Life Insurance – Making An Unhappy Future Easier

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.

Percentage Payout Denials For Each Type of Life Insurance
Source: ASIC

Underinsurance Is A Thing

2010

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.

Life Insurance Only Covers 61% of Basic Needs
Source: Rice Warner

2015

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.

2017

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.

75% of people feel reliant on their partners for financial support.

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.

Effect of Insufficient Life Insurance in people's own words.

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.

Families had to take on debt after death of a loved one.

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”
Distribution Channels for Life Insurance in Australia
Source: ASIC

There are advantages and disadvantages to obtaining insurance for all three methods.

Superannuation

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.

Death Cover Stepped Benefits
My default life insurance benefits decrease significantly as I age.

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.

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6 thoughts on “Life Insurance – Making An Unhappy Future Easier

  1. I love how detailed this post is! I’m firmly in the pro-life insurance camp, although I know many people in the FIRE arena feel differently. I think that, as long as you have debt, you need life insurance. The insurance needs to be able to replace several years’ worth of your lost income to decrease the burden on your family.

    • We’ve just always had it, which I think was influence from our parents. It can be costly, but imagine if the worst ever happened? I think this is also particularly true for women. Statistically, many are earning less than their partners. They could be left with less than 50% of the pre-death income, possibly to support a family.

  2. I am also in the pro-life insurance camp. Hell, I am pro-anything insurance. I think my father having a career in insurance has a lot to do with this tho – brainwashed since young? Either way, I am insured to my eyeballs though I recently have been thinking that I need to review my policy again because it’s been a couple of years since I took it out and things have changed since then. My partner however, is completely opposite. He does not even think private health insurance is worthwhile. He is very much on the other side of the fence! Luckily he has no debt, nor assets, so I guess…..

    • We’ve always had life insurance, which I think was an influence from our parents. It was something that we “just did” after we got married. It can be hard to value insurance if you aren’t earning very much, but the problem is… it’s not about you. It’s about looking after the person you’ve left behind. Even without debts or assets, he might need to review that if you have kids (fingers crossed for you xxx). Or maybe you take a policy out on him to protect yourself!

  3. Uh-oh. You probably already know how I feel about this 😉
    It really depends on everyones own financial situation. The less wealth you have, the more you need it. Same goes if you have high expenses. So essentially you could keep the insurance until you reach a low spending, higher wealth situation, then there really isn’t any need.
    Not sure I understand the income replacement study. I thought you receive a lump sum. How are they assuming you use that lump sum… in cash as you need it? I doubt they are assuming you invest the lump sum to create some income.
    Payday to payday – well to me it seems many expenses are optional anyway, so it may not be quite so dire.
    People seem to have lost their ability to adapt financially. It’s almost like it’s insurance to cover taking out too much debt, or having large expenses. It seems harsh, but they are choices.
    I firmly believe the best insurance you can take out to cover everything is self-created – by dramatically cutting your expenses and growing your wealth. If your family only has half the expenses, they can easily survive on half the pay. Some cases this insurance would help, absolutely. But in many cases, if we just improve our spending situation then there really isn’t much use for insurance. Funnily enough, we end up paying so much for insurances that we can’t save, further entrenching our reliance on insurance…how ironic.
    Well laid out article Mrs ETT!

    • What a wicked insight – “Funnily enough, we end up paying so much for insurances that we can’t save, further entrenching our reliance on insurance…how ironic” I can definitely see how that is true, but when much of the population isn’t saving or reducing expenses (or, for those that are genuinely living under the poverty level), life insurance could make a huge difference. Also as you said, it’s about reviewing it to figure out if you really need it as expenses reduce and wealth grows.

      The study assumed that a lump sum would firstly be paid towards debt. If there was any debt left over, it would be rolled into the home mortgage and the repayments negotiated. If there was any money left after debt was paid, the assumption was it would be put into a “low-rate” account at 4.5% (how times have changed since 2010).

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