Life insurance. As with all insurance, the question becomes: how much do you need? Economists and statisticians can put a price on human life, but most people I know generally don’t tend to do so. And as long as you can afford the premiums, you can find some policies that will allow you to insure yourself for a very large sum indeed.
Our History of Life Insurance
As I spoke about in my goals post last year, we have two policies. We are each insured for $125,000 through our superannuation. This is the standard offering given to all new members, and being default cover, is unlikely to be anywhere near sufficient for our needs.
Outside of super, we are each covered for $400,000 through a policy that I seemed to remember was somehow attached to our home loan. When I went to look for the policy, imagine my shock on finding this…
It was a lender’s mortgage insurance policy, dressed up as “Family Protection Insurance”. That protects the lender for the outstanding balance of the loan if one of us dies; the money doesn’t go to us! We all but paid off our mortgage 8 years ago, so can you imagine the sick feeling I had to think that we have paid $120 every month to protect THEM?! Luckily, as I kept going through the folder, I discovered that we had ceased that insurance after about 7 years, and bought a private insurance policy. I have no memory of how we got this, except that it definitely wasn’t through a financial advisor.
So, no problem, right? I have the new policy. Except I don’t. I have every renewal notice since 2005, but I cannot find the actual policy document itself. It turns out that this is a really important document – the only document that I need to have. The renewal notices mean nothing. I had to fill in a statutory declaration to state that it was missing and that we’d done our best to find it, to get it replaced.
Back to the Numbers
We each bring home $60,000, so $525,000 is equivalent to just under 9 years of full replacement income once one of us dies. However, costs would drop. Not to half, because it is more expensive to live as one than two, living the same life post-death. But we would get rid of one car, which drops expenses by $5,000. (If Mr. ETT died, the motorbike would have to go as well. Sorry Mr. ETT!) Then there is food, clothes, spending money – just how much could be saved if only one of us was left? I think expenses could easily drop from our current $80,000 to $60,000. That means either of us would be fine living off the wage we currently have.
Eventually though, if we were withdrawing the full $60,000 a year, the lump sum would run out. If for some ridiculous reason we wanted to continue to spend $80,000 a year, then investing $525,000 @ 4% will generate an income of $21,000/year, so we could keep the lump sum forever. Seriously, though, we are already trying to cut back on our spending for the two of us. The scenario I just painted would be unnecessary. Another consideration is our superannuation. Right now we would each get $200,000. That could either be rolled over into our own super, or invested outside.
A standard rough calculation is to clear all debt, and then add 10 times your annual salary (Choice). Having no debt, this means I would need $790,000 cover. However, it might be worth doing just a bit more of a calculation to make the numbers more meaningful to my circumstances.
According to the Lifewise/NATSEM Underinsurance Report, the insurance industry recommends cover that will clear all debt, then have enough for 7 years of 75% of current net income (for families with children). By this calculation, I would need $315,000 cover. Big difference between the two, isn’t there?
Insured Amount = Debt + ((Post-tax income x 0.75) x 7)
Then there are multiple calculators to help determine the required insurance amount based on your exact numbers (this is another reason I love YNAB – all of our numbers are at my fingertips whenever I need them.)
AMP calculated that I need no cover for death and TPD. Same for Mr. ETT.
Canstar calculated the same.
Allianz allows you to specify your required spending. The results say I should have $700,000 in life and TPD each for income of $60,000/year net for 20 years. If we reduce that to $20,000 annual income so Mr. ETT earns $60,000 for the $80,000 we spend now, then it drops to zero.
AAMI calculates that I need zero to replace half of my current living and housing costs for 5 years. If I increase that to 20 years, I should be insured for $38,000. That’s easily covered by my insurance inside super.
The Final Decision
Right now, we are each covered for $525,000. By all accounts, we don’t need any cover. I could simply drop both policies and be done with it. But… if we drop it, and then our circumstances change, getting back in is HARD. Not only is there a 12 page form to fill out with questions like:
…the premiums are likely to be much higher, or the insurance company has a right to decide that we shouldn’t be insured at all. They can refuse to provide cover. By taking out insurance when we were young and fit, we were “insuring our insurability.” There are no updates to your medical history once you have coverage. Policies sold outside of super cannot be altered without our permission. I don’t want to lose that insurability. So, I will reduce the amount we are each insured for to $250,000. Then every 5 years, I’ll drop it by another $50,000.
Our superannuation coverage is on a sliding scale, and is naturally reducing. I will stop that all together when we turn 50, because it will only be worth $76,500. All being well, we should have saved a significant stash by then, and what I was paying in premiums can again compound for the remaining 17 years until we access our super.
What to Look for in a Life Insurance Policy
What if you aren’t in our boat yet, and the calculators tell you that you need some life insurance? Things to consider when looking for a policy are:
- Inclusions. What is specifically mentioned as being included in the policy?
- Does the policy cover pre-existing conditions? If so, what is the waiting period for cover? This might be blanket across the policy, or only for specific events.
- Exclusions. My insurance through superannuation excludes death due to war outside of Australia (which makes me ask, what about a war in Australia?) The family protection policy I mentioned earlier? It excluded death from HIV. Thankfully we have moved on since then, but you need to carefully consider if the exclusions may affect you.
- Due to the long-term nature of life insurance, it’s only as good as the longevity of the company providing it. Choose an insurer with history and at least a reasonable reputation.
- Ensure the policy you purchase offers the option to change your cover. You don’t know what life will bring, so it’s worth checking for some flexibility. Be aware that some will restrict changes to yearly at policy renewal time.
- How quickly do you have to make a claim after someone has died? This is a totally overwhelming time, and paperwork could be the last thing on your mind. If you miss the claim period, though, you may miss out all together. Doesn’t sound fair to me. It’s not like the person is going to come back, after all.
- Do you work in a dangerous occupation? What about hobbies? If either of those are considered high risk, you may find they aren’t covered.
- If your family couldn’t get access to a lump sum of money quickly – for example, to cover funeral costs – some policies offer an advance benefit payment. This will help get them through immediate costs by paying an expedited small lump sum.
- If you have plans to travel or migrate in the future, check whether your policy will cover your death outside of Australia.
- Can you put your cover temporarily on hold? This means pausing payment of premiums, and your cover, without having to reapply to get back in.
- Is the policy indexed to inflation? $400,000 in 2005 is actually equivalent to $525,000 in 2017 dollars. It doesn’t matter for us, but it may be important for you, especially if you can’t yet afford to cover yourself for the recommended amount.
- Financial advice – some policies offer free financial advice on dealing with a lump sum payout. Others might offer a specific payment to visit a financial advisor.
What Should YOU Do?
I don’t want you to buy into the insurance industry’s hype. Nor do I want you to ignore it. What I ask is that you sit down with the important people in your life and figure out what is best for those left behind. Not for you. It’s not about you. To put it bluntly, you’re dead. But at the very least, do some back of the envelope calculations to determine how much they would need to cover the basics. If you have the time and inclination, model a budget. Calculate how much you could have brought in over the next 10-50 years, or how much they are likely to require.
It’s possible you’ll discover you can’t afford the premiums for the level of cover you want. Don’t give up. Think about what the reduced level of cover you can afford would practically mean if you weren’t around. Can you at least insure enough to clear debts? I just want you to have made a deliberate, informed decision, having worked through possible consequences. Maybe your emergency fund is enough to cover your funeral and a few months off work for the survivors. Or perhaps like us, you have no kids, no debt and a healthy working significant other. Maybe you’re single, or you value spending your dollars elsewhere. That’s all fine. It’s your choice, but remember – it’s not just about you.