Should we cancel our life insurance and invest the contributions instead?

I noticed that you referred to having no debt and that all your purchases are made in cash. You also referred to having substantial investments and savings. I would like to commend you on this – you have stuck to the very basic principle of financial planning, namely to keep debt to the minimum and focus on investing as much as possible as soon as possible.

Where you invest is less important (don’t read not important, read less important) than when you actually start investing. Those who start investing early in life have the benefit of experiencing the power of compound interest. They will have to invest less over time than those who delay investing and their cash flow will not be pressured later in life.

Generally, one starts your career and a family with limited assets. During the early phases of one’s working career, debt is higher than later in life due to home loans, car finance, baby expenses, education costs etc. During these times the requirement for life assurance reaches a peak.

As one’s investment portfolio gains structure and value, the requirement for life assurance reduces.

There are exceptions where insurance requirements can be very high in later life, for instance when a business is bought or expanded, and life assurance is required as surety, but I am not going to delve into those specific requirements for now.

Before one purchases or cancels life assurance, you need to determine what you need the assurance for and how much you need. Let us explore a few reasons why one should have life assurance or shall I rather say capital. Life assurance is only required to cover the shortfall of the capital that you have available to meet certain demands or “wishes”. There are many circumstances to take into consideration when deciding on life assurance. The following come to mind, but the list can be extensive:

• To provide capital to your surviving family should you die. If the breadwinner dies, their spouse and children need funding to maintain their standard of living and cover day-to-day expenses.
• Should a person lose their ability to earn an income through an injury or illness capital is required to replace their income either temporarily or permanently. Capital in this case can either be as an insured lump sum or a monthly payout by the assurer.
• In the event of death various expenses become payable, for example:
  • Settling debts i.e., bonds, vehicles, overdrafts, credit cards etc;
  • Paying death duties; and
  • Executor fees.

Where there is insufficient capital (liquidity) available to service expenses in the estate of a diseased, assets will be sold to cover the costs. Life assurance can play a vital role to prevent the unwanted or forced sale of assets within the estate.

So, the main question is, how much life assurance is needed, if any?

Earlier on I referred to life assurance as available capital and that is exactly how it should be viewed. What we must accept is that life assurance is a grudge purchase. Very few people wake up in the morning and with a stretch yell: “Today I am going to buy some life assurance, yay!”

Life assurance must therefore be justifiable and measurable, otherwise it stands to be cancelled as soon as cashflow constraints set in. Every person should therefore also know exactly what the implications will be when they decide to cancel life assurance.

Interestingly, the average person would rather insure their car and household goods than their own life. When asked why, they state in case they are in an accident or theft. My question is always, what are the chances of you being in an accident or losing your car due to theft? And what are your chances of dying….? I think the odds favour life assurance as a potential claim.

My colleagues know that my take on financial planning is simple: It’s all about the income.

Life assurance is no different to investing. The only difference is that with investing the planner gets the benefit of the fruits of investing. With life cover/death cover, the survivor/s of the deceased experience the benefits of it.

Why do I say planning is all about income? It’s simple. The income requirement under all circumstances, whether it be retirement, income for the family should you die or taking a sabbatical, will be the driver of how much investments and how much life cover you need.

Math’s time again…

The rule of thumb is that for every R10 000 income you require per month you need approximately R3 million capital if we base income at 4% per year against the capital/investments. Inflation is assumed at 6% and the intention is that capital will be preserved for approximately 20 years. If any of the variables change then the required capital amount will change. If the income term is shorter or if capital preservation is not important, then the required capital amount will reduce. The required capital amount will obviously also be affected by investment returns. The more conservatively you invest the more capital you will require and vice versa.

In the event of death, the same formula as above can be used however, outstanding debt and death expenses (executor fees and estate duty etc.) must be taken into consideration and added to the required capital amount. If you have a strong investment base that will cover all the above, then you don’t need life assurance. On the flip side, if your investment base does not cover all the potential expenses mentioned above in the event of death, then you know how much life cover needs to be either retained or taken out.

Unfortunately, in most instances death is unpredictable and generally, we just do not know when we are going to die. If we did, planning would be much easier. In the planning world, we always work on the assumption of today.

In other words, if you die today, how will your capital base shape up?

I hope I provided some indication or assistance to help you decide whether you should cancel your life cover or not. If you are still in the dark, please drop me a line and I will gladly assist with some guidance.

Live life to the full and keep on investing.