I recently read an article that gave the reader ten must follow financial tips. While most of the tips were not that outrageous, the writer did advise the reader to always take term cover instead of whole of life (WOL) cover. This proved to be a fairly controversial point and most of the comments argued either that WOL was always better than term cover, or vice versa.
So, you may be wondering what the difference between term cover and WOL is. Let’s do a quick recap:
Term Life cover only covers you for a set number of years, after which the policy ceases and you no longer have cover. If you die before the end of the term, your beneficiaries are paid out a lump sum. If you die after the end of the term, no payment is made because cover has ceased.
WOL cover has no term. The policy remains in force for the rest of your life. On your death, whenever that may be, the policy will pay out to your beneficiaries.
WOL will cost more than term cover, because it offers you cover for the rest of your life.
Why did the writer of the article advise you to always choose term cover over WOL? He argued that you should take the lower premium offered by the term life cover, and invest the difference between the term premiums and the WOL premiums. Once your term life cover ceases you now have no more life cover, but you do have an investment from all the savings you have made.
While this is an option, there are several issues I have with advising people to always choose fixed term over WOL. These are:
- The savings might not be big enough to justify choosing term life cover
Let’s take an example of a 40 year old man who wants R10 million in life cover. His premiums for WOL cover would be R2320 per month. His premiums for term cover to age 65 would be R1950 per month. So by taking term cover he would save R370 per month.
If he was to invest the savings for the next 25 years and earn a return of 10% after tax, charges and commission, he would have a portfolio of R582,665 at age 65. However, if he was to take the WOL option, he would still have life cover in force of R19.2 million at age 65. Which is worth more, the life cover or the investment? That depends on your personal circumstances and attitude to risk, but it is impossible to declare that one is definitely better than the other (as the writer has done). Remember that the savings you make by taking term cover instead of WOL are unique to your personal circumstances, so you would need to tailor the calculations to your own situation.
Secondly, this is all well in good in a simple example, but not all of us are disciplined to invest those savings every month.
- The argument ignores your needs
Any good adviser is going to quote you benefits that match your needs. A lot of your life cover needs are best met by term cover, like paying off a mortgage. However, some life cover needs are best met by WOL cover. If you are using life cover to settle estate duties or meet the cost of your funeral, those needs are for your whole life, and so your benefits should also be.
- Your retirement date is unknown
I always like to think of life cover as the present value of the income I was going to earn for the rest of my life. As such, if you choose term cover, you should pick a term until the day you intend on retiring. Once you’ve retired, you would no longer be earning an income from working, so you have no need for life cover (or so the theory goes).
The problem with this is that it is incredibly difficult to know when you will retire. A lot of people are working to older ages because they can’t afford to retire yet. Choosing term cover with a fixed term places you at risk that you need to work beyond that age and, as such, would need life cover.
- Continuation options aren’t all they’re cracked up to be
“But what about continuation options built into term life cover?” some may ask. Yes, continuation options do allow you to continue your life cover when you reach the end of the term, but they have two significant problems:
- Your cover at conversion will be priced for you at that age. This means that your premiums after continuation will probably be significantly higher than your WOL premiums at this stage.
- These options often require you to go for medical underwriting, which means they will check how healthy you are at continuation. While most policies mention that you have to undergo “minimal underwriting” at continuation, they fail to set out what tests they will and will not perform. This means that you have very little guarantee in terms of avoiding underwriting. It is also worth noting that you will be quite old at continuation date, and at older ages medical underwriting is a very big risk to you obtaining insurance cover, because of the high likelihood of you having a medical condition. Medical underwriting can quite easily result in your premiums being even higher, or cover being declined. Any form of medical underwriting at conversion stage makes the conversion option worthless in my eyes.
So, am I going to tell you that WOL cover is always a better option than term cover? Most definitely not. The most important thing is to understand the difference between WOL and term cover and decide on which is the best match for your needs. Remember that the best solution may be a combination of WOL and term cover (For example R5 million term cover and R5 million WOL cover).