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How can you determine your insurance requirements for better financial risk management?
We often encounter young members of the workforce looking to embark on their financial planning journey with a simple life insurance coverage. This move should be lauded as it makes a lot of sense to play defense before offense, so to speak. To kick start the conversation, the question of affordability will inadvertently crop up – how much can you afford to pay? While this is a practical approach for young career starters, is there a more optimal way to determine your insurance needs for better financial risk management?
Before sharing some thoughts on risk mitigation needs that should be addressed by leveraging on insurance tools, perhaps it is best that I briefly touch on the types of life insurance coverage that individuals can consider.
The most basic is to address concerns in the event of death. The idea is that should financial dependents and family members face a premature or untimely departure of a main breadwinner, there will be a financial payout to help the next of kin recover from this setback by ensuring that living expenses and financial commitments can continue to be met with minimal disruptions for an extended period thereafter.
Related to this is the need to provide financial relief if the breadwinner is still alive but no longer able to generate income due to a total and permanent disability (TPD). In this scenario, funding is required to replace the revenue of the income earner while also considering any additional living expenses that can arise due to the disability.
The third area is for critical illness (CI) needs where a lump sum is paid to the insured if there is a diagnosis of a covered serious illness. This payment can be used to fund non-hospitalisation related medical expenses as well as rising living expenses to aid a faster recovery.
It is no secret that medical inflation is rising rapidly. The escalating medical costs and the fact that life expectancy is prolonging means that it is more important now than ever to have our own hospitalisation & surgical (H&S) coverage (also known as medical card). Lastly, we are also exposed to the risk of all forms of accidents that might partially incapacitate us for a short period or permanently. Personal accident (PA) coverage provides payment for accidental related risks.
Having an appreciation of these five types of coverage will enable us to address our personal risk management need through insurance planning more comprehensively. However, as alluded to earlier, trying to address these areas based on affordability alone might give one a false sense of having effective risk mitigation in place. So how then should one go about calculating the more accurate amount of insurance coverage for the respective funding needs?
1. FAMILY INCOME
Family income refers to the amount of money required to provide sufficient levels of funds to surviving financial dependents, so long as they remain financially reliant on the breadwinner. This will need to cover expenses such as living expenses for the whole family including dependent parents (ideally until the youngest child reaches the age of 25 and for non- working spouse for their remaining life expectancy), education fees and related costs for minor children up till tertiary education and insurance premiums for family members.
It can include funeral expenses and estate administration costs of the deceased also. The sum of these costs will give you a more precise indication of the amount required for death insurance coverage.
2. INCOME REPLACEMENT
This refers to the need for funding if one is no longer able to work due to TPD and is calculated based on how much expenses are incurred in a year for normal living expenses. In the ideal scenario, the calculation should be from now till one’s life expectancy.
However, this could be a tall order for most people, particularly young employees, as such a simple guideline is that TPD coverage should amount to at least five years of income or until one’s retirement age (assuming that one is able to fund retirement expenses separately).
3. DEBT CANCELLATION
For those who have outstanding loans, especially a mortgage on the family home, or any other loans, this may reduce the amount of money the family will receive and should be considered. Some clients will expect investment properties to be sold while others would prefer to transfer the assets to their loved ones free from encumbrance.
As such, depending on your wishes, you should consider the loan cancellation needs to ensure that your estate has sufficient funds to pay off these loans as well as providing the required funding for the family. You have the option to self-insure (if there are sufficient assets to settle the loan) or transfer that risk to the insurance company. The sum assured needed can be provided for utilising potentially cheaper products such as a term insurance policy over the outstanding loan period.
4. CRITICAL ILLNESS
If you are diagnosed with CI, you may need to stop work temporarily to undergo the necessary treatment and take a break to have a successful recovery. If you need to cover your living expenses during the recovery period due to concerns over non-covered medical expenses or higher cost of living, then CI funding will help to defray these expenses. To ensure that you are not over-paying in premiums for this need, you can use the rule of thumb to provide a sum assured of between 3-5 years of your current annual income.
5. MEDICAL EXPENSES
As mentioned earlier, medical costs particularly for private hospitalisation needs is rising. While one can depend on public hospitals for treatment, it is better to have alternatives via the private medical route. We do have some clients who work with multinational companies providing comprehensive medical card coverage and question the need for their own medical card.
However, our advice is always to obtain your own medical card early so that the premiums are lower while you are in better health. Purchasing one only upon retirement may make you ineligible (due to pre-existing medical conditions) or having to pay a hefty premium due to your age or loading due to medical factors. Ideally one should have a medical card providing a room and board of at least RM200 with an annual medical limit of minimum RM1 million and no lifetime limit.
6. PERSONAL ACCIDENT
Lastly, one should also have coverage for the risk of accidental injury, TPD or accidental death which may not be covered by the above policies. It does not help that the statistics do not favour the young – a higher percentage of youths meet with accidents resulting in the inability to carry on employment, permanent disablement or even death.
One should not only rely on payment from SOCSO for accidental claims as there are terms and conditions to be met. Often forgotten (as they are rarely sold due to low premium costs), PA policies are generally very cost effective especially with the attractive renewal bonus offered. Similarly, you can use the guideline of providing a sum assured of between 3-5 years of your current annual income for this need as well.
In summary, the path to having the right insurance coverage is indeed a balancing act of sorts. Too much, and you might make it more daunting to save and invest to achieve your desired financial goals. If you are under- insured, then you or your dependents might be in a financial quandary. So good on you for getting the ball rolling by purchasing insurance policies based on what you can currently afford as a fresh member of the workforce, but do recognise that you will need to review your needs over time to ensure that you have an effective financial risk management plan in place
First published in Smart Investor 03/04, 2022 Issue
Felix Neoh
Director of Financial Planning at Finwealth Management Sdn Bhd
