Very early on in my working life, a colleague and I had a conversation about life insurance. She was totally against the prospect, saying that she would never want to profit from the death of her husband. She had a moral objection to the idea.
I see life insurance as a safety net. No amount of money will ever replace a loved one, of course. But to me, that isn’t the purpose of life insurance. The purpose is to enable those left behind to continue to live the standard of life they had while you were alive. Imaging dealing with the most stressful event in life, while also having to come to terms with wondering how you can afford buy groceries or pay the next electricity bill.
In the industry, life insurance is an umbrella term, encompassing death, total and permanent disablement (TPD), trauma and income protection. In this post I will be focusing on life (death) insurance only, also known as term life cover.
Can I Trust The Life Insurance Industry?
Unfortunately, the life insurance industry has recently been under intense scrutiny for unfair practices. In October 2016, the Australian Securities and Investment Commission published an industry review of life insurance claims. The catalyst for the review was a media expose on the practices of CommInsure, which does not make for pleasant reading. The review examined processes for making a claim, as well as the outcomes of claims made. This included whether claims had been “improperly or unfairly declined.”
For consumers, the intrinsic value of an insurance product is in the ability to make a successful claim when an insured event occurs. Not being able to successfully claim on life insurance in these circumstances can be financially devastating for the consumer and/or their family.
The good news for life (death) insurance is that the industry paid out 96% of claims in the first instance. In this case, as long as you insure with a “reputable” company and understand the PDS, you should have nothing to worry about.
Underinsurance Is A Thing
According to research, Australians are woefully under-insured in the event of death.
Back in 2010, the National Centre for Social and Economic Modelling concluded that typical families (with children) covered by typical levels of insurance would have between 55 – 60% of pre-death income, after taking into account decreased taxes and government payments. Unfortunately, these percentages continue to drop 5 and 10 years after the death of the partner, down to 50%. Stop and think about what this might mean for the typical Australian family. Estimates report that up to one half are living payday to payday already.
The most recent report from an independent body (Rice Warner’s Underinsurance in Australia 2015 report) showed that less than 57% hold insurance. Of those that do, the money will only cover 61% of basic needs. Basic needs are defined as the minimum required to sustain the current living standard until age 65 or until children reach age 21. It doesn’t include mortgage debt.
The underinsurance numbers are even worse for people with young children. Partially due to default cover within Superannuation, this gap has slowly closed over the last decade. However, while most super funds offered life insurance for members…
The amount of cover you get from a default group insurance scheme is … by no means going to cover your actual needs if something were to happen. – James Williams, Rice Warner report author.
In April 2017, Real Insurance commissioned CoreData to conduct a Family Protection Survey. This supported Rice Warner’s figures of 2015 – 38% of people had no life insurance. Of those surveyed (which were only families with children), roughly 75% felt somewhat-to-fully reliant on a partner or family for financial support, and an equal amount felt their partner or family was reliant on them.
Interestingly, they also found that 13% of surveyed people had experienced a financial burden when a loved one died. The verbatim responses to the question “What the most difficult thing to deal with because of this?” make for discomforting reading.
What Are the Benefits of Life Insurance?
To me, hearing stories from affected people best demonstrates the benefits. However, to explore them a little deeper:
- Everything you know is turned upside-down. Every person is different, but the grieving process can be long and painful. Just trying to accept and adjust to the change can take up all of your brain power. Having to deal with financial burden at the same time would make it even worse.
- Time. Life insurance provides a financial buffer, to let your significant others buy time to sort things out.
- Debt inheritance. Lately, debt levels of Australian families have been all over the media, particularly mortgage debt. Not having to worry about keeping a roof over their heads would be a huge release of stress for family members reliant on you.
- Prevent further debt, such as to cover funeral costs or medical expenses. Even though we are a country with “free” healthcare, medical expenses definitely still occur. Without adequate cover, people have had to resort to loans to get them through.
- You could provide for future expenses, such as educating your children.
- Ensure a business can be continued, wound up or sold.
- Altruism – it’s possible to use a life insurance payout to donate to charity.
- Depending on whether the life insurance policy was bought inside or outside of Superannuation, and whether the recipients are dependants, a payout may be tax-free.
Where Do I Get a Life Insurance Policy?
Life insurance is generally obtained one of three ways:
- Superannuation, also known as “group cover”
- Through an insurance broker or financial advisor, also known as a “retail policy”
- Directly by an insurance company, also known as a “non-advised policy”
There are advantages and disadvantages to obtaining insurance for all three methods.
If you have employee superannuation, you will typically receive a default level of cover when signing up. This is often automatic, which means you don’t have to fill out any health questionnaires.
The default level of cover is based on a simple age/gender formula, and is highly unlikely to be enough. You are able to apply to increase the level of cover.
The premiums are likely to be cheaper. Superannuation companies receive discounts for buying policies in bulk.
Premiums are paid from your superannuation balance. This means they are paid pre-tax, so you are receiving a tax benefit compared to paying out of your own pocket.
This may be an advantage for people without surplus cash to pay for insurance, or a disadvantage because of the effect on your final superannuation balance (you can help mitigate this by salary sacrificing the cost of the premiums).
There may be a delay, as the money is paid to the superannuation trustee rather than directly to the beneficiary. Unless you have a binding nomination in place, the trustee may have some discretion in who gets the money.
If the beneficiary is not (or is no longer) a dependent, they will be required to pay tax on the amount received.
Premiums tend to remain steady while the amount you are insured for decreases. The theory is that the older you get, the more superannuation you will have accumulated, so the less of a life insurance payout you will need.
Financial Advisor or Insurance Broker
You will have to pay to receive the advice.
You must supply details of your health history, which can be a long and complex document.
The financial advisor may be independent, or may be affiliated with a particular insurance company (or a selection only). The advisor or broker may receive an upfront or ongoing commission.
You will receive advice targeted to your specific goals and financial circumstances, including a recommended insured amount.
Insurance is “guaranteed renewable”. This means that for as long as you are paying for the policy, the insurer must continue to cover you. Likewise, the terms and conditions of the policy cannot be changed without your consent.
Benefits paid to the beneficiary are generally tax-free (of course, there are exceptions.)
Insurance Company or Sales Affiliate
General advice only. Your specific situation or requirements are not taken into account. It is assumed you do the work to decide if the policy is the best one for you, and determine how much you need.
Easy to sign up – often through a website or phone call, however you will also need to supply details of your health history, which can be a long and complex document.
Free to sign up. It’s completely obvious where you are buying the policy from, so there are no fees or commissions.
As above, insurance is guaranteed renewable.
Benefits paid to the beneficiary are generally tax-free (of course, there are exceptions.) If unsure, it probably is best to consult a financial or tax advisor.
But I Still Have More Questions!
I know. There’s way too much to deal with in a single blog post. Next week I’ll be talking about what to look for when choosing a life insurance policy, as well as how to determine the amount of insurance you need. The final amount calculated for Mr. ETT and I surprised me.
There are NO affiliate links in these posts. If specific insurers are mentioned, it’s only because I obtained information from their sites, or their commissioned reports. This post came about because we are trying to reduce our spending by 10% in 2017, and I thought life insurance might be one expense we could reduce or cut.