I received an email from a client the other day. This client has recently reached financial independence, and has left the workforce in pursuit of new adventures. He’s currently in the process of reviewing his cost structures, and is wondering if it is still worthwhile maintaining the two critical illness policies that were an important component of his plan during his working years.
What is critical illness insurance?
Critical Illness Insurance provides a tax-free lump-sum benefit upon the diagnosis of a critical illness. It can be vital to the recovery of a family during such a trying time by providing the cash they need to wipe out all of their immediate financial concerns. There is no specific direction on how the funds are to be used, but commonly it’s used to pay for medical expenses not covered by government or group benefit plans, travel and accommodation costs to a medical facility, family income for a spouse or parent to take time off work, or to fly children home for Christmas.
Once you’ve reached financial independence, the need for insurance changes. There is no longer a need to protect income because income is no longer based on your ability to be healthy. On the other hand, most people who have transitioned into financial independence are no longer supported by employer-sponsored prescription drug coverage, and that adds an additional risk.
Related article: Do you need insurance in retirement?
Therefore, in order to determine how much, if any, insurance (the process of offsetting the burden of risk for something you can't otherwise afford to replace) is required, we need to figure out if your portfolio can otherwise afford to replace the expenses triggered by an illness. We call this process a “shock test”.
The shock test
It can be very hard to determine what the cost of a critical illness would be since such a variety of illness are covered, and each illness can have a different outcome. Some people with heart attacks go back to work and have minimal additional expenses. Some people with cancer are distraught to find out that three quarters of the take-home drugs cost over $20,000 for a single course of treatment, and the average cost for a newer drug is $65,000 (According to the Canadian Cancer Society). Depending on where you reside, costs for travel and accommodations can add in another $10,000 in expenses.
An average estimate for the purposes of a shock test during independent years would be $50,000 to $75,000 if you or your spouse fell ill or $10,000 to $25,000 if any independent child fell ill. Therefore, in order to perform a shock test for a single event critical illness, you need start by pretending to pull $75,000 from your assets. This is the net amount. If you're pulling from RRSPs, or a non-registered account with significant unrealized capital gains, then you need to consider tax consequences, possible redemption fees, and lost future growth. If most of your income is locked up in GICs or a pension, then you need to consider interest costs for a medical line of credit up to the time when your assets become available, and again any lost growth after that.
Once the gross cost to your portfolio is known, your financial planner can re-run your financial independence plan with your portfolio reduced by the gross cost of the illness, to determine if your current lifestyle goals (we're assuming you have a full recovery with no impact on your life expectancy) are still able to be met. If you can still maintain a good standard of living even during the shock test, then it's probably fine to cancel or reduce your critical illness insurance.
On the other hand, if the shock test reveals a significant deterioration in your ability to comfortably remain independent, maintaining critical illness insurance policies, even during your financial independence, should have some additional consideration.