A critical illness is a life threatening or altering condition that often strikes with little or no warning. In Canada, one in two men and one in three women will suffer from heart disease (Heart and Stroke Foundation, 2004) and 1:2.3 men and 1:2.6 women will develop cancer (National Cancer Institute of Canada, 2004).

Most people are insured if they die from one of these diseases, but very few are insured if they survive. The good news is that more people are surviving. 80% of hospitalized heart attack patients survive and 80% of stroke patients survive (Heart and Stroke Foundation, 2004). However, survival does not ensure financial or emotional well-being.

Surviving a critical illness can place a huge financial strain on a family – lost income, renovations

Critical illness (CI) insurance is designed to address this concern by providing a benefit while the insured person is still alive. This benefit is extremely important when someone suffers a serious illness that affects their ability to earn income or reduces their life expectancy.  

The benefit paid out by critical illness insurance is paid in a tax-free lump sum. How the benefit will be used is up to the patient. It can be used to replace lost income, pay for medical services, make a necessary home renovation, pay off debts or even to take a final vacation if the critically ill is expected to die.

There is a waiting period before the benefit is paid out. The benefit period can range from 14 to 30 days, but usually falls closer to 30. Once this waiting period is satisfied, the lump sump will be paid out regardless of whether they are expected to live or die.

What classifies as a critical illness?

Under a CI policy the insured must suffer a certain critical illness as defined by the policy. There is no standard definition of critical illness but the standard illnesses covered are heart attacks, cancer and stroke. You can find CI policies that will cover addition illnesses and some will cover up to 24 illnesses and will pay you even if you lose loss of independent existence.

In case stuff happens, but what if stuff doesn’t happen?

Another option, or rider, to look for is the return of premium. For example, Great West Life has a CI policy that will return you 100% of your premiums after a certain period if you don’t make a claim. This means that DI and CI offer you a chance to recoup your premiums that can then be invested for your retirement if you never make a claim.

3 crappy ways to cover the expense of a critical illness

Having a policy in place that will pay you a tax-free lump sum benefit is extremely important. For people that don’t have a CI policy there are four common ways to cover the costs associated with a critical illness:

RRSP withdrawal

Withdrawing a lump sum from your RRSP could result in a huge tax liability. For example, let’s say you are at a 40% tax rate and you need $70,000. Before tax you would need to withdrawal more than $130,000. You don’t just lose the tax money, you also lose the possible growth. If you would have left the $130,000 in your RRSP it would have growth substantially – after 20 years with an average return of six percent it would be worth more than $400,000.

Borrowing

A lender may charge a borrower with a known critical illness a higher rate of interest. On top of that problem is that you may have to leave your job because of your illness and that means that you will be applying for credit without employment income. If you can get a loan of $50,000, the 10 year cost assuming an APR of 8.25% is $73,151 and the 20 year cost is $101,208. Using a loan to cover your critical illness is complicated further because chances are you either won’t have a job or won’t be working as much.

Selling assets

There are three problems with selling off your assets, such as your home or cottage.

Timing the market is complicated and you can end up having to selling in a down market.

You run the risk of having to sell in a market like we saw in 2008 and the early part of 2009. Some times it is extremely complicated to find a buyer and when you need to money immediately, this is not a safe option.

Finally, it will reduce your overall net worth, hinder your future ability to get access to cash and reduce the inheritance you can leave to your children or heirs.

A critical illness policy will provide you with the assets you need if you survive a critical illness. You won’t have to worry about liquidating your RRSP, borrowing money or selling your home. Try to find a CI policy with a return of premium option and you’ll get 100% of your money back if you never make a claim.

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For most people, the ability to earn an income is their most important financial asset. If this is taken away, they will not be able to sustain their standard of living or repay their debts. While a person’s most important asset is their ability to earn an income, very few people have their income properly insured.

The most common concern about disability insurance (DI) is the cost. People don’t like paying for something that they might not use. This hesitance has always confused me. People pay for house insurance, car insurance and even trip cancellation insurance, but they won’t pay for disability insurance.

People who work for a company or institution may have group disability coverage through their employer. However, many people are self-employed, don’t have a group plan or don’t have a group plan that provides enough disability insurance. If you are one of these people and suffer from an illness that causes a prolonged disability, chances are around one in eight, you could easily lose everything that you’ve worked for.

Non-cancelable DI

Some disability plans can be cancelled by the insurer at any time. Make sure you avoid these. You want to make sure that the disability insurance policy you sign is a non-cancelable disability plan. Under this type of plan, as long as you are paying your premium the insurance company must renew your plan.

A non-cancelable disability insurance policy will pay out a monthly benefit if you suffer a disability. The payments do not start right away after the insured suffers a disability. Before payments are issued, the insured must satisfy the waiting period. The waiting period is the period of time between when you are classified as disabled and when you will begin to receive your monthly benefit. Waiting periods are usually 31, 61, 91 or 121 days and this can be adjusted when you are getting quotes on your policy. If you are concerned about cost, an easy way to lower your monthly premium is to extend your waiting period. A 91 day waiting period is typically the best bang for your buck.

How much is enough?

It is important to note that most insurers won’t cover 100% of your monthly income. The most an insurer will usually provide is 75%.

There are two ways to determine how much disability coverage you will need:

1. Determine your total amount of recurring monthly expenses and apply for that amount.
2. Determine how much money you make in a month and apply for 75% of that coverage.

Get the base model or upgrade?

There are several options that you can and should add to a DI policy.

• Waiver of premium benefit – If you become disabled, the insurance policy’s premiums will be paid for by the insurance company.
• Future purchase option benefits – If you are purchasing a DI policy at the beginning of your career you should look into a future purchase option. This option allows the insured to purchase additional monthly benefits on certain dates without provided any evidence of insurability.
• Cost of living adjustment (COLA) – You can choose to have your monthly benefit increase with the Consumer Price Index (CPI) or you can have it increase at a fixed percent, for example, four percent per year. Some policies will allow you to switch back and forth between a fixed percent and the CPI options.
• Return of premium – This is an excellent way to solve the problem that most people have with insurance. You pay a bunch of money to cover you in the event of a disability, but you might never suffer from one. With the return of premium option you will be eligible to receive a return of a percentage of your premiums at certain dates if you don’t make a claim. For example, my DI policy gives me back 50% of my premiums every seven years. If I get my premium back, I’ll use it to top off my investments.

Protect your most important asset

Disability insurance protects your most important asset, your ability to earn an income. If you are worried about the cost or that you’ll spend a lot of money you can solve those problems. A good DI policy is essential when you are building the foundation of your financial security plan.

Once you have life insurance and disability insurance, the next thing you need to look at is critical illness insurance. This will be the topic of tomorrow’s post.

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