Know Risk is a community education program designed by the Australian and New Zealand Institute of Insurance and Finance (ANZIIF) to improve our understanding of insurance and how it relates to managing the many risks we all face in life.
Life Insurance 101
Your life is your most important asset
There are only two things you can’t avoid in life — death, and taxes (unless you employ the services of an accounting wizard). However, there are numerous steps we can take to ensure that when we pass, or are severely disabled, we do not leave our loved ones with undue financial burdens, due to diminished earning capacity or loss of income.
Generally, when we think of life insurance, there are four types we need to consider.
This is most common types of policies available. Basically, as the policy holder, you nominate how much you want to insure your life for and the policy then pays out that figure in a lump sum of money to your family in the event of your death or contracting a terminal illness.
Working out how much cover you need
As with any type of insurance, you need to think about how much you need to cover and how much you can afford to pay. Unlike something like contents insurance, you’re not valuing how much it would cost to replace an item, rather how much your family would need in the event of your death.
When calculating how much you need, think of what costs your wage currently covers and how your family would be able to cover them should you pass. These could include:
- Your home mortgage
- Any personal loans
- Credit card debt
- Education costs – how much will it cost to send your children to school
- Food and groceries
- Health insurance
- Car insurance
- Home and contents insurance
- Petrol and car maintenance
- Funeral costs
Work out how much you would need to cover these costs and whether the premium is affordable. As always, the higher the total value of the policy, the higher the premium. The trick is finding the balance that is right for you.
All policies will vary on how much they cover and under what circumstances. When thinking about renewing or purchasing your life insurance policy, keep TPD cover in mind. Remember, always shop around and find a policy that suits your individual situation, ensure you always read the Product Disclosure Statements and ask questions for clarity, when in doubt, seek independent financial advice.
Life insurance premiums usually come in two forms - stepped premiums and level premiums.
Stepped premiums are the most common, making up almost 70% of all policies written. A stepped premium is recalculated each time a policy is renewed and, as the name suggests, usually goes up, according to risk factors such as age, weight and health levels. However, there are some situations when the premium will actually drop because of your age. While this seems counterintuitive, research shows that at certain points in life, our age is less of a risk than the previous year. For example, a man in his early twenties becomes less reckless as they become thirty.
A level premium is calculated on your age at the start of the policy and the premium remains consistently level as you get older. While in the beginning, you may pay more than you would using a stepped premium, a level premium does not increase as you age. Be mindful that while rare, your insurer may choose to review the whole insurance contract, increasing the premium.
The best way to explain the difference is to think of stepped as a variable mortgage and level as fixed. Just as in a home loan situation, which is better, and why, are questions an adviser or planner can best answer.
While life insurance policies generally cover you in the event of your death, they typically don’t cover you in the instance of a permanent disability. This is where Total Permanent Disability cover, (TPD) comes in. TPD covers you, if you become totally and permanently disabled as a result of an accident or illness and are never likely to return to work again. It will not cover any temporary disability or disablement. The key words to understand with this cover is that in order to make a successful claim you need to be ‘Totally’ and ‘Permanently’ disabled. TPD cover can be bought with a Life Insurance policy or by itself, and can be issued as a ‘rider’ policy to a life insurance contract or as a standalone policy. Claims will generally be paid as a lump sum payment.
Being affected by a disability is a daunting thought. Long-term disability is something none of us wish to think about. The idea that you will never be able to work again or even live the way you are used to is difficult to understand.
While the chances of suffering from a long term disability may appear to be small, the financial burden of this can be massive. Some of the financial pressures can be removed if you have the right cover in place. Many of us don’t think about what changes we would need to make if for some reason our ability to work and earn an income was totally removed for the rest of our lives. Expenses not only come in the form of ongoing medical and rehabilitation costs or the cost of home modification or lifestyle changes, but also from the day to day living costs that we take for granted.
TPD definitions: what you need to know
As with all insurance policies, you need to understand exactly what kind of cover you are purchasing. The definitions of cover differ and will determine how you are covered and under what circumstances you may be paid.
Policy definitions for TPD insurance are typically either “own occupation” or “any occupation”. With an “own occupation” policy, if you are injured and no longer able to perform the occupation you were working in at the time of the before the injury or illness occurred, you would be eligible for a payout.
“Any occupation” on the other hand has a broader definition and usually means that in the case of a permanent disability, you need to be deemed unable to perform any occupation. So although you may not be able to do the job you were already in, you may still have the ability and skills to be able to do something else and will therefore likely not receive a payout from a claim.
“Own occupation” is generally the preferred policy option but it is not available for all occupations and premiums will also generally be higher.
Some life insurance companies offer a third definition aimed at people who do not work, a ‘home maker’ definition. Often people do not appreciate the importance of the home maker to the primary income earners’ ability to work and earn income. What would happen to a workers income if, due to the incapacity of his/her partner, they needed to take time away from work to act in a career capacity? Or, what additional and ongoing medical and rehabilitation or lifestyle change costs would be incurred? For these reasons, having a TPD policy in place for a home maker deserves careful consideration.
Trauma insurance, like TPD, pays your benefit as a lump sum; however only pays you when you’re diagnosed with a critical illness, rather than a disabling injury. Unlike TPD, trauma insurance doesn’t require a disability test, but you do need to meet the listed medical definition of a critical illness or medically diagnosed event. Insurers will have different definitions of what a critical illness or medically diagnosed event is, but most will generally include conditions such as:
- heart disease
- organ transplants
- severe diabetes
- severe rheumatoid arthritis.
To date there are at least 40 types of critical illnesses that you can seek cover for in this type of policy.
Trauma insurance restrictions
Trauma Insurance will typically have more restrictive entry and expiry ages compared to life insurance or TPD insurance, with most policies expiring at either age 65 or age 70.
However, many trauma insurance policies will include an option to revert to a ‘loss of independence’ policy at the expiry age which allows policies to be extended to age 80. Generally, the maximum amount of Trauma Insurance that can be applied for is $2m.
One of the more widely misunderstood types of insurance, income protection insurance covers you financially if you are unable to work temporarily due to illness or injury. Generally, policies will cover up to 75% of your pre- tax income, for the period that you are off work (the benefit period which is typically 2 years, 5 years, or up to age 65). This is set at the time you buy the policy. The benefit will be paid to you by the insurer until you are able to return to work or for the entire benefit period.
For anyone who is working, income protection is something worth considering.
What type of income protection?
While insurers may offer any number of unique products and policies, there are two main types of income protection insurance: agreed value policies and indemnity value policies. The type of policy you choose will depend on your personal and professional circumstances.
Agreed value policies
Agreed value policies mean the amount you are covered for is agreed on at the time you take out the policy, up to 75% of your earnings at that time. So even if your salary has changed or varied a lot from year to year, if you make a claim, your benefit will be paid at the agreed amount. Because of the certainty they provide, agreed value policies typically have higher premiums, so you may have to pay more up front.
Indemnity value policies
Indemnity value policies cover you for up to 75% of your income at the time you make a claim, so you need to be able to show your current income when you claim. This type of policy works well for people with regular incomes that can easily produce a pay slip showing their current salary. These policies also have lower premiums than agreed value polices.
What you’re not covered for
Income protection is there to provide an income in case you are unable to work. When comparing policies, think about how much cover you will need to be able to meet your ongoing expenses, like mortgages, debts and day-to-day living costs.
It is important to understand that most Income Protection policies available in Australia do NOT provide any cover if you lose your job or your job is made redundant.
As with all types of insurance, it is important to read and understand the terms of the policy as the definitions, exclusions and benefits will nearly always vary. Make sure understand what you are getting when you take out the cover.
Similar to how income protection helps cover a loss of your wage, business expenses insurance is a financial back up plan for business owners.
Should you be struck down with illness or injury, business expensess insurance can help keep the business running until you're back on your feet.
Business Expenses insurance is tax deductable, and covers your fixed business costs, as a monthly reimbursement, so you can focus on your recovery - and not your bills and generally covers:
- office rent or fees plus interest on your property loan
- leases on cars, equipment or machinery
- insurance and security costs
- bills - such as utilities
- salaries and staff superannuation (for employees who don't generate any business revenue)
- costs of a locum to help out while you focus on getting better.
Contact your insurer to understand the terms of the policy as the definitions, exclusions and benefits will vary from insurer to insurer.
Funeral Insurance sounds pretty self-explanatory in that it helps your family cover the costs of your funeral. Insurers will guarantee cover if you are aged between 18 and 80, provided you are an Australian resident and haven’t been declined by a life insurer due to health reasons and will provide a lump sum of up to $30,000 for funeral related expenses.
Generally, for cover of $20,000 or more, insurers will offer a 10% premium discount, with further discounts for multiple policies. Most insurers will cover you worldwide 24 hours a day, 365 days a year.
Will you need a medical exam?
Many insurers will require you to undergo a medical exam to determine your level of risk. For most people, the idea of medical check-up is a scary thought and assume it will prevent them from getting insurance to begin with.
Now, not everyone needs a check-up. It can depend on how much insurance cover they need. There’s something called a ‘non-medical limit’: if the amount of insurance you’re applying for is under that limit, you won’t need a medical check-up. Be aware that this limit will decrease the older you are. However, if you want to be insured for a sum that is over that limit, you need may need a check-up.
A lot of people think it is some kind of brutal and gruelling obstacle course designed to weed out ‘undesirable’ clients. The reality is that it’s similar to a standard check-up at your doctor’s office and is often less stressful.
The medical is used to find any underlying conditions that may shorten your life or adversely affect your health and will generally consist of:
- a blood test to check for health conditions (both hereditary and otherwise)
- a urine test
- blood pressure measurements and
- in some cases, an ECG to measure your heart rate.
Should the tests find something, it doesn’t necessarily mean you won’t be able to get cover, but you may need to pay a little more. Talk to your insurer about the impact it will have on your premium.
There may be times when an insurers will apply a loading or exclusion to a policy. This can be the result of a number of factors, including your medical history, whether you have a dangerous job or are travelling to a dangerous, high-risk destination.
A loading is a percentage increase on the standard premium, usually due to a pre-existing medical condition. These increases are relatively common and ensure that people can obtain cover in situations where they may have previously thought they weren’t eligible.
A loading is calculated if there is a higher than average probability that you will make a claim in the future, based on the information in your application.
Exclusions may be applied to your policy if you have risky or hazardous hobbies; have a pre-existing medical condition; have high-risk travel intentions; or a hazardous occupation.
Exclusions mean that a claim cannot be made as a result of an excluded pre-existing medical condition or from participating in an excluded activity. For example, if you had a sky diving exclusion, you would not be able to make a claim if you were injured, became totally and permanently disabled or passed away while participating in this activity.
When should you think about getting life insurance?
As a rule, most people don’t like thinking, or talking about dying.
Have you thought about or made plans with your partner or family should the unthinkable happen? If you answered no, you’re not alone.
According to recent studies, almost one third of Australians haven’t put together a financial plan for their family in the event of their death. Worse still, it usually takes the tragic loss of a family member of close friend for fifty per cent of people to consider taking out life insurance. And, did you know that almost a quarter of all Australians needed a major life changing event, like getting married, buying a house or having a child to influence whether or not they take out life or income protection insurance?
So…when should you consider taking out cover? Different times call for different actions; this is true of life and equally true for buying insurance. The following tips may help.
Till death do us part
When those rings go on, life takes a new dynamic. Few people think about the financial implications of something happening to them or their partner. Life insurance cover can help ensure that neither you nor your partner will need to worry about financial hardship if either of you were to pass away.
When the bun is in the oven
Here’s a commonly known fact - kids cost money. Food, clothes and education are some of the costs that grow as your children grow. If you are considering having children, or indeed if you already have a child, it is time to review your insurance needs to ensure that you have the right amount of cover to make sure your children are looked after in the event that something should happen to you or your partner.
Be it your first home, an investment property or the family castle, property is often the biggest financial commitment you will ever make. We all save hard for our first deposit and often continue sacrificing our lifestyles to ensure that we keep up with the repayments. However, how would a sudden and traumatic injury, illness or death impact on your ability to repay and retain your home? Making sure you have the right level of insurance cover to ensure that your home is protected not only against fire but also in the event of a personal trauma or death is one key strategy that will ensure peace of mind for you and your family.
Single with no kids
So you’re single and don’t have any commitments? Think carefully about who will be impacted should something happen to you. Funeral cover, for example is one relatively cheap way you can ensure you don’t leave your loved ones with the financial burden that often follows death.
So, what happens should you suffer a serious accident or illness and survive? Many people take their ability to earn an income for granted. Think of it this way, you are involved in an accident or are diagnosed with an illness that leaves you incapacitated, sure your hospital and medical bills may be looked after, but who will pay your rent? Your mortgage? The car loan? Food or electricity? Having the right insurance in place will help you meet your financial ‘living’ expenses in those times when you need it most.
The early bird gets the worm
It’s best to look at taking out cover earlier in life because, depending on the cover you choose, you may be able to take advantage of more competitive premiums. It is common knowledge that the older you get the harder it becomes to take out cover, getting in early helps ensure you get the right cover at the right time. As your life situation changes you should be able to easily review your level of cover and increase it by contacting your insurance company. A better, cheaper policy? Getting in early is the key in this strategy. It is the responsibility of each individual to decide how much life cover they should have. It should not be a question of ‘do I need life insurance?’ but ‘how much life insurance do I need?’
A Product Disclosure Statement ( PDS) is a legal document, or sometimes a group of documents, that contains information aboutyour insurance policy. A PDS will typically include any significant benefits and risks, the cost of the policy and the fees and charges that the policy provider may receive. Supplementary PDSs may be issued from time to time and must be read in conjunction with the PDS to which they relate. A PDS will help you understand the insurance policy and give you the the information about the terms and conditions, policy benefits and exclusions that you can use to compare differet policies. You should be aware that a PDS doesn't take into account your individual needs or financial situation.
Reading the PDS will help you compare and make an informed choice about the policy and give you information on you how your insurer will respond if you need to make a claim. And most importantly, if you don’t fully understand the PDS contact your insurance company and ask for more information. It's always better to have more information than less.
When you take out a new policy make sure you have the details of your new product explained to you and confirmed in writing. In most cases, you will also have the benefit of a 30-day cooling off period. This means if you change your mind in the first 30 days after joining, and haven’t made a claim for benefits on the new product you may get a refund of any contributions you’ve paid.