Quick question…What percentage salary increase did you get last year?
So how much was it – 10%, 5%…0%?
The reason I’m asking is that life insurance can seriously dent your pocket especially IF you make the wrong financing option in the beginning.
Let’s imagine your life insurance was costing R200 a month last year and it’s just gone up by 10% to R220 a month. That means two fewer loaves of bread you get to take home.
Now that would be fine if your salary also went up by 10%, but what if it didn’t?
So you’ve got four options:
Let’s start with 5% compulsory annual increase premiums
Before the introduction of age rated and stepped premiums, you had very few options when it came to the financing of life insurance.
You could either:
- opt for a fixed premium or
- you could have a premium which increased every year with 5 or 10%.
But you’ll be amazed at the number of people who still get confused when it comes to compulsory annual increase premiums.
Lawrence, why must I pay more for life cover every year when the cover always stays the same?
Good question you agree?
The easiest way for me to explain is to compare it to an investment…
Let’s say that you want a lump sum of R30,000 available in five years time.
Divide the R30,000 by the number of years and months. R30, 000 divided by 5 years divided by 12 months equals R500 per month.
Start off with a low premium of, say, R400 per month and then increase that by 10% every year to get to the R30,000.
Life insurance works in pretty much the same way except you don’t get the R30, 000.
So why would anyone choose a compulsory annual increase?
The short answer is…affordability.
- “I need R3 million in life cover but can’t afford the R1, 000 a month level premium. Why don’t I go for the R600 per month policy with the 5% increase every year? My salary increase is around that every year anyway.”
But what if you want my cover to increase as well?
You can always do that. All that happens is that every year your life cover increases with either:
- 15%, or
- CPI (consumer price index)
Let’s say, for argument’s sake, that you chose 5% as your cover increase amount, and that you originally bought R1 million in cover…
Your cover will increase as follows:
- Year one – R1,000,000
- Year two – R1,050,000 (R1,000,000 x 5% = R50,000)
- Year three – R1,102,500 (R1,050,000 x 5% = R52,500)
The insurer then calculates the appropriate premium for the additional R50,000 in cover – bearing in mind that you’re one year older – and simply add it onto your existing premium.
So let’s say the additional R50,000 in year two costs R40 a month extra. Then in year three that R40 increases by 5% as well.
The insurer does illustrate your future premiums on the quotation, so you will know upfront what you’ll be paying every year.
There is another option with compulsory annual increases…
You can choose to have the cost increase with an additional percentage every year.
Why choose a compulsory annual increase of 5% in the cost instead of a 5% increase in the actual cover?
It’s simple really…let’s assume you can afford to increase the premium with 10% each and every year.
The insurer then takes that extra 5% and purchases additional life cover on your behalf (Bearing in mind that you are now a year older) for that exact Rand amount.
This way you get to control how much you spend on life insurance along with an annual hike in the amount of cover!
By the way, this also applies to ‘age rated’ and level premiums.
So hopefully you’re starting to get an idea of what’s really important when buying life insurance.
It’s not what life insurance is costing you now that’s important – it’s what life insurance is going to cost you in 5 years time that’s important!
Still have questions around 5% cost increases?
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