Critical illness insurance: Deciding on a dollar amount

By Warren S. Hersch

April 11, 2014 at 11:02 AM

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While sales of critical illness insurance — a product that pays a lump sum in cash if the policyholder is diagnosed with a critical illness covered by the contract — are growing, the needs analysis underpinning a product recommendation (a key component of the sales process) remains a work in progress.

Should the policy size be $30,000 or $300,000? Beyond certain known figures, estimates often become guesstimates. one reason is the lack of industry data about expenses incurred by those diagnosed with a critical illness, be it heart attack, stroke, cancer or other life-threatening ailment. That information would be especially useful for individuals who have a family history dealing with one disease or another. The data might also help boost revenue for an industry that prides itself on the ability to leverage numbers to achieve financial objectives.

A look at potential expenses

Advisors, however, are not without a foundation to guide their planning recommendations. Among the main out-of-pocket expenses factored into a critical illness insurance (CII) needs analysis are costs not covered by an individual's health insurance plan. These include deductibles, co-payments and limits on total plan payouts — expenses that could quickly place a family's financial position in peril.

This assumes, of course, that there's a health insurance plan to discuss. Since enactment of the Patient Protection and Affordable Care Act (PPACA), many Americans have had their insurance policies cancelled because the contracts (primarily bare-bones major medical plans) failed to meet the government's new standards. Those who can't afford, or elect not to purchase, qualifying health plans available through the federal or state exchanges will need to factor non-covered CI expenses into their calculations.

Steve Rowley, senior account executive and vice president of individual products, life/health division at Gen Re, observes that health care expenses will also vary substantially by benefit eligibility trigger (e.g., cancer vs. heart attack) as well as by the severity of the trigger (i.e. low stage prostate cancer vs. high stage lung cancer). And then there's recovery time.

"Dying may not be the biggest threat to a family's financial survival," says Lloyd Lofton, a vice president and chief operating officer at American Eagle Financial Services, LLC, an independent marketing organization. "A long recovery from a critical illness can result in a lack of income to pay the mortgage. When you don't pay the mortgage, you may end up losing the home." Ken Smith, director of health product sales at Assurity Life Insurance Company, adds that CI policyholders should figure on covering between two and five years of mortgage payments.

Also to weigh are personal relationships that may be impacted by a critical illness. A spouse, adult children or other family members may need to take time off from work, potentially without pay, to care for someone with a critical illness.

Critically ill individuals who have disability income insurance can also depend on DI policy proceeds to cover a financial shortfall stemming from a loss of income. But DI policies come with often unhelpful restrictions.

Assuming a critically ill person has only a group policy through an employer, then the contract will pay up to 60 percent of income (usually defined as base salary). The group DI policy can be supplemented by an individual DI policy to cover most (though not all) of pre-disability income.

Regardless, the most popular DI policies have a 90-day elimination period before benefits kick in — a time frame that individuals with little in savings can't easily afford. To boot, a DI policy may not pay out because of how disability is defined (e.g., an inability to perform one's own occupation versus any other occupation for which the policyholder is qualified by education, training or experience).

In the event an individual with a CII policy is diagnosed with a covered critical illness, there's no wait time: The policy pays out upon diagnosis of the illness. CII policies will also pay out, says Lofton, in the event that treatment of one covered critical illness leads to another.

A debilitating critical illness may also require home modifications (such as a wheelchair-accessible ramp) or a home attendant to provide certain services. The critical illness may also entail travel to "centers of excellence" to receive necessary treatment — a situation that can substantially boost out-of-pocket costs.

"Someone living in or near New York City has access to some of the best hospitals in the world and many would be in network," says Gen Re's Rowley. Contrast this scenario with "someone living in rural America who may have to travel substantially for treatment, incur hotel expenses and likely have to pay higher out-of-network costs." Beyond the known variables, arriving at policy size requires a certain degree of guesswork. In many cases, the face amount will simply be decided by what an applicant can afford. Affordability should be less of an issue if critical illness insurance is purchased as a rider to a term life insurance policy. Hybrid life/CI solutions, like their long-term care insurance counterparts (life/LTCI), are growing in number to cater to middle market consumers for whom a single-purpose product is beyond reach.

But there's a catch: If the critical illness rider is invoked, the policy death benefit will be reduced by the amount distributed to cover CI expenses. For those intent on passing on a legacy to policy beneficiaries, that has to be of concern. Also a potential issue is the limited duration of coverage. Whereas the critical illness rider lasts only as long as the term contract, stand-alone CI policies typically last to age 100.

Whatever the policy chassis, CI coverage is becoming increasingly prevalent within the individual, voluntary/worksite insurance markets and group/non-worksite markets.

A 2013 survey published by Gen Re, LIMRA and the National Association for Critical Illness Insurance (NACIII) pegged new business CII premiums in 2012 at $308 million. That's up nearly double from the $162 million recorded in 2011 and up from $227 million in 2010.

Worksite/voluntary products continue to account for the lion's share of these aggregate totals. But on a per contract basis, individual products take the lead. The average policy size for individual insurance in the 2013 survey is $27,458. This is followed by true group policies at $23,832 and worksite products at $19,550.

Getting on the bandwagon

The burgeoning CII market is prompting more carriers to join the fray. Of the NACII member companies polled in a 2011 survey, 87 percent indicated they are currently developing (or currently have) a critical illness product. Key reason: Doing so can help fulfill their "product diversification strategy" and meet agent/sales force demand.

The face amounts available for purchase vary by market segment. Bob Patience, vice president of voluntary benefits at Prudential Group Insurance, says that in the employer space, policies typically are limited to $100,000 in coverage. In the U.S. individual market, carriers offer up to $500,000 in coverage. At Assurity, the average policy size is $115,000. But Ralph Weber, founder and president of Route 3 Benefits, says he has sold — in Canada — face amounts of up to $2 million. "If a need can't be met under Canada's socialized health care system, a critically ill individual may need a lot of cash to get treatment in the U.S.," says Weber. "That's one reason why Canadians tend to buy more coverage."

They tend to buy more, too, because there is a greater focus on critical illness insurance in financial planning engagements north of the border. According to Weber, Canadian financial advisors take a holistic approach to planning, in contrast to U.S. counterparts who tailor their practices more narrowly (specializing in, for example, investments and/or particular lines of insurance.)

Such generalized planning in Canada is reflected in the more comprehensive financial planning software they use: Most of the apps have a CII needs analyses built in, in marked contrast, Weber contends, to planning software available in the U.S. Further, many providers of critical illness insurance are now developing tools to help U.S. advisors generate estimates or recommendations for CII coverage. But given the difficulty in estimating out-of-pocket CI expenses, deciding on a formula remains an elusive industry goal, in part because of the dearth of industry data on critical illness expenses incurred. "There are no known formulas, such as percentage of income, percentage of health care costs, etc., that we are aware of for CI policies," says Gen Re's Rowley.

Prudential is developing a Financial Wellness Index that focuses on key financial risks, among them premature death, loss of a paycheck and likely out-of-pocket costs (health care plan deductibles, etc.). The index is expected to be unveiled in the third quarter of this year.

"What we're doing is using the index's financial measures to create risk profiles for particular groups," says Patience. "There are other indices in the marketplace, but the application of these measures to particular groups makes ours unique.

"Our behavioral finance research shows that often people don't address a financial need because they don't know where to start," he adds. "So the idea of the index is to create a starting point for a conversation about critical illness insurance."

And hopefully the ending point will be a sale — or, more likely, multiple sales. Prudential, like other market players, is now targeting the sweet spot for CII products: the voluntary/worksite market. A key appeal of the worksite space, notes Patience, is the ability to win many new policyholders at a stretch — typically open enrollment periods for employee benefit offerings. The worksite market is also attractive, says Patience, because employees tend to "pay a lot of attention" to company-vetted benefits; and because of the "power of automatic payroll deduction," making policy lapses are less of a concern.

For policyholders, be they of worksite, group or individual products, critical illness insurance is likely to grow in popularity as product manufacturers expand the number of medical conditions and benefits covered under contract. In contrast to the first generation of products, which mostly covered a diagnosis of cancer, the current offerings embrace other common critical illnesses, among them: heart attack, stroke and renal (kidney) failure.

Some CII providers also cover other low frequency critical illnesses. But the advantages of insuring an ever-expanding list of medical conditions have to be weighed against a another variable: meeting consumers' desire for product simplicity.

"The number of conditions covered varies tremendously, from as few as four or five to as many as 45 to 50," says Gen Re's Rowley. "There are honest arguments as to the merits of each approach."

There are merits, too, to a streamlined underwriting process; or better yet, no underwriting at all. Many CII providers, says Patience, now avail employees at large companies of guaranteed issue products, the face amounts ranging between $10,000 and $30,000, that can be obtained without providing evidence of insurability. For those with pre-existing conditions, that can be a godsend.

Underwriting is very much in play, however, at the high end of the market: business owners eyeing critical illness insurance to help fund a business succession plan or contingency plans involving key executives. Weber says these financial needs are often overlooked by advisors.

"Most buy-sell agreements don't provide for scenarios where a business partner becomes critically ill," says Weber. "Critical illness insurance really fits that need, as it can pay out immediately upon diagnosis. The product should be a key component of any key person or exit planning."

Closing the sale

Whether selling individual, group or worksite critical illness insurance, advisors would do well to follow certain best practices. Topping the list: knowing how to pitch the product as part of a comprehensive insurance or financial planning package. Often, says Weber, the mere mention of "illness" when referring to CII calls to mind health insurance. So to distinguish the offering, he describes the product as "critical insurance," a label that reliably prompts questioning and thus serves as a good conversation-starter.

To help make the financial case for the product, Weber also describes how critical illness insurance might impact the needs analysis for other insurance products. If, say, an advisor recommends $40,000 in critical illness insurance to cover basic expenses over two years, then this total may reduce the amount of life insurance required.

"Critical illness insurance entails a different type of calculation," says Weber. "Advisors generally aren't trained in how to do this."

That's changing as product manufacturers (Prudential, Assurity, Manulife, among them) devote more sales training dollars to critical illness insurance. Such investments will be necessary to maintain the upward momentum in new business premiums.

The market's long-term outlook will hinge on other factors, too: how CII features and benefits evolve in future years; the level of increased receptivity to a product category with which many consumers remain unacquainted; and, not least, a better understanding of the out-of-pocket costs that critically ill individuals are likely to incur so they can make more informed insurance buying decisions.

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