Finance 101 – Life Insurance

 

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Insurance began as a way of reducing the risk to traders, as early as 2000 BC in China and 1750 BC in Babylon. An early form of life insurance dates to Ancient Rome; “burial clubs” covered the cost of members’ funeral expenses and assisted survivors financially. The first life table was written by Edmund Halley in 1693, but it was only in the 1750s that the necessary mathematical and statistical tools were in place for the development of modern life insurance. This is a really cool fact among us finance geeks, as most people only know Edmund for the famous “Halley’s Comet”. Did you know he was also a VENTURE CAPITALIST???

Life What? How does it work?
So basically it works as follows (in plain English): A bunch of people pool their money together, and a pay-out is made from the very large pool of money if one of the members die. People who are more likely to die soon have to pay more than people who are less likely to die soon. Thus, a 75 year old guy would have to pay more for, let’s say R1 million cover than a 25 year old guy, assuming they are both equally healthy in terms of their medical history, simply because statistically, the older guy is more likely to pass away in the near future than the younger guy. Subsequently, a 25 year old male who is a diabetic and who has undergone heart-surgery is also more risky than a 25 year old guy who has had no out-of-the-ordinary medical conditions, and will thus have to pay a higher premium. So what happens if a young guy gets hit by a bus, how is that fair towards the old guy? Thing is, all people are more or less equally likely to get hit by a bus so you can’t exactly work this into the pricing model, and because insurance models have thousands of members, these extreme events tend not to have such a big impact, although it is still taken into account, but that’s a topic for another day. The importance for this article is the basics, being, you pay x amount every month and if you pass away someone else (who you choose) will receive a pay-out.

So why would I need life insurance?
In my opinion (now this is not the be-all and end-all, but it makes logical sense) is that you need life insurance for any combination of 3 reasons.

1 You have dependents who will need the money if you pass away
A classic example would be John, a father of two children – both in primary school, and also a corporate lawyer. John is married to Lisa, who has a half-day job in order to spend more time with the kids. John would take out life insurance because their family is dependent on his income, and should he pass away, they would be able to invest the money from the life insurance in order to continue living at the same standard as before his death.

2 You have DEBT
Debt is unfortunately a reality for the majority of people in the twenty first century. If you pass away, the debt does not disappear, but forms part of your estate (the total of all your possessions which someone inherits) and your relatives may well end up having to pay your debt. As an example, consider Peter, who is married to Suzy. Peter has R1m debt on his home and R500 000 on his car. Peter has R1.5m life insurance cover, so that Suzy can pay off the debt if he should pass away.

You have more than R3.5m in possessions
South African law works as follows: If a person has more than R3.5m in possessions, and he passes away, he needs to pay estate duty (20%) on the amount above R3.5m, which is a fancy way of saying he needs to pay tax to SARS. As an example, Jack is married to Jill, and Jack has a house worth R3m, two cars worth R500 000 each and investments to the value of R1.5m, all registered in his name. Ignoring all other possessions, Jack has a total estate of R5.5m. If Jack passes away, Jill will inherit Jack’s possessions, but will have to pay the estate duty of 20%, on the R2m (R5.5m – R3.5m). Thus, Jill has to find R400 000 (R2m x 20%) somewhere to pay to SARS, as a tax. If Jack has R400 000 life insurance, she can use this to pay the tax man. This is an over-simplified example, as life insurance may form part of the estate, but it paints the principle…

So what will it cost me?
This is dependent on many factors, your gender (men pay more – yes we also think it’s unfair…), your age, your medical history, your education, your income, your occupation, your marital status – these being the common criteria, but will differ from company to company. You may end up paying R100 per month, for R1m life insurance, where your buddy who is the same age ends up paying R200 for the same amount of cover at a different company, or because he is just less risky to insure.

How do I get life insurance?
Insurance companies work through brokers, who sell their products to the public, and receive commission from these companies for acting as the intermediary between them and the new client. Some insurance companies offer direct insurance, but you will usually still end up paying commission to an internal sales agent – There Aint No Such Thing As A Free Lunch as we economists always say…

Any advice or tips I should know?
YES – Shop around! The only way you will know which company offers the lowest premium is to get quotes from as many companies as possible. Also, look for an independent financial advisor (financial advisor is the fancy word for broker – these guys hate it when you call them reps or brokers). Independent financial advisors work for more than one company, and are not bound to selling only products from a single company. If your financial advisor does his work correctly you will receive multiple quotes from him, drawn from more than one company – so he does all of the searching around for you. Also remember (brokers will hate me for telling you this) that the broker can offer you a commission discount. This means that the broker is paid a little less, making your premium a little cheaper. Now don’t get me wrong, brokers work hard to earn a living, just like any other profession, but people rarely negotiate the fees that they pay, mostly because they are not aware that they can actually do this. And that is the whole point of these articles, giving you the inside info…

Look out for more articles, covering everything from investments to medical aid – keeping men IN THE KNOW

Editor’s note: This article was written by Francois Liebenberg, who works with numbers and stuff when he is not on his mountain bike. Got any finance questions? Pop him an email – Francois@audaciously.co.za

*This article serves to provide information only, and does not constitute proper financial advice as it is not tailored to any individual.

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