Life-threatening cancer. Permanent disability. Premature death. These are all facts of life. Not pleasant ones, but very real ones.
When we think about building a robust financial plan to accomplish family goals, we need to crash-test it. From my perspective as a financial planner, it’s not a matter of if one of my clients is going to experience a catastrophic life event, but simply a matter of when.
So, we build our financial plans assuming everyone gets cancer to make sure all family goals can still happen.
What is Human Capital?
Human Capital is the potential to convert your labour into dollars and cents over the course of your life. Simple math can demonstrate the scale of what that amounts to, especially for younger folks. We’ll start with a stripped-down scenario and layer on more assumptions.
A 30-year-old person planning on working until 65 with a $50,000 after-tax, annual salary, just with simple multiplication, will earn $1,750,000 over their working life. That’s no chump change. We’ll just assume that person got raises matching inflation yearly, so that figure doesn’t need to be adjusted downward to account for the effect of rising price levels.
And if, as is generally the case, your later income years are your highest… Well, you can see how substantial that figure can become.
How do I protect my Human Capital?
Your Human Capital is typically the greatest single asset a person has in their young adult life. You insure your house; how are you going to pay for your mortgage? If the answer is “go to work,” then it is more than sensible to insure against that catastrophic scenario.
The three tools we employ are, in prioritized order, Disability, Critical Illness, and Life Insurances.
Disability (DI) Insurance
Our first line of defense is Long-Term Disability insurance. I regularly sit down with clients to discuss our bullet-proofing plans and ask about their group insurance. People invariably can tell me how much money they have allocated for massage benefits but have no idea whatsoever about their group Long-Term Disability insurance. That coverage is far and away the most important in the package.
High quality Disability insurance is designed to replace your monthly income in the event you can’t work due to illness or injury. Most group benefits plans pay tax-free benefits also, but this varies from plan-to-plan. And there are other bells and whistles that may or may not be attached to the plan.
Most group plans have a key weakness, namely how they define “disability”. Having reviewed hundreds of group benefit plan coverages, almost all contain what is known as an “own occupation” definition for the first 24 months you are disabled, which is what it sounds like. The idea is that you are covered if you can’t perform your job functions. The coverage then typically reverts to “any occupation” AFTER 24 months, which is also just as it sounds. Can’t develop software anymore but you can push a broom? Tough nutties, you aren’t covered.
I always recommend reviewing this coverage to make sure it is sensible for the individual and then we can supplement with individual coverage accordingly.
Critical Illness (CI) Insurance
I speak regularly with Canadian who make off-handed remarks about how great it is to have “free” healthcare in the Great White North (usually by contrast to our Southernly Neighbours). It’s at that point that I realize they likely have had limited engagement with the health care system. As a Type-1 Diabetic, I am constantly engaged with various doctors and pharmacists in the Canadian healthcare system; I can assure you it is NOT free to use.
Critical Illness insurance provides a one-time, lump-sum, (generally) tax-free payment designed to help a family weather a period of increased costs and reduced income while undergoing treatment for a covered condition. Coverages vary, but almost all policies will provide a payout for heart attack, life-threatening cancer and stroke (the Big Three), potentially including a host of other conditions such as severe burns, loss of limb, paralysis, Alzheimer’s disease, etc., etc.
The policy can be structured in many ways, but I generally recommend mapping the duration of the coverage onto a retirement plan. Once you retire you should be “self-insured” for these risks, having saved sufficient funds along the way to insure this risk with said funds.
More and more group insurance plans are beginning to include some amount of CI, although this typically is a token amount like $25k and the covered conditions can vary broadly. I generally recommend total coverage of about 2-years gross salary.
Life (LI) Insurance
Most people are aware of Life insurance and its purpose, so I won’t spend much time here. The reason it should be mentioned is that part of a proper Life insurance needs analysis is to calculate income replacement for survivors. The same logic applies as with Disability above; how are your spouse and/or children to pay for their mortgages, educations, costs of living, etc. without your income?
Again, proper analysis will use a time-value of money calculation which can be complicated for the lay person. I’d recommend getting assistance from someone who knows what they are doing there also.
The Main Point (TLDR;)
There are times to play the odds to your advantage and there are times to hedge your bets. If the risk is financial ruin and the joint probabilities of disaster are between 50-75% (https://insureright.ca/calculator/#analysis)…
Hedge; don’t bet.
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