Filling the Gaps with Critical Illness Insurance

It is the nature of health insurance that any major illness inevitably results in large out-of-pocket costs. As a result, many employers are expanding their voluntary benefit programs to include critical illness insurance.

Generally speaking, critical illness insurance provides a fixed, lump-sum payment following the diagnosis of any illness listed in the policy, which can include cancer, heart attack, stroke, paralysis, kidney failure and more. Some policies include, in addition, a per-day benefit for certain treatments (e.g., dialysis). The benefit payments are made directly to the insured and can be used for any purpose, such as covering deductibles, medical co-payments, income shortfalls and travel expenses.

Employees typically elect coverage ranging from $5,000 to $50,000 each for themselves and their spouses, although some policies, with substantially higher premiums, provide coverage up to $1 million.

The premiums are not tax-deductible for an individual purchasing coverage, but the benefits are received tax-free. Premiums are priced based on factors including the policy holder’s age, gender, health status (typically with a pre-existing condition exclusion), family medical history, use of tobacco and the state where they reside. For example, a 50-year-old male who doesn't smoke might pay a monthly premium of around $25 for a single-payment $10,000 policy but over $100 monthly for a $50,000 policy (a calculator for estimating premium costs is available online).

Critical illness insurance has its own niche, separate from and complementary to:

• Broad-based health policies, which pay care providers (rather than the policy holder) for covered expenses.

• Long-term care insurance, which typically pays only if one of the basic life functions is inhibited (e.g., feeding, bathing, ambulation).

• Disability insurance policies, which replace lost income but might require a lengthy waiting period to take effect.

“Critical illness insurance is not designed to replace other insurance policies but rather to supplement them,” said Bob Hamilton, a principal with Bean Hamilton Corporate Benefits in Little Rock, Ark. “These policies can help pay the costs that are being shifted from the employer to the employee” through higher deductibles and other out-of-pocket costs.

Conditions that are covered by critical illness insurance vary from policy to policy, Hamilton added, and “the broader definition of what is covered, the better the quality of the product.” However, the premiums are likely to be higher as well.

How It Works

Critical illness coverage played an important role when Paul Kerr’s wife was diagnosed with cancer. Following the initial cancer diagnosis, the Kerrs received a $5,000 lump-sum benefit, which could be used for anything the Carlsbad, Calif.-based couple needed. Beyond that, the policy provided a per-day benefit for surgery, a hospital drug benefit and a per-day benefit during radiation treatment. Overall, the policy paid out about $15,000 in benefits. The couple relied on those benefits to cover $8,000 in out-of-pocket costs not covered by their health insurance plan and used the rest to cover household expenses through the course of treatment.

“You're going through an emotional roller coaster when the thing hits,” said Kerr. “The insurance is a way to help stabilize things on the financial side.”

That is exactly the role intended for critical illness coverage. Research conducted by insurer MetLife estimates that the costs associated with recovering from a critical illness are $35,500, most of which is linked to lost income.

“The chances of being diagnosed with a critical illness or experiencing an accident are steadily increasing, as are survival rates, which leads to growing financial challenges for the affected family,” noted Lawrence Daurelle, president and CEO of Reliance Standard, an insurance provider.

An Evolving Product

The market for critical illness insurance is still relatively new and continues to evolve. For example, as these policies become more popular, employers have more group products available, which can be a better deal for employees. Group plans not only help to drive down the cost of these policies but also might allow for some level of guaranteed issue that limits or eliminates the reasons why employees in the group can be turned down for coverage.

However, not all products and carriers are the same. Employers interested in offering critical illness coverage should keep a few things in mind when evaluating carriers. One of the most important considerations is how these products will be sold. Cancer insurance policies developed a bit of a negative reputation in situations where policies were sold by agents working for a commission, who sometimes resorted to high-pressure sales techniques. To avoid that type of situation, employers should:

• Look carefully at the sales approach for any critical illness policies that are offered to employees. “Commissioned sales agents are not appropriate for these plans,” said Amy Hollis, a principal with Buck Consultants in Atlanta. Instead, employers can look for policies sold by salaried benefit counselors.

• For large employers, offer a group plan for critical illness coverage rather than individual policies, especially if the employer has operations in multiple states, to ensure that all employees are eligible for the same benefits regardless of their location. Because insurance regulations are set at the state level, individual policies are likely to vary considerably.

• Look for an insurance carrier or broker with experience working with companies of similar size to ensure that the vendor can accommodate the company’s and its employees’ needs.

“Employers may want to limit the policy choices they offer to avoid overwhelming employees,” said Hollis. “Offering a $10,000 and a $30,000 policy can help ensure that these policies are affordable to most employees.” In addition, Hamilton suggests that employers focus on policies with a waiting period of no more than 90 days between the purchase of the policy and when the policy will pay claims.

A Few Cost Caveats

In weighing whether critical care insurance is appropriate, employees should be made aware of the cumulative cost of the premiums for these plans. Employees who might foresee difficulties paying the deductible on their health plans also might be challenged financially when critical care insurance premiums are deducted from their salaries. Some with high-deductible health plans (HDHPs) might do better if the money that they plan to spend on critical care insurance premiums were instead directed to an employee-owned health savings account (HSA) to help pay future medical expenses subject to the deductible and other out-of-pocket medical costs (in effect, self-insuring for these expenses with tax-free dollars).

However, funds from an HSA can be used only to pay for qualified medical expenses, whereas the lump-sum payment from critical illness insurance can be used for any expense incurred following diagnosis with one of the covered conditions.

Another caveat: Employees may become overwhelmed by a surplus of insurance options available through their workplace cafeteria plans, each with its own advocates and marketing campaign. In addition to traditional health, dental and vision policies, top competitors for employees' dollars now include life insurance, long-term care insurance and supplemental disability/wage-replacement policies. Along with paycheck deferrals already going to 401(k) or 403(b) retirement plans and perhaps to fund HSAs or health care flexible spending accounts (FSAs), there might not be much left for an average-income worker to take home.

A Safety Net

Still, as employee concerns about the expense of health care and rising out-of-pocket costs increase, employers are likely to face a greater demand for critical illness policies. “Critical illness is probably the most popular plan in the market today from a voluntary benefits perspective,” said Buck Consultants' Hollis. “There are financial limitations and potential exposure in today’s health plans, and these policies can help to fill those gaps.”

With the growing trend toward higher deductibles and other out-of-pocket costs continuing, some employees might need that safety net more than ever.

Joanne Sammer is a New Jersey-based business and financial writer. Her articles have appeared in a number of publications, including HR Magazine, Business Finance, Consulting, Compliance Week and Treasury & Risk Management.