Risk Insurance

Broadly speaking, there are five types of life insurance:

• Life cover (this is sometimes called death cover);
• Income protection cover;
• Total and permanent disability cover (TPD);
• Trauma cover; and
• Business cover (for either business expenses or a key person in the business).

We will look at each of these in turn. But before we do, let’s look at a few general concepts that apply to all or most forms of life insurance.

Insurance is like a bet… and we hope you lose it!

In many ways, insurance is like a bet. But it is an unusual bet: it is a bet you hope you lose!

The idea of insurance is that you pay a relatively small amount each year. This is the amount that you bet. If the ‘insured event’ occurs, you then receive a payment. This payment reimburses you or your loved ones for the financial consequences of the insured event.

For example: Think about life cover. Life cover is an insurance policy that pays a benefit if you die. Life cover is generally taken out by people who are financially responsible for someone else. Mums and dads who are raising families are the most common buyers of life cover. If a mum or a dad were to die, then there would be less income to raise the kids. So, mums and dads pay a relatively small premium to an insurer, and if the ‘insured event’ happens (that is, if mum or dad die) the insurer pays the insured amount to beneficiary of the policy.

The premium is the bet. And we hope you lose the bet because that means you did not die.  But if you do die, then at least your loved ones are being looked after financially.

The Premium

The premium is the amount that you pay when you buy an insurance policy. There are two main types of premium. A stepped premium is one that changes each year.  The amount of the premium changes each year as the probability of the insured event changes. This usually means an increase. For example, as we get older, the chances of dying increase. So, for life cover, a stepped premium will usually increase each year. The insurer needs more money from us each year to account for the increased chance that they will need to pay out on the policy.

The other type of premium is a level premium. As the name suggests, in a level premium the amount paid each year does not change (other than to adjust for inflation). With this kind of policy, the premium is usually higher in the early years of the policy. But because it does not rise each year, at some point the level premium often falls below what would be paid with a stepped premium.

Whether you prefer a stepped or level premium is something to discuss with an adviser. Generally, stepped premiums are lower in the early years of a policy, and many people like them for this reason. The lower initial premium allows the client to use the money saved for other purposes, such as paying off a mortgage or educating the children. But level premiums give you certainty: you know exactly how much you will pay in the future. They can also have the benefit of being cheaper in the future – so people who know that their living costs will rise often prefer a level premium.

Underwriting

When you apply for a life insurance policy, the insurance company undertakes a process known as ‘under-writing.’ Basically, the under-writing process determines how likely it is that the thing being insured against will happen.

For example, if the insurance is for life cover, the under-writing process works out how likely it is that you will die during the life of your policy. To do that, the under-writer will look at things like the lifestyle of the person (recreational activities like hot-air ballooning and parachuting are considered more risky), the person’s health history, their age, etc.

The insurer can only work in probabilities, of course. They cannot determine exactly whether the insured event will happen. But they can determine how likely it is to happen.

Once the under-writer has made their assessment, they can do one of four things.

The first is to accept the policy. From this point forward, you simply pay the premium and the insurer will make a payment if the insured event occurs.

The second is to accept the policy but to place an ‘exclusion’ on the policy. For example, where a person engages in risky activities like sky diving, the insurer might exclude death or injury experienced while skydiving. If the insured person is hurt or dies while skydiving, there is no benefit payable. If the insured person is hurt or dies due to some other cause, a benefit would be paid.

The third course of action is for the insurer to adjust the premium upwards to reflect the heightened prospect of a claim. This is known as a ‘loading.’ The principle is simple: the insured person is asked to pay an increased amount that reflects the fact that the chances of a claim are higher than normal.

The fourth course of action is where the under-writer decides that the likelihood of the insured event occurring during a policy is too high. In this case, the insurer will decline to provide insurance. An example of this might be where a person with terminal cancer applies for life insurance. In this case, the insurer will almost certainly have to make a payment. So, they decline to offer a policy.

Factors that affect under-writing and the premium

There are various factors that the under-writers consider. These include:

Age. By and large, younger people pay less for life insurances. (Very young men can sometimes pay higher premiums, basically because they drive their cars faster than they should). The reason for this is probably obvious: younger people get sick less and die less than older people. Therefore, the risk of the insured event occurring is less for younger people.

Gender. Gender is another factor that impacts on the premium. On average, women live longer. This makes them less likely to die at a younger age and this usually means a lowered premium for a woman.

Health. Again, the healthier a person is, the lower the premium is likely to be. And again, the reason is obvious: healthy people tend to die later and become ill or injured less.

Smoking. Smokers pay higher life insurance premiums. The reason is obvious: smokers get sick and die more easily than non-smokers. This provides yet another way that giving up smoking saves you money – not only will you spend less on cigarettes, but (if you stay off the ciggies) you will pay less in life insurance as well. Higher insurance premiums are one of the hidden costs of smoking.

Occupation. While most occupations do not have an impact, there are a few occupations that will attract higher premiums or even see insurance declined. Neil Armstrong, for example, could not get life insurance before he flew to the moon.

Your Duty of Disclosure

People applying for insurance cover must disclose all relevant information to the insurer. This is known as a duty of ‘utmost good faith.’

Most insurance policies state that the contract for insurance may be voided (ie be ignored by the insurer) if the insured person did not tell the insurer something that is ‘material’ to the underwriting decision. ‘Material’ means that the insurer may have made a different underwriting decision had they had the information.

The general point is that you should always give the insurer honest answers to every question that they ask. If you don’t, there is not much point in having insurance in the first place.

Affordability

For most people, affordability is the biggest issue that determines whether and how much they insure themselves for. Premiums are not cheap, and spending money on a bet that you want to lose can sometimes be written off as a low priority.

Because of this, it is crucial that life insurances be as affordable as possible. There are various ways to make insurances more affordable. These include:

• Using superannuation benefits to pay for those insurances that are available within superannuation. This usually means life cover, TPD and a limited amount of income protection. Paying these amounts out of superannuation does not necessarily make them cheaper. But because you are using money that is not accessible to you anyway, it reduces the effect of insurance on your day-to-day cash flow.

• Claiming tax deductions wherever possible. Premiums for some life insurances, in particular income protection, are typically tax deductible. Some life cover and TPD, especially for self-employed people, is also effectively tax deductible. This is because the superannuation contribution that you make to finance the insurance premium reduces your taxable income.

• Accepting a degree of under-insurance. Under-insurance is where the amount for which you are insured is less than would normally be recommended. Don’t get us wrong here: we think people should always be insured for an appropriate amount. But if you simply cannot afford the premium for the recommended level of insurance, then taking out a lower level of insurance is better than having no insurance at all.

• Accepting some of the risk of the insured event yourself. Here, you insure yourself against some of the risk of things going wrong. For example, you might decide that you could ‘get by’ for a year if you become too unwell to work. You could then choose an income protection policy that has a one year waiting period. Very few people are sick for more than a year. This means that the premiums for this kind of policy are much lower than for policies with a shorter waiting period, such as a 30 day waiting period. If you get sick for a period of less than a year, you will be out of pocket. But the sickness that goes on for more than a year is the one that would be financially ruinous – and you are insured against that.

• Get multiple quotes and don’t be loyal to any one insurer. We can easily do this for you and there can be substantial amounts of money saved by choosing the best-value insurance policy.

We also know other ways to ensure that your premium is as affordable as possible. Affordability of premiums is a key consideration whenever we provide advice.

Continuity

If you are contemplating changing your insurer, make sure that your cover continues from one policy to the next. We can help you here. You want to make sure that there are no gap periods in your cover – the last thing you want is for the insured event to occur after you have cancelled one policy but before the next one has kicked in.

Tell people you have the policy

When you take out a life insurance policy, tell trusted people about it. This should include at a minimum the executor of your estate, but also your partner and some good friends or relatives. The reason is simple: if you have an insurance policy that no one knows about, and the insured event happens and stops you telling anyone about it, they may not know to make a claim. Think about life cover: after you die, you can’t come back to tell anyone that you had an insurance policy.

The same goes for all important documents: wills, mortgages, etc. Make sure that your loved ones, and your executor if you have one, know where to find these all-important documents. Saving these documents somewhere in digital form can be very effective, especially if you move around a lot – although your executor will need an original signed copy of any legal documents such as a will.

As the name suggests, life cover is an insurance policy that pays an amount to beneficiaries if the insured person dies.

The most common form of life cover is term life insurance. Term life insurance is an insurance policy that pays an agreed benefit in the event that the insured person dies or becomes terminally ill. The maximum age at which the insurer will continue to insure the policy holder varies, but is typically pegged at age 65.

Most term life policies will pay a benefit in the event that a person is diagnosed with a terminal illness and has less than 12 months to live. Some policies allow for part of the benefit to be paid in such a circumstance; other policies allow the entire benefit to be paid.

The word ‘term’ in the name ‘term life insurance’ indicates that the insurance policy only lasts for a set period (‘the term’ of the policy). This period is usually a year. In order for the policy to continue beyond the end of the insurance period, the client needs to ‘renew’ the policy. This is usually done each year.

Renewing the policy

Traditionally, most risk insurance policies are guaranteed renewable. This means that the insurer must agree to renew the policy each year regardless of any changes in your health or employment status or your personal circumstances. This is particularly important in terms of ill-health that commences after a policy is first taken out. Because of guaranteed renewability, even if an insured person becomes ill, the insurer is obliged to keep renewing the policy. As long as the person’s health changed after they first commenced, the insurer must renew the policy.

Renewing Income Protection Policies

In October 2021, there will be a small change in terms of the guaranteed renewability of income protection insurances. New policies written after that time will be limited to a period of five years. The insurer must renew the policy each year within that five year period (provided the insured person pays the annual premium). After the five years has elapsed, the insurer is able to factor in changes to a person’s income or personal circumstances when issuing a new policy, and that new policy will also have an upper limit of five years.

Basically, this change means that the terms of an income protection policy do not remain unreviewed for a period of any more than five years. There is one important point to remember, though: in conducting the ‘five year review,’ the insurer is not allowed to factor in changes to an insured person’s health status. So, if you develop an illness or injury that could eventually lead to you making a claim, the insurer is not allowed to decline to issue a new policy as a result of the onset of that illness or injury.  The insurer can only recalibrate those aspects of the policy that relate to your other circumstances, such as your age or your income.

Who gets the benefit?

Most term life policies allow the policy holder to nominate the person(s) to whom payment should be made in the event of their death. If no nomination is made, then the insurer typically has discretion as to whom the payment should be made. Usually, the insurer will pay the benefit to the deceased’s estate, in which case the deceased’s executor will have the responsibility of distributing the money in accordance with the deceased’s will.

Who uses Life Cover?

People who normally should take out life cover:

• Mums and dads still raising their children;
• Potential mums and dads who are trying to, or may have already become, pregnant;
• Husbands or wives (married or de facto) whose partner relies on their income; and/or
• Anyone else with financial dependants.

How to hold your life cover

Life cover can be held either inside or outside of superannuation. In your own hands, the premium is not usually tax deductible. When it is held within superannuation, the premium is often effectively tax deductible. When paying using superannuation, you can either use existing benefits or, if allowable, make contributions to a particular fund so that the fund can then purchase the life cover for you.

When you use superannuation, you need to ensure that you have lodged a binding death benefit nomination with the fund, so that the trustees know where you want the benefit to be paid. You also need to remember that using superannuation to pay for life cover will reduce your superannuation balance (unless you reimburse the fund via increased contributions). If you can use super to effectively make your premiums deductible, however, the total amount you pay will be reduced, which means the reduction in your super balance will be more than offset by you having more wealth available elsewhere. If you don’t spend the tax saving, you will end up with more money.

More information

To learn more about Life Cover, please visit the ASIC website here.

As the name suggests, income protection insurance allows a person to protect their personal income in the event that they are unable to continue working due to illness or injury.

The idea is that if you become sick or injured and you cannot work, then any income you lose can be compensated for by the insurance.

What income can I insure?

Insurers will typically only allow individuals to insure income that is related to the insured person’s labour. The general term for this is ‘personal exertion’ income. This is the income that will be lost if the insured person cannot work. So-called ‘passive’ income (income from assets which do not require active management, such as shares or investment properties) is typically not insurable. But this is OK because this income is not lost if the insured person cannot work.

Income protection can be complex. This is because there is a greater variety in the features offered by different providers, and the same insurer will often offer differing terms to individuals with different income features. Talk to us about your specific income protection needs and we are confident that we can arrange cover that is appropriate for your specific needs.

How long are benefits paid for?

One of the ways that policies differ is in the benefit period. The benefit period is the time over which the insurer will pay income protection benefits. The standard periods are one year, two years, five years, to age 60 or to age 65.

As you might expect, shorter periods lead to smaller premiums.

Waiting period

Income protection policies often allow people to alter the waiting periods. This changes the minimum period that a person needs to be off work before a benefit starts to be paid. For example, a person may choose a policy with a 30 day waiting period. If they are unable to work for a period of less than 30 days, then no benefit is paid. If the period off work exceeds 30 days, then benefits start to be paid on the 31^st day.

Longer waiting periods reduce the likelihood that a benefit will be paid. This is because people are less likely to be off work for a longer period. This means that insurers are less likely to make a payment on a policy with a longer waiting period.

Limits on benefits paid

Income protection benefits are also typically limited to 75% of the pre-disability income. Many insurers take your average income over the two years prior to the illness or injury to calculate pre-disability income. They will then pay 75% of this amount.

Most insurers also apply an ‘absolute’ upper limit. If the absolute limit is $12,000 per month, for example, then this is the most that a person can receive in a month.

Agreed value or indemnity – changes from March 2020

Historically, the amount insured could also vary according to whether the policy was an agreed value policy or an indemnity policy. In an agreed value policy, the amount of benefit payable is established at the time of the policy being written. Such policies typically are favoured by people with variable incomes, such as consultants or casual workers whose income may fluctuate across time.

In the agreed value situation, when the policy was first undertaken, the individual must demonstrate that the amount of insurance is realistic. Once the amount was established, it became the amount that would be payable, even if the individual’s income has fallen during the period of insurance. The main parameter is that the change in the individual’s earning must be considered to be ‘normal.’ You can discuss what this means with us at any stage.

The under-writing process was longer for an agreed value policy. This is because the income was verified at the time the policy was taken out. This in turn meant that the verification happened for the policy even if no claim is made. This led to more work for the insurer – and so the premium was higher to reimburse the insurer for this work.

As of March 2020, agreed value income protection is no longer available. Basically, as of that date, all new income protection policies are indemnity policies. If you hold an agreed value policy that was established prior to March 2020, it is still a valid policy and the terms under which you entered into the policy still apply. But you cannot establish a new agreed value income protection policy anymore.

Under an indemnity policy, the amount of benefit paid is linked to the actual income being earned in the period (usually 12 months) prior to the illness or injury occuring. In general, the insurer will pay out 70-75% of this actual lost income.

If you hold an indemnity policy and your income situation changes (for example, you change or lose your job), please let us know immediately. This will help us make sure that you are not paying excessive premiums for a sum insured that is greater than the insurer would actually pay.

Who needs income protection cover?

Anyone whose circumstances would be negatively affected by a loss of income should take out income protection cover. This includes people with financial dependants such as mums or dads. But is also includes people with financial commitments such as mortgages and other debt.

Essentially, most people should consider income protection cover.

To learn more about Income Protection Cover, please visit the ASIC website here.

Superannuation and income protection

Many superannuation provide a small amount of ‘default’ income protection cover. Default cover is cover that is given to all members without them needing to apply. This level of cover can be increased if the member applies to do so.

The availability of income protection within superannuation can make it easier for people to afford the premium for income protection. This is not necessarily because insurance is cheaper within a superannuation fund; it is more to alleviate demands on day to day cash flow.

That said, if income protection premiums are paid by a super fund, then they are not deductible to the insured person. Basically, there are both pros and cons to using super for income protection – all will depend on your personal circumstances, and our job as advisers includes helping clients decide whether super is the best way to access this type of insurance.

TPD provides insurance cover in the event that a person becomes physically or mentally unable to earn a living from their work.

TPD cover is often offered within the same policy as life cover. This is because, financially, becoming totally disabled often has the same effect as dying. For example, if you are a parent with dependent children, and you become disabled and cannot work, then your family loses its income.

What does total and permanent disability mean?

Different insurers use slightly different definitions. The definition used by AMP for their Elevate TPD insurance is as follows:

You are permanently incapacitated if AMP is reasonably satisfied that your ill-health (whether physical or mental) makes it unlikely that you will engage in gainful employment for which you are reasonably fitted by education, training or experience.

Own occupation versus any occupation

TPD insurance can insure against a person becoming unable to work either in their own occupation or in any occupation. As the names suggest, ‘own occupation’ means that you are disabled from pursuing your own occupation. For example if you are a plumber and you are paralysed and can no longer stand, then you could not pursue this occupation. But you might be able to engage in some other occupation. The definition of own occupation used by AMP for their Elevate TPD insurance is as follows:

You are unable to follow your own occupation for a continuous period of three months because of an injury or sickness and in our opinion, based on medical or other evidence, because of that injury or sickness, you are unlikely ever to be able to follow your own occupation.

‘Any occupation’ is slightly different. Any occupation cover means that you cannot do any work that you are reasonably fitted by education or training. The definition of any occupation used by AMP for their Elevate TPD insurance is as follows:

You have been unable to follow your own occupation for a continuous period of three months solely because of an injury or sickness, and in our opinion, based on medical or other evidence, solely as a result of that injury or sickness, you are unlikely ever to be able to follow your occupation or any other occupation for which you are reasonably fitted by education, training or experience, which would pay remuneration at a rate greater than 25% of your ‘income’ during your last 12 months of work.

Any occupation has a slightly more demanding definition, although you can see that a person earning a huge salary is not forced to undertake work that pays far less than they are receiving now.

Under-writing

The under-writing process for TPD insurance is similar to that for life cover. The insurer is assessing whether you are likely to become disabled in the future. This means they look at the same sort of risk factors (such as whether or not you enjoy skydiving) that they look at for life cover. 

As with life cover, most insurers do not insure policy holders for situations in which the disability is caused by something that existed before the insurance was first taken out. For this reason, most insurers require that policy holders undertake medical tests and complete detailed questionnaires (as they do for life cover) before they provide TPD cover.

Similarly, most TPD policies exclude disabilities that are self-inflicted. Insurers are also reluctant to offer TPD policies where the insured person would be (financially) better off being disabled. Such a situation has an obvious potential for abuse. For this reason, most insurers check a person’s income before offering a TPD policy. If the income is low, the amount of TPD cover will also be low. This reduces the potential for a person to claim to be disabled so as to obtain their insurance payments.

Certain occupations are known to be associated with injuries. People in these occupations typically pay higher premiums for TPD.

Who needs TPD cover?

Anyone who needs life cover also needs TPD, as the financial effects of becoming disabled are actually worse than the financial effects of dying.

In addition, people who are themselves dependent on their continued good health should consider TPD.

Trauma insurance is a form of insurance that pays out if an event occurs, regardless of the consequences of that event. For example, if an individual suffers a heart attack which does not kill them and which does not render them totally and permanently disabled, then the individual would not receive a benefit from a term life/TPD policy.

This can create a situation where a person experiences a significant event – a ‘trauma’ – that forces a loss of income and/or significant expenses (such as hospital treatment, modifications to the home, etc), but for which life cover and TPD do not insure. Trauma insurance allows a person to insure themselves against the financial consequences of such an event.

Trauma insurance allows a person to receive a benefit if they contract a specified illness or experience a specified event. The list of specified illnesses and events varies from policy to policy. The insured person does not have to prove that the event had serious consequences (such as becoming permanently disabled) to receive a benefit. They need only to prove that the specified illness or event occurred. If they do this, then they will receive a lump sum. This lump sum is also usually specified in the policy.

Most trauma policies require the insured person to live for a designated period (usually 14 days) after the event. That is, if a person suffers a heart attack that kills them, the insurer does not have to pay a trauma benefit to the deceased’s estate (they may have to pay a death benefit if the individual also had a term life policy).

As with term life insurance, it is usually possible to combine trauma insurance with term life insurance and/or TPD insurance.

Who uses trauma cover?

Trauma cover is typically less popular than life cover or income protection. This is because many people also have things like health insurance which covers some or all of the costs of getting sick, or income protection cover which reimburses them if they lose income due to an illness or injury. Nevertheless, there are times when trauma cover is warranted and you should discuss whether you need it with us when we meet.

For example, a person who is not working cannot take out income protection insurance, or a person who is not working much may not be able to gain much income protection insurance. This might be a member of a couple who is staying home, or only working part time, or taking a break from paid work for some other reason. This person might consider trauma cover so that they receive a benefit to pay for medical expenses, etc, if they were to experience a traumatic event.

To learn more about Trauma Cover, please visit the ASIC website here.

There are two main forms of life insurance that a business should consider. These are usually known as ‘key person insurance’ and ‘business expense insurance.’

Key person insurance

Key person insurance is a policy that covers a business in the event that a key person within dies or becomes disabled. In essence, it is life and/or TPD cover taken out by a business. The main difference to a standard life policy is that the business is the beneficiary of the policy.

Key person insurance policies are often taken out by business partners. The idea is that, if one of the partners dies or becomes disabled, the business will receive an amount of money which can be used to buy the deceased or injured partner’s share of the business. This allows the business to keep operating without the surviving partners being placed in financial difficulty.

The amount of the policy is typically tied to the amount of the loss that would arise in the event that the key person was lost. This will obviously differ according to the individual circumstances of the business. For that reason, you really need to discuss key person insurances with an adviser to see how it can be of benefit in your practice.

Business expense insurance

Business expense insurance is often taken out by smaller businesses where the expenses of the business would continue to roll in if something happened to the principal. A common example is a self-employed builder. He or she might be injured or become ill and thus unable to generate income. But the expenses of the business (office costs, car costs, insurances, staff costs, etc) continue to arrive.

The amount and type of business expense insurance that your business needs depends on the specifics of your business. This is why we recommend that you discuss business insurance needs with us.