Critical Illness Insurance

What is critical illness insurance?
Critical illness insurance pays out a lump sum on diagnosis of a range of serious illnesses. Provided the patient survives a minimum period after diagnosis, typically 21 or 28 days, the cash is paid regardless of whether they make a full recovery. The exact conditions covered varies from insurer to insurer but generally cover heart disease, strokes, most forms of cancer, kidney or liver failure, and many other serious complaints. Each policy will specify exactly the range of illnesses that it covers.

Advances in medical know-how are making it possible for people to survive and even enjoy life during and after suffering a serious health setback such as a heart attack or a stroke. And if you survive, but are not well enough to work, you will still have the mortgage and the bills to pay. In fact it's likely that your living costs could increase if you need some sort of nursing care, have to adapt your home etc.

Critical illness cover first appeared in the UK in the late 1980s. The concept originated in South Africa, developed by the brother of the famous heart surgeon Dr Christian Barnard. Although initially offered as an "add-on" to term, whole of life and endowment policies, it is now available also as stand-alone insurance cover.

There are broadly two types of critical illness policy: whole of life and term cover. As their names suggest whole of life lasts as long as you live, whereas term is for a fixed period; usually 10 or 25 years.

When buying a policy, you have to choose between guaranteed and reviewable rates. Guaranteed critical illness polices are so called because they charge the same premiums for the whole of life policy. A reviewable policy on the other hand has rates that may be altered by the insurer. A typical reviewable policy will have premiums fixed for the first five years, and then reviewed at regular intervals afterwards, whether every five years or even every year.

The policy holder's advancing age and likelihood of developing serious disease are factored in from the outset so there is no age banding once the policy starts — unlike private medical insurance.

If you already have a life assurance policy, you may think critical illness cover is a waste of time but it offers very different protection. Your life assurance policy will only pay out if you die, whereas critical illness insurance will pay up as soon as you are diagnosed with a life-threatening illness.

What critical illnesses are covered?
Different policies cover different critical illnesses. Each policy will only cover the conditions set out in the product literature that your financial adviser or insurance company will give you, and no others. However, all critical illness policies cover cancer, heart attack and stroke. The Association of British Insurers (ABI) publishes model definitions as a minimum standard for the most common critical illnesses covered. This means that insurance companies will assess claims for all these conditions using the same or more favourable definitions.

However, you should be aware that some types of cancer may not be covered. The full definition under each heading in your policy document shows what your policy covers. You may ask your insurance company for further information if you require it. br />
The Association of British Insurers' model definitions are grouped into 'core' and 'additional' conditions. The 'core' conditions are generally the critical illnesses most likely to happen.

The 'core' conditions are:

• cancer
• coronary artery by-pass surgery
• heart attack
• kidney failure
• major organ transplant
• multiple sclerosis
• stroke

The 'additional' conditions are:

• aorta graft surgery
• benign brain tumour
• blindness
• coma
• deafness
• heart valve replacement or repair
• loss of limbs
• loss of speech
• motor neurone disease
• paralysis/paraplegia
• Parkinson's disease
• terminal illness
• third degree burns

What affects the cost of my policies?
The cost of cover will be driven by a variety of factors including your age, sex and occupation. Premiums will be sharply higher if you smoke. Some jobs that you might not consider risky can affect the cost. For example, teachers, chefs and investment bankers may pay more for critical illness cover because of the impact of stress.

As with all types of insurance, life assurance policyholders pay premiums into a common fund from which all claims are paid out. In order for the insurer to be certain there will be sufficient funds to pay out all the claims, there has to be a relationship between the premium charged and the benefit given under a policy. This is easier to predict with life assurance and critical illness insurance than with other types of insurance, because mortality and illness tables can be used to predict the number of deaths and illnesses and, therefore, the number of likely claims.

However, the tables dont always tell the whole story. In the late-1980s life assurance costs rose sharply with companies worrying about the potential impact of AIDS. When it became clear that there was not going to a mass impact on UK death rates from AIDS, premium costs started to come back down.

Equally, advances in medical care have been responsible for soaring critical illness premiums since the mid-1990s. Costs have risen because insurers have had to meet an increasing number of claims, which have come about by the earlier diagnosis of a critical illness due to medical advances.

How much cover do I need?
The short answer is likely to be more than you already have (if you have any at all). According to the Swiss Re Term & Health Watch report, here in the UK we are collectively under-insured to the tune of around £2.2 trillion (Source: Money Marketing 26/5/2005). There are four reasons for the protection gap: ostrich syndrome — people simply don't want to think about dying or falling ill; confusion over the appropriate cover; mistrust of financial professionals; and expense — people wrongly see cover as costly.

Many people choose to insure their lives for £100,000. It is a nice round sum and it sounds like a lot of money — and it is. But is it enough for surviving dependants to live off? Can it pay off all your various debts — mortgages, loans and credit cards — and still leave a big enough sum to generate an income?

People hugely miscalculate the rate at which a family can get an income from a lump sum. At current levels, without risking the capital, that £100,000 may pay a maximum annual income of little more than £5,000.

To calculate the amount of cover you need, you will need to take account of the mortgage, the potential cost of replacing family income if you are the primary earner, the cost of childcare and any education expenses.

Some life assurance experts will suggest you consider a policy that covers 20 times salary. The idea, based on an assumed interest rate of 5%, is that this lump sum would provide an income equivalent to salary.

However, while this may sound a lot, it may still not provide adequate cover for someone who may see a rapid increase in salary over the next few years or someone who is paid performance-related bonuses and is about to hit their prime income-earning years. There are hard choices to be made about how much cover you are prepared to have.

Who should be insured in the family?
Life assurance is not the sole province of the main income earner. A family with young children should also consider the impact of the loss of the main child-carer. Equally, given that you are five times more likely to be seriously ill than to die before the age of 65 you may wish to consider critical illness insurance as well. (Source: Daily Telegraph: 26/01/2005).

The person on whose life the policy depends is called the 'life assured'. However, although the person who owns the policy and the life assured are frequently one and the same, this is not necessarily the case. Spouses may take out life-of-another policies on each other. Life-of-another policies require that you prove an insurable interest in the person whose life you are insuring; however, spouses are assumed automatically to have an insurable interest in each other's lives. .

Policies may be taken out jointly by two persons assured — for example, husband and wife — on their joint lives. Furthermore, although the vast majority of joint life policies have two lives assured, it is theoretically possible to have more if insurable interest exists. Almost any type of life policy may be arranged on a joint life basis.

There are two kinds of joint life policy — first death and second death contracts. A 'joint life first death' policy pays out on the death of the first life assured to die commonly for family protection or mortgage cover. A 'joint life second death' policy pays out on the death of the second life assured to die. These are sometimes called joint life last survivor contracts and are commonly used for inheritance tax planning.

Policy beneficiaries are usually close family members but you may specify the beneficiary(ies) when you take the policy out.

What do I have to tell my insurer?
You must tell the policy provider all relevant or material facts. If you don't, you may find that the policy does not pay out. A material fact is one which would influence an underwriter whether to accept the risk, and the terms and conditions that should apply. If you fail to disclose (or misrepresent) a material fact this may result in you taking out a policy that you may not otherwise have been able to get or taking out a policy on more favourable terms.

If the policy provider discovers these facts after the event (which they usually do when a claim is made if not before) you are highly unlikely to see a pay out. The providers legal remedy is to 'avoid' the policy. This means the insurer is entitled to treat the policy as though it never existed. Unless actual fraud is involved, the insurer will normally return the premium and will not pay out on any claim made under the policy.

'Non-disclosure' is the term used to describe the situation where a customer fails to reveal a relevant fact when applying for — or renewing — an insurance contract. The legal position is quite straightforward — an insurance contract is a 'contract of utmost good faith', which means that all parties to the contract are under a strict duty to deal fully and frankly with each other. If you don't, you shouldn't expect the policy to payout.