This week I wanted to take a look at insurance. Specifically, we’ll be taking a look at personal insurance, as that’s the space that we offer advice in as financial planners. There are primarily four types of personal insurance:
- Life insurance
- Total and Permanent Disability insurance
- Income protection
- Trauma insurance
We’ll get into an explanation of what each of those do a little later, but I just wanted you to know what you’re getting into. We won’t be looking at private health insurance or general insurance like house and car.
Also, as regular listeners will know, we have our general advice warning at the end of each episode, but given we are talking in some degree of specifics during this episode, I thought it’s worth just reminding you at the beginning of the episode that the information contained here is general in nature, and quite clearly doesn’t take into account your particular circumstances. That being the case, you’re encouraged to seek out advice that is specific to your circumstances prior to making any changes to your insurance arrangements. On the Financial Autonomy website you’ll see details on the advice page about our Financial Autonomy programme, which will include insurance where that’s relevant. However if all you need is insurance assistance, then if you go to our financial planning business website, which is guidancefs.com.au and click book now you will see one of the options there is specifically for an insurance appointment, so if that’s what you need, that’s where you should head.
Alright, enough with the preamble, let’s dive into this week’s post, are you paying too much for your insurance?
The 4 types of Personal Insurance
Let’s start by giving some simple definitions on the four types of personal insurance so that everyone listening is on the same page. Life insurance is the obvious starting point. I’ve always thought it really should be called death insurance but I assume that didn’t get through the marketing department. Life insurance pays out a lump sum if you die. It’s particularly relevant for people with young children, and perhaps those with a mortgage.
Often linked to life insurance is total and permanent disability, which you will very frequently see abbreviated to the acronym TPD. Now if you stop and consider the name of this product, its purpose and payout conditions become fairly obvious. Just like Life insurance, TPD pays a lump sum benefit. It pays in the event that you are both totally and permanently disabled. An example might be suffering a stroke that leaves you paralysed down one side of your body. In that instance it’s permanent, not something that will improve with time, and from the perspective of you being able to do everything that you could do before, that would be considered total disablement as well.
Almost always, Life insurance and TPD cover are linked. This means that if you get a payout for TPD, that will reduce your amount of Life cover. Often, the default will be to have an identical amount of Life and TPD cover. So in this instance, once that TPD is paid out, there is no Life insurance remaining at all.
Most of us will hold our Life and TPD insurance through our super, we’ll dig into that a little bit more shortly.
So that’s two of the four personal insurances. Number three is income protection, sometimes referred to as salary continuance if it is within super.
Income protection replaces a portion of your wage, typically 70%, if you are unable to work due to illness or injury. It’s important to recognise that this is not unemployment insurance. Income protection policies have a waiting period, most typically 30 or 90 days. This is the period where you need to be able to provide for yourself via sick pay, your savings, and perhaps even things like annual leave and long service leave where they are relevant. If you continue to be off work beyond the waiting period, then you become eligible to make a claim.
And the 4th type of personal insurance, the one that is least well known, is Trauma insurance, occasionally also called Critical Illness insurance depending on the product provider. Trauma insurance pays a lump sum in the event that you suffer one of the listed conditions of the policy. Most Trauma policies have around 40 conditions, and the most common reasons for making a claim are malignant cancers or heart related conditions such as a heart attack. Trauma only pays if you survive these events, usually you need to survive 14 days from diagnosis. In this way it is not a substitute for Life insurance. Instead the intention is that the Trauma policy gives you a lump of money to cover out of pocket medical’s, and any other expenses that your household might incur. As an example, it could be that your partner needs to take time off work to take you in for chemo treatment if you were suffering cancer. If you live remotely perhaps you might have accommodation costs too. The idea is that trauma gives you this pool of money to use however you need it.
Why Have Insurance?
So now you know the four different types of personal insurance it’s probably also worth a quick reflection on why you have this insurance at all. Bottom line, like all insurance, it’s about having peace of mind. Hopefully you never claim on this insurance. But the purpose of having it is so that should a bad event befall you, you won’t have financial stress to deal with on top of whatever else it is that you’re battling to overcome.
Insurance Ownership
Appropriate ownership of your personal insurance is another important consideration and here I’m referring to whether your insurance is held within superannuation or outside, in your personal name. Trauma cover, cannot be held within super so let’s just set that one aside for now. The other three, being Life, TPD, and Income Protection, can all run through super if you choose.
Again, with the caveat that this is general advice only, most commonly, running your Life and TPD cover through super will make sense. The insurance premiums for these covers are tax deductible to a super fund, however they are not tax deductible to you as an individual. For this reason most of the time it will cost you less to run these covers through your super. Now of course these insurances don’t come for free, so you do need to allow for the fact that the premiums are being withdrawn from your superannuation savings, and as a result your ultimate retirement benefit is being reduced through the payment of these premiums. There are some people who would make top up contributions to super sufficient to cover the insurance premiums to offset this issue. This damage to your ultimate retirement benefits is a key reason why it’s important to consider whether you are paying too much for your insurance, typically in this case because you have more insurance than is actually required for your circumstances. We’ll get into the issue of how much is enough next.
Income protection can also be run through superannuation. Most of the time when where advising clients, we suggest they hold their income protection outside of superannuation. This is because income protection insurance premiums are the only ones that are tax deductible to you as an individual. Super funds pay 15% tax whereas you as an individual likely pay at least 30% tax. Therefore the tax deduction when owned as an individual is likely to be higher than when owned by a super fund. It is also the case that income protection policies running through superannuation tend to be a little simpler than the policies you can obtain in your personal name. This has to do with the superannuation preservation requirements. There’s no point having any income protection policy within superannuation that has a whole lot of extra benefits, if when those benefits are paid, they are then not able to be released from the superannuation fund until you retire.
It’s important to note that whilst it is the case that we generally recommend people take their income protection cover outside of super, sometimes it does make sense to hold it within super where their cash flow is at a point that the income protection would not be affordable were it to be outside of super. It’s definitely better to have some income protection within super, if the alternative is to have none at all.
Am I Paying Too Much for Insurance?
Okay, so let’s dive into how you might be paying too much for your insurance. Generally it will be because you have more insurance than you need. So let’s think about appropriate levels of insurance.
Starting with Life insurance, you are typically trying to have enough cover that if you were to pass away your dependants would be taken care of, and usually you would want enough that the mortgage on your home is cleared. Clearing of the mortgage is not likely needed if you don’t have children, however for those with children most people would like to know that if they passed away their spouse would be left with a debt free home and some money in the bank to help raise their children through until adulthood.
With these two inputs in mind, an amount for dependents, and an amount to clear the mortgage, it should be the case that your need is largest when your children are very young, and when your mortgage is at its peak. Over time, as your children grow up, the amount that you need to provide for them reduces, as they get closer to adulthood and financial independence. Similarly, your mortgage will reduce over time. In combination therefore it should be the case that your insurance can progressively be reduced through your lifetime, and once your children move into independent adulthood, and your mortgage is paid off, quite likely you could cancel your life insurance altogether. This is really helpful given insurance gets more expensive as you get older. Being able to scale down your level of cover and ultimately turn it off altogether as you enter into later life, helps avoid you paying too much for your insurance. Given that most life insurance is run through superannuation, this also helps it damaging your ultimate retirement benefit too much as well.
Total and Permanent Disability has a similar calculation method to life cover, except that there is some overlap between TPD and income protection. There is no single right way to determine the appropriate level of TPD cover, but we would often see people decide to have enough to clear the mortgage only, on the basis that with good quality income protection in place, if they had no mortgage to pay, they could live quite comfortably off their income protection benefit. In this way the TPD benefit amount is lower than the death benefit, which of course reduces the premiums, again helping ensure you’re not paying too much for your insurance, and also ensuring the cost of the insurance isn’t doing any more damage to your retirement benefits than is necessary. Of course clearly if you can’t get income protection, perhaps because you’re a full time carer for instance, then ordinarily you would have your TPD cover equal to your Life insurance amount. Most insurers won’t allow you to have more TPD and Life cover.
So when you’re thinking about whether you’re paying too much for insurance, rather than reflect on whether you need to change provider, which would typically mean changing your super fund, I’d encourage you to instead focus on whether the amounts of insurance are appropriate for your circumstances. Now as mentioned, if you’ve got a young family and a big mortgage, personal insurance is highly relevant to you, and it may be that you don’t have enough insurance. But if you’re a bit further along in life, what we often find is people having more insurance than they need. They ramped it up when they started their family and it’s simply been adjusted up for inflation ever since.
Income protection is a little different, in that as mentioned earlier, generally we would recommend people having that outside of their superannuation. In this way it is a little easier to shop around and consider prices from other providers. It is important to note however that there were significant changes made to the structure of income protection policies from October 2021, and as a general rule, policies that existed prior to this date are of a higher quality than the newer policies. That’s not to suggest that the newer policies are terrible, but just that if you are comparing prices of an older policy versus a new policy, you are almost certainly not comparing apples with apples, and it may be that a lower cost newer policy is cheaper for very good reason.
Income protection insurance is an area where costs have gone up quite considerably over the past few years and so concerns about paying too much for this insurance are something regularly raised by our clients. Again, the starting point is to consider whether the level of cover, and in the case of income protection the other key parameters such as waiting period and benefit, remain appropriate. As with Life and Total and Permanent Disability cover, typically your needs reduce as you progress through life and your personal balance sheet strengthens. So for instance whereas perhaps when you obtained your income protection insurance in your mid 20s, you needed a 30 day waiting period, perhaps now in your early 40s, with $100,000 sitting in your offset account, you could get by with a 90 day waiting period, or in the case of some policies, even longer. Altering this waiting period will have a significant impact on your premiums, a great way to reduce your income protection costs.
Occupation Rating
Something else you could have a look at if you are concerned that you’re paying too much for your insurance is the occupation rating that they have you down for. Insurance premiums are based on risk. Your age therefore is one factor, your smoking status is another, and one very important risk parameter is your occupation. A tradie working on a construction site will be considered considerably higher risk, particularly for injury, compared to someone that spends all their working time in an office. Sometimes through peoples careers they might start off in a manual role and then progress into a supervisory or managerial type role. When this happens, the insurance rating applied when you began your career might have been be at a high risk occupation rating, whereas if you make the insurer aware that your role now entails you working entirely in an office, they could change that occupation rating, leading to you seeing a significant reduction in your insurance premiums.
So if you’re concerned that you’re paying too much for your insurance, have a look at your levels of cover in consider whether they accurately reflect your need. Remember, insurance payouts aren’t intended as lottery wins. They exist to avoid financial hardship. Don’t hold more insurance than your family needs. Insurance costs money, and that’s money that could have been used to help strengthen your financial position and gain the choice in life that you deserve.
As mentioned at the beginning, if you need help with insurance, we can assist either via our Financial Autonomy programme, or if insurance is the only thing that you need help with, then book an insurance only meeting through our guidancefs.com.au website.
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