Understanding Critical Illness Insurance

Understanding Critical Illness Insurance


Recalling our catastrophic financial loss test, to answer how much critical illness insurance we need, we need to first look at the loss. The simple question is, if you get a covered condition (say cancer, or a heart attack), where’s the money you lose, and how much?

Out of country medical and travel costs

A common intent for the insurance payout would be to pay for out of country medical funds (and to a lesser extent, travel plans). There’s two problems with this. First, it’s not a financial loss – it’s a lottery. So consider this carefully if this is your intent. Secondly, most consumer do not purchase a policy that’s anywhere near large enough to cover out of country medical costs. I’ve seen cost estimates for cancer treatment at the May Clinic in the US range from $250,000 and up. A $100,000 policy won’t provide enough money to fund such treatment.

A second example of the horrific out of country costs for treatment; my daughter had superficial malignant melanoma while studying in the US. The cancer was actually incised in Canada, but she later sought treatment in the US near where she was studying. She had roughly two appointments. In the first appointment, the doctor made a larger incision to remove more skin tissue. This was done right in the doctor’s office. The second appointment was to discuss results and provide a full body image scan for future reference. These two short appointments, plus some travel costs for my wife to attend the appointments, cost approximately $20,000.

In the end, we don’t know what out of country medical costs will be since we don’t know the condition you’ll have. We do know however that if this is the purpose of your insurance that a $100,000 policy is quite likely not going to be nearly enough. The amount is entirely a judgement call, but if out of country medical treatment is your intention, then you should consider a policy of a minimum of $250,000-$500,000. Otherwise you may find yourself with a condition and not enough money to cover the treatment.

Alternatively, resign yourself (I’m joshing. I’m a fan of our Canadian medical system and personally quite happy with it) to get treated in Canada where your hospital treatments will be for the most part, covered.

Loss of Income

If you develop a critical condition, you’re going to be off work likely for quite a while. Even if you have long term disability insurance you’ll probably have a 3 month waiting period.

Further, your partner or spouse will likely need to be off work for your treatment as well.

The connection between loss of income and critical illness is less firm than it is with life insurance. With life insurance, you’re dead so your income is lost permanently. With critical illness we are forced to estimate and we have less precise numbers. Since we’re looking at coverage a downside risk, you should be conservative in your estimates. Being a bit over covered is better than buying insurance and finding out too late that you don’t have enough coverage.

Based on my experience with clients who’ve experienced a critical illness, I suggest that your initial estimate of coverage amount equal the total of one year’s income for each of yours and your spouse’s income. If you each make $75,000, then individual coverage of $150,000 is a good starting point. That ensures that you can be off work for a year and your spouse can be off work for a year as well to act as a caretaker. After that point your long term disability coverage should have kicked in and you should’ve made any lifestyle adjustments necessary.

Save your RRSP’s

You have two choices – purchase critical illness insurance, or don’t. And for each of those two choices, you can develop a covered condition, or not. People that don’t have critical illness coverage will often cash in their RRSP’s to pay for the loss of income. In terms of loss, it thus makes sense to compare paying for critical illness premiums and having coverage, vs saving the premiums and using your RRSP savings to pay in the event of a covered condition.

Lets look at two scenarios, one where we purchase critical illness insurance and one where we don’t. Then we’ll see what happens in both cases if we develop a critical condition and if we don’t. The benefits of having critical illness become apparent in this comparison.

The general case

We’ll take a male age 45 who’s contributing $10000 per year to their RRSP. In Scenario 1, we’ll purchase a critical illness policy for 10 years and reduce the $10,000 per year deposits to pay for the insurance. In Scenario 2, we’ll skip the insurance coverage and save the premiums in our RRSP. For simplification, we’re going to assume everything is on an annual basis.

No Critical Condition

In this comparison, Scenario 1 is paying $1178/year ($106/month) in critical illness coverage and saving $10,222 into their RRSP at 5%. Scenario 2, the entire $12,000 per year is placed into an RRSP. Neither scenario develops a covered condition. What do both cases look like at age 65?

Age 40, Male Nonsmoker.

Scenario 1
Scenario 2
CI Premiums$788$0
RRSP at age 55$121,161$132,067

Assuming neither scenario has a critical condition we can see that the cost of the critical illness protection has reduced our savings mildly. The overall impact on retirement however is minimal.

With a Critical Condition

Now lets see what happens if we develop a critical illness at age 55 that costs us $75,000. In scenario 1 because we have $100,000 of insurance, paid out after tax. In scenario 2 we need to withdraw $75,000 after tax from our RRSP’s. Here’s the situation at age 55 just before and just after the condition:

Scenario 1
Scenario 2
Total RRSP (before)$121,161$132067
Total RRSP (after)$146,161$ 14,067

In scenario 1, we’ve taken our $100,000 in benefit, paid our $75,000 in expenses and put the remaining $25,000 into our RRSP. In Scenario 2, we had to withdraw $118,000 from our RRSP ($75,000 plus we assumed $39,000 in taxes that must be paid on the RRSP withdrawal).

The overall impact on a critical illness is that with insurance, retirement is still on track. Without coverage, our retirement savings are devastated.

Here’s the final summary – based on these assumptions, if you purchase critical illness insurance, your retirement savings are not severely impacted whether or not you develop a condition. Without critical illness insurance, there’s not a large impact if you don’t develop a condition, but if you do then your retirement will be wiped out.

This to me is the most compelling reason to purchase critical illness insurance, it’s protecting our retirement in the event of a critical illness.

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