Life insurance – are you over- or underinsured?

If you have life insurance, being overinsured or underinsured can leave you financially exposed.

Being underinsured may leave you unable to cover your expenses should you become disabled or fall critically ill – or leave your family in a financial bind should you pass on. Being overinsured will mean spending money on premiums that could be better spent elsewhere, such as a retirement fund.

We consider how to tell if your insurance is fit for purpose, and if not, the adjustments you can make to ensure the correct level of cover.

Tip: Thinking ahead to retirement? Find out more and start saving here.

Assessing how much cover you need

Insurance is a benefit that mitigates financial loss, says Cherise Erasmus, a financial planner at Crue Invest. Any potential losses must be calculated according to your specific needs.

“If you have a mortgage bond and you owe R1 million on it, your insurance should cover R1 million. If you also owe R200,000 on your car, you should be insured for R1,200,000,” she explains.

Your employer may offer you cover, but you must ensure it’s sufficient, notes Leigh Solomon, head of underwriting at MiWayLife. If the amount covers your outstanding debts and any legacy amounts you want to leave for your family, further cover won’t be necessary.

A practical way to assess how much cover you need, especially if you have dependents, is to look at your monthly expenses and decide which financial gaps may need to be filled if you’re no longer around. Online insurance calculators can help you to determine how much cover you need, and you can make adjustments based on affordability.

“As circumstances and finances change with time, it’s important to regularly check whether you have sufficient cover,” Solomon says.

Consequences of under- and over-insurance

If you have a significant debt, such as a home loan, for which you have insufficient cover, you could be placing your estate at risk.

“If you pass away, the remaining amount must be covered by alternative liquidity in your estate,” says Erasmus. “This may mean that money in your estate meant for a different purpose, such as your children’s education, will have to be used to cover your bond repayment, leading to another shortfall.”

“The other risk is that you don’t have sufficient liquidity in your estate, and your beneficiaries need to pay these liabilities. Alternatively, an asset from the estate will need to be sold, which could affect your entire plan.”

Being overinsured presents its own set of problems, explains Munaf Mukadam, a wealth manager at Gradidge-Mahura Investments.

“If you earn R40,000 a month, for example, and you have income protection to the value of R60,000, you’re clearly paying for insurance you don’t need,” he says.

Some insurers’ income protection products don’t pay out more than the client was earning, which means that you may be paying for income protection cover that you will not be able to claim.

“It’s important to check whether your employer offers income protection, as this is also taken into account when an insurer determines a payout,” Mukadam says. “Employer risk benefits are often included in your cost-to-company package, so it’s important to account for your employee benefits when preparing a risk plan.”

How to find out if you have the right cover

Craig Baker, CEO of MiWayLife, says you should ideally review your life cover every two to three years, or whenever you have lifestyle or life-stage changes, such as getting married or divorced, having a child, acquiring significant assets, or changing jobs.

An independent financial planner can perform calculations based on scenario simulations, such as what would happen if you were to die suddenly. “These calculations can be complex, so it helps to work with someone who can tell you if you’re under- or overinsured,” says Erasmus.

You need to understand the specific risk for your life stage, along with the requirements, such as life cover, income protection or critical illness cover. Mukadam says it’s prudent to be insured for your specific needs. Some factors to consider are the end date of the cover and premium patterns.

“You don’t want an age-rated premium pattern for cover you’re planning to have for the rest of your life,” he says. “However, if affordability is an issue, then an age-rated premium pattern may be suitable. Also, you won’t require income protection after retirement, so be sure to cancel insurance you no longer need.”

He points out that insurance is not as straightforward as you may think.

“There are numerous technical details to an insurance policy. It’s vital for a financial adviser to have a thorough understanding of your financial circumstances and your objectives to devise a plan that best fits you,” he says.

Erasmus says that if you have limited funds it makes sense to prioritise the most important insurance need, and add other insurances as cash flow allows.

What can you do if you’re under- or overinsured?

If you’re underinsured, your financial planner will provide you with comparative quotes to assess which offers the best value for money, taking affordability into consideration.

If you’re overinsured, you can cancel cover you don’t need and redirect the saved premium. “Cancelling cover is not difficult, but most companies request this in writing to cover themselves and the insured person,” explains Baker.

Baker points out that it is possible to consolidate your cover, thereby getting cover at a cheaper rate with an existing insurer. “This is preferable to having multiple policies – but you should obtain quotes from the companies to understand the options,” he says.

Tip: Did you know that you can consolidate your debt as well as your insurance cover? To find out more about debt consolidation, click here.