Protecting your wealth and standard of living is just as important as building it in the first place. Unfortunately history is full of real-life stories where people have suffered long-term financial hardship because they didn't insure against unexpected death or disability. You are gambling with your financial future if you do not have adequate insurance.
Death and disability insurance summary
Death cover helps your family members maintain their living standards if you die unexpectedly. It provides a lump sum that can be used to pay off debts and/or invested to meet cost of living expenses.
Total and permanent disablement (TPD) cover pays a lump sum should you become totally and permanently disabled through illness or injury. This covers expenses such as medical and rehabilitation costs as well as day to day living expenses. The key points here are that most policies dictate that you have to wait six months before making a claim, and that a medical practitioner has to sign off that you can never work again. For a white collar worker, this test can sometimes be difficult to prove.
Income protection insurance (otherwise known as salary continuance) provides a regular monthly income should you be temporarily unable to work because of illness or injury. There are a number of benefit periods and waiting periods to choose from. The benefit period defines how long you will get paid for (two years, five years, to age 65 for example), and the waiting period defines how long you have to wait before you can make a claim (30 days, 60 days, 90 days for example). A crucial point here is that it takes about a month for an insurance company to process a claim once they receive it, so you need to factor this into your calculations.
Unlike TPD, you only have to prove that you are unable to work at the time of the claim. In order to make sure that you are still disabled, you will be required to consult a medical practitioner on a regular basis during the benefit period. The payments stop as soon as you are judged to be well enough to return to work, or until the benefit period ends.
Trauma insurance pays you a lump sum if you are diagnosed with specified medical conditions (e.g. a heart attack, stroke or cancer). This avoids financial stress during the period of recuperation when home modifications and specialist medical attention may be necessary.
Getting the mix right
Part of the difficulty in choosing the most appropriate insurance is that these four policies can overlap, and unless you have a lot of money, you will probably have to make some choices.
If you have a home loan and a family to consider, you need more life insurance (death cover) than someone who is single and renting. It would really ease your family’s financial position if the home loan was paid off and they also were left with a lump sum that could be invested to generate an income stream. Whilst singles or couples without children should not need as much cover as families, there will be debts to be paid off, solicitor’s fees and funeral expenses to consider.
In most cases, it makes sense to have both TPD and income protection insurance. A major reason is that you may suffer a disability that is not permanent and doesn’t kill you. You lose your monthly income which makes it hard to cover your expenses.
Income protection is a must for anybody who needs to maintain cash flow and doesn’t have substantial savings to draw on in emergencies. So even if you are single with no dependants, you still need to feed yourself and pay the rent.
Trauma insurance is probably the hardest to assess. The cost is elatively low when you are younger but rises stratospherically once you reach your late 40s, just when you may need it.
On balance, your disability insurance should be structured so that you receive a lump sum upfront to pay for big ticket expenses if you are permanently disabled, but also include some salary continuance insurance to replace your income so that you can meet your day-to-day living expenses. A small amount of trauma insurance is also advisable for disabilities that involve upfront expenses but don’t stop you working for a long period (breast cancer, heart attacks, for example).
You should also remember that insurance is designed to protect your cash flow and assets if unforeseen circumstances occur. Insurance should give you peace of mind so you can live comfortably and provide for your dependants without worrying. Your strategy should be to pay off debts and build wealth so that as time goes by you need less insurance not more. Insurance costs rise significantly as you get older, and become very expensive in your 60s. If you are paying for your insurance via your superannuation, you need to recognise that insurance premiums are depleting your retirement funds. At some stage, you may have to make a decision about whether the potential benefit is worth the cost.
Arranging your policies – inside or outside super?
The first step is to find out what insurance you have already. If you are in an employer or government super fund, you will usually have been allocated some death and TPD cover, and sometimes income protection as well. Bear in mind that in most circumstances you are paying for this out of your super balance. It is not usually ‘free’ unless you have a generous employer.
There are three primary benefits of insuring via super:
- the premiums are paid from your super balance rather than your after-tax income which is usually more tax-effective. You are using money that has only been taxed at 15% rather than your PAYG tax rate which could be as high as 46.5%, although you are depleting your super balances
- you are using money that is normally inaccessible until you are at least age 55
- you don’t have to dip into your everyday living expenses to pay the premiums.
Group insurance via an employer super is usually cheaper than arranging a separate individual policy. You also don’t have to take medical tests for the allocated cover.
Insurance policies via a personal super plan are usually more expensive than a group policy, but there are some exceptions. Group rates are often the same for smokers and non-smokers, but personal policies quote different rates. Non-smokers may be better off with a personal policy.
Insurance policies arranged outside super can give a lot more flexibility. For example, you can choose your insurance company, and there is more product choice. Insurance policies have different definitions for disablement so you can choose the policy which best suits your needs. The big disadvantage with stand-alone policies is that you have to find the money from everyday living expenses. This gets progressively more arduous each year as premiums rise with age.
Many advisers recommend death cover and salary continuance via super, plus a stand-alone TPD policy. In most cases, super fund members get allocated equal amounts of death and TPD cover. There is no reason why this should happen, and it does have some disadvantages. For example, if you make a successful TPD claim, the payout automatically reduces the value of your policy so that you will receive less money when you subsequently die. Another disadvantage is that a successful claim from a super TPD policy involves two steps: first, acceptance of the claimed, and second, getting the money out of super by proving you have met a ‘condition of release’.
Working out how much insurance you and your family need is no easy task. It’s tempting to ‘cut out the middle man’ but a good financial adviser will have access to a range of insurance solutions and will individually tailor a selection of insurance policies to fit your specific circumstances.