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Advisers debate efficacy of critical-illness insurance

Those who pay the costs themselves can quickly go into debt

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By Darla Mercado

September 22, 2008 6:01 am ET

Although disability insurance and medical coverage have long been hailed as the best ways to protect one's income, financial advisers are debating the use of critical- illness insurance as an additional layer of protection.

"It's a financial tool that can help you," said Kevin Grant, a certified financial planner at Higgenbotham & Associates in Dallas. "If it's a challenge to set money aside for that type of emergency but you can deduct $20 a month to pay for coverage, it might be a good deal for you."

The coverage protects clients against the financial blow from a serious illness. While disability insurance makes up for one's missing wages while being laid up with an injury and medical insurance pays for illness-related expenses, critical-illness insurance covers out-of-pocket expenses that arise immediately.

Those expenses can easily drive clients into piles of debt, according to a new survey, "Benefits & Behavior: Spotlight on Group Critical Illness Insurance," from The Guardian Life Insurance Company of America in New York.

Of the 1,000 people polled, 170 were either sick themselves or were watching their spouses suffer. Of that number, 21% had used a credit card to pay for recovery expenses.

Among all participants, 59% said that they would tap their savings to cover out-of-pocket costs, while 40% said that they would seek help from their families.

"[Critical-illness insurance is] something that's not well-known as a [type of] coverage, but it's very important to have," said Barry Petruzzi, second vice president for group benefits at Guardian.

Typically, the customer takes out insurance against specific major illnesses or serious conditions, such as cancer and kidney failure. If a client develops a condition that is covered in the policy, he or she receives a lump sum payment upon confirming the diagnoses with the insurer.

Upon receipt of the money, the client can use it for a variety of costs, both medical and non-medical.

That flexibility raises other issues for advisers whose clients either have a group or individual critical-illness policy, Mr. Petruzzi said.

"Contractually, the benefit doesn't have a specific use to it, but my suggestion is that if they have an adviser, maybe they can talk about how to use the money," he said. "The costs of getting an illness like this are pretty clear, but we make it flexible for them so they can figure out their cost priorities."

Still, not many advisers recommend the coverage to their clients, and some are skeptical of using it.

"If someone in your family died of cancer, you might have enough anxiety that you buy the coverage, but you're overlooking other things that could go wrong," said Ed Stuart, a CFP and wealth manager at Regent-Atlantic Capital LLC of Morristown, N.J., which has $1.8 billion under management. "You might never collect on your cancer insurance, and you won't be covered on the other things that can go wrong," he said.

"I'd want to be sure that the client's insurance needs are well-covered and that they would be covered by any catastrophic expense, but to pick an illness out and buy extra coverage doesn't make much sense to me."

However, there are still purposes for the insurance. For instance, a disability policy may not kick in for 90 days, and the lump sum from the critical-illness policy can go toward paying bills until then.

Still, Mr. Grant pointed out that there are pitfalls for advisers who are unfamiliar with the way critical-illness policies work. For example, a client and a carrier can have very different definitions of "critical illness."

Most policies will cover what is known in the actuarial world as "the Big Five": cancer, stroke, major organ transplant, kidney failure and heart attack. However, if a policyholder goes blind or develops Lou Gehrig's disease, they will bear the full brunt of the out-of-pocket expenses, Mr. Grant said.

Also, clients typically are covered for one occurrence of each of the covered conditions, so a policyholder may receive a claim payment for cancer and a second payment for kidney failure but will get nothing if the client develops either of those conditions a second time.

What's more, a coronary-bypass operation may qualify only for a portion of the lump sum, as opposed to the full lump sum, depending on the specifications of the product.

"Be very careful to read the agreement," Mr. Grant said. "It's just like disability: What's in the contract is what's covered. And it's a bad thing if you have a client who thought he would be covered and the money doesn't come in."

E-mail Darla Mercado at dmercado@investmentnews.com.

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