Mortgage Insurance Part 3 – Critical Illness Insurance

I have already made the case that if you die or become disabled you are not going to be able to pay your mortgage bills. The same is true if you get seriously ill. Critical Illness Insurance is a new kid on the block as far as insurance goes, it was developed by a doctor, one Dr. Marius Barnard in South Africa in 1983, not an insurance company. Dr. Barnard witnessed many patients, suffering from heart attacks and cancer, losing their homes and life savings while trying to pay medical bills and make ends meet. He thought up the idea of buying insurance to protect from the possibility of getting seriously ill. Critical Illness Insurance pays a lump sum cash benefit, this is not how an insurance company would have designed it, and we are lucky they didn’t. If an insurance company invented the product they would have designed it to reimburse you for your medical expenses as you incur them, not nearly as good as a big old bucket of tax free money.

Critical Illness Insurance historically had covered three main illnesses; recently the number of covered conditions has increase to 25 or so. Definitions for what qualifies have also just recently been standardized across a large number of insurance companies.

The big three

1. Cancer
2. Stroke
3. Heart Attack

About 90% of all claims are due to these three illnesses.

The other illnesses include:

• Alzheimer's Disease
• Aortic Surgery
• Aplastic Anaemia
• Bacterial Meningitis
• Benign Brain Tumour
• Blindness
• Coma
• Coronary Artery Bypass Surgery
• Deafness
• Heart Valve Replacement
• Kidney Failure
• Loss of Independent Existence
• Loss of Limbs
• Loss of Speech
• Major Organ Failure on Waiting List
• Major Organ Transplant
• Motor Neuron Disease
• Multiple Sclerosis
• Occupational HIV Infection
• Paralysis
• Parkinson's Disease
• Severe Burns

A lot of people think that disability insurance and Critical Illness insurance are redundant, while this can be true there are situations where one would pay a benefit and the other would not.

For example, if you were to suffer from a heart attack, and need to take 3 months off work, which is typical, you would receive your critical illness benefit, however, you would not receive any disability benefits. Most disability policies have a 120 day wait, you have to be off work for at least 4 months before you start to receive any disability income payments. Since you were able to return to work in only 90 days you receive no disability benefits. You still suffered a heart attack, you still had a life threatening experience, your life is very likely changed forever, shouldn’t you be compensated?

Critical Illness Insurance comes with a few options which are worth looking into. First is the term of the policy. Most CI policies are either a fixed term such as a 10 year term. Or provide coverage to a specific age, usually 65 or 75. 10 year term policies are the least expensive, term to 75 are most expensive.

Return of Premium

One of the most interesting options for CI is what is known as Return of Premium or ROP. By purchasing an ROP benefit you are essentially betting that you will not get sick. If you never claim on your Critical Illness policy you can cash it out and receive a cheque for all of your premiums paid to date. This can be tens of thousands of dollars. A good strategy to employ is to purchase a term to 65 policy, with a return of premium option, once you reach age 65 and retirement, your need for the CI policy ends. At this time your need for future retirement income increases, so we cash out the critical illness policy and put the proceeds to use funding retirement or to purchase a Long Term Care policy.

What’s the catch? There is always a catch, say you have been paying into a $100 CI policy for 25 years, you then cash out the policy at age 65, and receive a cheque for $30,000, how can the insurance company make any money when they give you your entire premium back? Two ways, first they have had control of your premium for the last 25 years, and they have been investing it. Assuming the insurance company earned a modest 4% on your premiums they have accumulated $21,000 in interest which they do not pay back to you. Second, there is a cost to purchasing the ROP option; usually it adds another 30% or so to the cost of the policy. The insurance company has already worked out what kind of premium it needs to collect to break even, which is the regular premium of the CI policy. When a claim is paid on an ROP policy the insurance company has received an extra 30% more than that they needed to break even. It essentially boils down to the loss of opportunity cost on your premium dollars, and if you do end up claiming, you have overpaid for your CI premium by the amount of the ROP premium. Either way you have the insurance when you needed it, and a bag of money if you get sick or when the policy ends.

Slightly off topic, but Disability Insurance also has a ROP option, however, I hate them. With disability you get usually 50% of your money back, rather than 100% with CI, if you never claim on the policy. Not only do you not get all your money back, you are put in a place where you can be legitimately disabled, but you do not file a claim because you don’t want to lose the ROP benefit. CI doesn’t put you in this situation, you either have Cancer or you don’t, you either had a stroke or you didn’t, you don’t have to choose between your health and your insurance benefit. For these reasons I rarely if ever recommend an ROP on a disability policy, yet almost always recommend ROP for Critical Illness Insurance.

What kind of insurance?

So now that we know what our options are what is the best setup for mortgage insurance? Term 10 CI policies are the least expensive, which is good when trying to maximize cash flow to pay off a mortgage. You can also add a ROP option, if you no longer need the policy you can cash out the policy and use the ROP benefit to pay off the last of your mortgage, fund retirement or a Long Term Care policy, or even just take a vacation. Benefit amounts should range from one year’s mortgage payments, to one or two years of family income.

For example:

Bob and Carol are married, they each earn $50,000 per year and each contributes half of their monthly mortgage payment of $3000, or $1500 per month each. If Bob is diagnosed with Cancer, and is off work for a year, his income will stop, so will his ability to pay his half of the mortgage, a CI benefit of $1500x12 = $18,000 would be the minimum recommended benefit. A better amount would be equal to Bob’s annual income, $50,000, this way his year off work would be fully funded just like if he was still working full time. Furthermore, if Carol needed to take time off work to care for Bob during his illness her earnings would drop, therefore, a benefit amount equal to the family income of $100,000 is the best choice.

Focusing on affordable protection, we can create a policy to solve the above problem for under $50 a month. A 30 year old Male, Non-smoker looking for $100,000 of term 10 Critical Illness Insurance, with coverage for all 25 conditions listed above and Return of Premium option at age 65 costs $43.92 per month. At age 65, with their mortgage paid off and no more need for the policy, Bob having never gotten sick can cash out the CI policy and receive a cheque for $44,590 tax free.

Robert Reynolds - GBA
Partner / Group Accounts Manager
HMR Employee Benefits Ltd.

Disclosure: The content of this post are provided as general information only and should not be taken as financial advice. I am a licensed life accident and sickness advisor, I am paid partly by salary for servicing my block of business and by commissions on new sales of insurance and financial products. I do not own any interest in any insurance company nor do any insurance company’s own any portion of my business. The opinions expressed are my own, and do not represent the opinions of HMR Employee Benefits Ltd.