need to know to establish how well or badly your life assurance investment is doing:
- The investment's actual value.
- The real rate of return - that is, the return after deducting the rate of inflation. Your real rate of return tells you whether or not you are becoming wealthier.
For example, if your policy is getting a return of 18 percent and the inflation rate is running at 15 percent, you are getting wealthier at three percent a year. If the return is nine percent and the inflation rate is six percent, you are still getting richer at three percent.
- The return against a benchmark, say the JSE/FTSE All Share index. Most investment performance is based on a benchmark. Often financial services companies blame an investment's bad performance on the markets. But when you compare the investment's performance against its benchmark, you find it has under-performed the benchmark the company has set for itself.
Totally ignore the BIA; it is phoney.
Assessing your risk assurance needs
One of the most important segments of your financial plan is risk life assurance against death and/or disability. Yet many people regard risk assurance as a "grudge buy". It is only when you die that your dependants (and you, should you become disabled) discover your folly in not having ensured that you were adequately insured.
And even when people take out risk life assurance, they often fail to properly calculate how much cover they need at particular stages in their life.
In a nutshell, there are risks you can carry and there are risks you must share with others (through risk assurance).
Here is a simple example: You are a married, 30-year-old breadwinner with two children. You have assets of R300 000 that could be used to generate an income. However, you need R3 million to generate sufficient income to replace your income for your dependants if you died prematurely. In this case, you need life assurance of R2.7 million.
However, in 20 years' time you have assets of R3.5 million that could be used to generate an income, your children are self-supporting and you have no debt. In this case, you may no longer need risk assurance because you can carry all the risks yourself.
Of course, the calculations are not as simple as this. For this reason you need to properly assess your needs. The best way to do this is to seek the guidance of reputable financial adviser who will conduct a proper analysis to establish your financial needs. The adviser will then help you select the most appropriate product.
The risk life assurance market has become a lot more dynamic in recent years. New companies have entered the market, making the industry more competitive. This has resulted more complex products being designed that are better equipped to meet individual needs and levels of affordability.
At the end of October, Personal Finance and Discovery Life co-hosted seminars on life assurance to help you understand your needs and structure your assurance.
Personal Finance is publishing the presentations made to the seminars. They are worth cutting out and keeping ... and acting on.
Speaking at the seminars, Herschel Mayers, the managing director of Discovery Life, used the term "protection" assurance rather than the more commonly used "risk" assurance. The latter term is more accurate, because risk assurance is about protecting the financial needs of you and your dependants.
Mayers pointed out that in the past life assurance products were pretty standard, wrapping investment and risk in one product. A new generation of assurance products has moved beyond this. One of the major changes has been to separate the investment and the risk components.
Previously, the main difference between risk products was "price" - how much you would pay for, say, R1 million in risk assurance. But the introduction of new generation products has complicated matters, Mayers said. Now, product features include different benefits and guarantees on premiums (when and by how much your premium may be increased in future).
"It is essential that a full understanding of these differences is fully understood by the consumer and the intermediary," he warned.
Although some of the articles address complex issues, they are well worth reading if you want to understand risk assurance and ensure you get value for the money you pay in premiums.