Understanding your disability benefits
Do you have sufficient cover?
By Trevor Kingsley-Wilkins
In this article
we talk about disability insurance, the cover available, the aggregation
thereof and we shed light on how group schemes differ from individual schemes.
Group versus individual policies
A group scheme is
a policy taken out by an employer to cover the employees in his employ in the
event of disablement, while an individual policy is one that individuals can
take out on their own.
The main difference
between a group and an individual policy is that with a group policy, the
insurer covers a group of employees, some sickly, some healthy, some young and
some old. The insurer of a group policy is therefore able to provide an
automatic level of cover, to a certain, limit without requiring members to complete
any medical requirements. This automatic level of cover is referred to as the
Free Cover Limit. Any member whose benefit exceeds the Free Cover Limit will be
required to undergo medical underwriting which will allow the insurer to make
an informed decision on the granting of any cover over and above the Free Cover
Limit. The medical underwriting requirements will vary according to the amount by
which the cover required exceeds the Free Cover Limit and may range from a
declaration of health completed by the individual to a full medical completed
by a Doctor.
Typically, group
policies are more affordable for the average member, benefitting both older
members who would otherwise not be able to afford the insurance cover, and younger
employees who would not normally worry about insurance cover.
With an individual
policy, the premiums are based on your personal situation; your age, your
health, etc and the premium is based on your
life. No Free Cover Limits will apply and there will be certain medical
requirements for all individuals. Younger, healthy individuals will benefit
from lower premiums, while older individuals may find individual cover to be
more expensive.
Cover available
There are essentially
two types of disability cover, lump sum cover or income replacement cover. We
will focus on income replacement cover as this is the cover most commonly
selected.
A group income disability
product covers the member for 75 percent of his/her pensionable salary. All
group benefits, including retirement funding and death benefits provided by the
retirement fund, are calculated based on the employee’s pensionable salary. It
is important to remember the following:
-
The employer may specify a risk salary which is different to the
pensionable salary, and
-
A group income disability benefit is not a retirement fund benefit, although
it is generally associated with a retirement fund.
Your pensionable
salary will usually be a percentage of your annual salary and may exclude, for
example, your car allowance and medical aid contributions. If your annual
package is not structured, your pensionable salary could be 100 percent of your
annual salary. In general, corporates and large employers use a percentage of
salary, typically 70 or 80 percent, as your pensionable salary.
Calculating your disability benefit
(This is a simplified
example as the group income disability policy is not a fund benefit.)
If an employee has an annual
salary of R100,000 per year and the pensionable salary is calculated at 80
percent, all risk benefits provided by the fund will be based on a pensionable
salary of R80,000 per year. As previously mentioned, income disability schemes generally
cover 75 percent of the member’s pensionable salary, therefore in our example,
the member will receive a disability benefit of R60,000. It is up to the
individual to determine whether this is sufficient.
According to
research conducted by ASISA (Association for Savings and Investment South
Africa) in 2010, the average South African is underinsured by R900,000 in the
event of disability. Based on the ASISA research, I believe that the standard
cover of 75 percent of pensionable salary is insufficient. So what needs to be
done?
As a start,
individuals need to review and understand their own disability cover and then
determine the amount of additional income they believe they will need. This
additional cover can be purchased on an individual basis if there are no
opportunities to increase the cover through the employer’s policy. Some
insurance companies are now offering disability cover of 100 percent of
pensionable salary which leads me to my next point of discussion, aggregation.
Aggregation
South African
legislation stipulates that individuals may not be better off financially after
receiving a disability payout than if they were still working. In other words,
no matter how much disability cover you have, you will never be paid more than
100 percent of your annual salary and the insurers of the various policies will
aggregate the benefit to 100 percent on disablement. For example:
If an employee with
an annual salary of R100,000 has taken out disability cover through various
insurers and policies (for example through the employer’s group scheme as well
as an additional individual policy) to the value of R200,000, on disablement the
insurers would reduce their benefits proportionally to R100,000, which in this
case equates to a 50 percent reduction in the total insured benefit. As the
member will have paid for a benefit they won’t receive, a refund of premiums
from the insurer may be payable. This aggregation applies to both income
replacement and lump sum disability benefits. Lump sum disability benefits are
converted to a ten year annuity benefit, so a R1-million lump sum disability
cover will be converted to an annual salary of R100,000.
The shortfall
that results from the difference between the actual annual salary and the
disability benefit may be insured either as a monthly premium or a lump sum
payment. With reference to the example used to explain how members may
calculate their disability benefit, where based on an annual salary of R100,000
the disability benefit was calculated at R60,000 the member could insure the
R40,000 per annum shortfall as a monthly premium or a lump sum of R400,000.
I encourage
individuals to review the cover they have in place to ensure that they are
neither under-, nor over-insured.
When does a disability policy stop paying?
Any group
disability product that replaces income will cease at the first of the
following three situations arising:
1. Death – Should a member
receiving a monthly disability payment die, the benefit will cease. The disability benefit does not continue and
does not accrue to the estate.
2.
Reaching normal retirement age – Upon reaching the member’s normal
retirement age, the benefit will cease and the member will retire in the same
way as anybody else reaching normal retirement age.
3.
Recovery – should the insurance company determine that the member is
no longer classified as disabled, the benefit will cease and the member will
need to find employment.
Please note that the terms and processes used have been simplified to
facilitate understanding of the concepts. We encourage you to discuss your
personal situation with a qualified Certified Financial Planner.
Momentum
Corporate Consultants: Employee Benefits Division
+27 10 201 4106
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