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Such is the success of ‘cash back bonus’ marketing campaigns that ‘Do you have a cash back bonus?’ is one of the most frequently asked questions from new policyholders. It is something that sounds so obviously to your advantage that few individuals have done the arithmetic to understand if they would truly be better off with or without it.
Our research suggests you would only be better off within a narrow set of circumstances, which in reality means most people would be worse off. In the case of a well-known local insurer, for example, cash back bonuses on life insurance come with T&Cs. To qualify for it you have to opt-in, and that comes at a cost of an increase in your premium of about 30%. Then you will only get the full bonus if you do not lapse your policy for 15 years and do not claim on it for 15 years. So whether you will be better off with a cash back policy depends on three criteria:
whether you could have made more money yourself by saving and investing that 30% loading on your premium;
whether you claim or lapse the policy during its life, thereby forfeiting the bonus; and
whether even the basic premium you pay isn’t higher than you could get from other non-bonus paying insurers.
We recently obtained a quote from this insurer’s call centre for R3 million life and R1m critical illness cover for a 53-year old woman. The premium quoted came to R2,893.43, including the cash back pay-out. By opting out of the cash back plan, the cost fell to R1,591.48 – which in this case is 45% cheaper - just to note this could possibly be skewed by the individual circumstances of the person i.e. their risk profile.
We used her risk profile and the quote to answer the question: Is the life bonus a good long-term option that is worth the additional average 30% charge, or in this case, 45%?
Could she make more money herself by saving and investing that additional 45% loading?She could – but only if she was very savvy and saved her 30-45% by investing it in one of the top-performing unit trusts in the country.
Based on the company’s marketing material, the premium option selected increases by 7.5% a year (though the group average is around 6%), which over 15 years would see R972,919 paid in total if no claims are made throughout the 15 years.
By foregoing the cash back option, your monthly premium would have been R1,301.95 less per month – over 15 years leaving a total of R437,784.89 to save and invest at your discretion. If one were to take that R1,301.95 a month and save it instead with a reputable fund manager investing on the JSE, how would it work out?
We crunched the numbers and calculated that an investment portfolio would need to generate an after-tax return of approximately 17.7% to match the cash back pay-out. That is not impossible: according to Moneyweb’s January ranking, a number of the top-performing equity funds in South Africa have shown an annualised total return between 17% and 20.3% over the past decade. Pick one of them, and she’s ahead!
Bear in mind that most people take out life insurance not as an investment but to financially protect their families. Should your family claim on the policy before the 15-year period is up, the cash back pay-out effectively disappears, and cannot be claimed. If you chose to invest your own savings, however, these funds would still be available to your family. That is the major differentiator.
Will the policy lapse during the first 15 years, thereby forfeiting the bonus?
Based on industry statistics, our policyholder is statistically unlikely to hold the policy long enough to receive the full bonus.
Based on industry statistics, our policyholder is statistically unlikely to hold the policy long enough to receive the full bonus.
Cash back bonuses serve one primary purpose – to lock you in for the long-term. It is a well-known industry fact that most policyholders lapse their policies within 10 years either because a policyholder can no longer afford the premium or she has found a better offer.
Bear in mind that what should be important in your life is NOT to be locked into any contract.
Most people are therefore giving away that 30% premium for something they are almost guaranteed never to receive full value from. You therefore need to be certain that you are going to stick it out for the duration to make the inflated premium worthwhile.
So ask yourself, how certain are you?
Is even the basic premium she’s paying on par with other non-bonus paying insurers?Comparable quotes obtained by the woman suggest the basic premium quoted to us is neither the cheapest nor the most expensive. This point talks to the obvious need of policyholders to shop around. In this current tough economy, most people are looking for clever ways to lower their costs, and our research suggests that cash back bonuses certainly do not fall into this category – so when taking out life insurance do the math for yourself (as above) rather than listen to one sided marketing hype.
How you should view life insurance
Here are four simple steps we recommend to cut through the clutter:
- Value for money: You want the best insurance for your needs and budget. Most people simply want assurance that either themselves or their family will get paid out as much as possible for the lowest monthly premium.
- Get the best benefits money can buy: Life insurance policies are bundled with a number of benefits, including immediate pay-outs to cover funeral expenses and terminal illness benefits. It’s important that you weigh up and compare all of these before choosing the product that best suits your needs. If you’re still considering a cash back pay-out, then it must be considered along with the other benefits offered by the provider
- Shop around: This obvious rule should apply to everything in your life!
- Don’t confuse life insurance with investment: If you want to save money every month for 15 years, don’t use your life insurance policy to do so!
The bottom lineIf you are considering buying life insurance, and a cash-back plan is still appealing to you, it’s important to be sure that you want to stay with the same insurer for the next 10 to 15 years, no matter what other offers come to market or what financial obstacles you might encounter.
