Factors to consider when deciding to keep or cancel a life insurance policy

Question: I took out a life insurance policy many years ago that will pay out about R20-million. I do not need the life cover any more, as the loan it needed to cover has been settled. The monthly premium is now about R35,000 and it increases by 6% a year. I am 70 and in good health.

Is it prudent to keep the policy or to terminate it?

Answer: The issue of keeping or cancelling a life insurance policy is a relevant one for many people. The premiums often increase by more than one’s income does and they start to use up more and more of the available family budget.

The question is whether you will be helping or harming the family’s financial health by cancelling it. I will take you through my thought process when it comes to answering this question.

We typically take out life insurance to cover a particular risk. This would include covering a debt or protecting the family income.

If the debt has been repaid or you have reached the stage in life where you are living off your capital, is there still a need to carry on paying the premiums on the life insurance? If you invested these premiums, at what stage would you be better off?

As we don’t know when we are going to die, there is no definitive answer I can give.

You can, however, do a calculation to determine at what age the value of investing the premiums is likely to exceed the sum assured should you pass away. There are, however, a few factors that you must be aware of:

Type of life policy

Not all life policies are the same. Many of the older policies combined investment and risk benefits. When you cancelled the policy, you would get a cash payout. This cancellation payout often increased the longer you kept the policy.

They were subsequently replaced by policies that provided just risk cover, so when you cancelled the policy there would be no cash payout. I like these policies, as it is very easy to make a decision as to whether it is worth keeping them.

The current trend among life insurers is to try to encourage you to keep the policies for longer by adding in complicated bonus structures that pay out bonuses or premium refunds at certain stages in the future.

This does muddy the waters a bit, but it is relatively easy to calculate the true value of this benefit.

Annual increases in cover

Is the life cover increasing, decreasing or remaining the same each year? If so, what is the size of this increase?

Annual increases in premiums

Are the premiums increasing each year? If so, what is the size of this increase?

In many instances, these increases are a fixed percentage, so the calculation would be quite simple.

You do, however, have life insurance that increases by an age-rated factor and the premium increase gets larger each year. I would recommend that you take the average increase over the past five years and then apply it into your calculation.

So, coming to your question, I would assume that there is no annual increase in the cover amount and that your premiums will be increasing by 6% a year for the rest of your life. I will assume that the returns that you could get on an investment would be 8%.

So, if you lived to the age of 86 and beyond, you would be better off if you cancelled your life insurance and invested the proceeds.

Remember that there are a number of variables at play, such as your life expectancy and investment returns.

Tax

The other factor that needs to be taken into account is income tax. You will be paying capital gains tax on any investment growth. The life insurance policy pays out a tax-free amount, but it will form part of your estate and possibly attract between 20% and 25% in estate duty.

I would recommend that before you make the decision to cancel your policy, you consult with a financial professional who can help you to unpack these numbers. DM

Kenny Meiring is an independent financial adviser. Contact him on 082 856 0348 or at financialwellnesscoach.co.za. Send your questions to [email protected]

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R35.