Under insurance is a chronic problem in Australia, despite the widespread availability of life and disability cover through our $1.9 trillion superannuation system.
Most of us still believe we are living in the lucky country. Didn’t you know? Illness and nasty accidents don’t happen to people like us.
As a result of this bad-things-only-happen-to-other-people mentality, individuals aged between 45 and 64 are 77 per cent underinsured, while 35 per cent of the population has no disability income insurance, according to professional services firm KPMG. About one-fifth of families have no death insurance cover at all.
These are startling figures. However what really matters are the extent of underinsurance at an individual level and finding the most effective way of obtaining the necessary cover.
For good measure, KPMG has one more notable figure – the average employed person needs insurance equal to 84 per cent of their income until retirement in the event of disability.
Furthermore, notes Sean McGowan, director of WLM Financial, most families don’t appreciate the need to obtain cover for non-working spouses. If a non-working spouse becomes incapacitated, the family will need to meet the cost of their care as well as the cost of childcare, in addition to other expenses.
“A lot of people don’t realise their value and their importance to the family’s financial situation, and also to the breadwinner’s ability to keep on working,” McGowan says.
And then there are individuals who are running a self-managed super fund.
“A lot of SMSFs have no life insurance at all,” McGowan says.
“Trustees’ motivation is to lower fees and costs so a lot of people don’t bother with life insurance.”
There are four basic categories of life insurance. Life cover will pay a lump sum on the death of the policyholder. Total and permanent disability (TPD) insurance will pay a lump sum if the policyholder becomes disabled and unable to work again. Income protection provides a replacement of the policyholder’s current salary or wage in the event they are unable to work because of illness or injury. Trauma insurance pays a lump sum on the diagnosis of a specific illness, such as cancer or a stroke.
The downside of talking about life insurance is that the topic can quickly get technical – and downright baffling.
The upside is that finding the right cover brings peace of mind, and that the industry is evolving, so new models and products are always landing in the marketplace.
Did you know that you can now get life insurance through a specific super insurance plan, offering flexible terms but still paid for by concessional super contributions?
And did you know that some pooled super funds allow you to take out only TPD without death cover? This is particularly relevant for individuals with no dependants.
The most obvious place to start looking is through super funds, where most Australian workers obtain cover because it is cheaper. According to actuarial firm Rice Warner, more than 70 per cent of life cover and 88 per cent of TPD cover is held inside super.
An advantage of obtaining life cover through super is that the premiums are paid from contributions, which for anyone earning less than $300,000 a year are taxed at 15 per cent.
Other key advantages are that super funds offer up to $500,000 or $600,000 of cover with no health checks. This figure might rise to about $1 million if the policyholder answers a couple of basic questions about their lifestyle.
With a full health check, most funds will offer unlimited life and disability cover, although a member might need to justify why they need amounts of more than $2 million or $3 million.
Things to watch for
Advisers argue there are catches. First, big super funds can refuse to cover existing conditions even when no questions are asked and second, super funds have the right to change policies and definitions at any time, even midway through a contract.
“Some forms of insurance in many pooled funds, in particular income protection, are cancellable,” says Kathryn Fitch, a financial planner at advice firm Leapfrog Financial.
Furthermore, in the case of income protection, group policies purchased through a super fund usually do not index payments to the rate of inflation, and the insurer will check that the policyholder has actually been earning the amount for which they are insured. If the policyholder has been earning less than assumed, their payments could be cut.
For many people, obtaining insurance through super may be sufficient. In particular, Fitch says, it makes sense to buy life and TPD cover through super, because if you purchase the cover outside super, there are no tax deductions available.
That said, smart investors should consider their options, the experts say. “Generally we are always topping up people’s cover,” McGowan says.
“Estimate your needs, then shop around and explore your options,” adds Russell Cain, chief executive of Life Insurance Direct, a life specialist.
And most importantly, know what you are covered for. “People don’t know what they are covered for until it is too late,” Cain says.
Here are some key aspects of life insurance you may not have thought about or may not know – and which might surprise you.
Life insurance outside super
There are several reasons for getting life insurance outside your super fund, according to advisers.
Individual policies offer level premiums. This is in stark contrast to pooled funds which only offer so-called stepped premiums, where the price rises each year as the policyholder ages. This is all very well for younger policyholders, but after about eight years, level premiums actually become cheaper, Fitch says.
Indeed she estimates that a 35-year-old female, who is earning $120,000 a year and is insured for $500,000 of death and TPD cover and $7500 a month of income protection, would be paying about $10,000 a year more in annual premiums by the time she is 65 if she were paying stepped, rather than flat, premiums.
A lot of pooled funds might only have a two-year benefit period, which means that the policy will only pay an income for two years, while an individual policy will offer a more flexible period.
In the case of life cover taken out within a pooled super fund, the benefit will often be offered only as a one-off payment, and not as an income stream.
An individual policy, however, will almost always offer to pay a death benefit as an income stream, which may be far more convenient as it means that the policyholder does not need to worry about investing the money.
The cost of premiums is also a potential issue. Pooled funds may not pass on the full 15 per cent tax deduction to members paying high premiums, because of pooling arrangements.
Following the recent round of sharp price hikes by industry funds, it is no longer a given that insurance obtained inside these funds is cheaper than taking out a private policy, Fitch says.
It is also worth noting that industry super funds have become wise to a strategy used by many self-managed super funds whereby members of do-it-yourself schemes leave some money inside an industry fund as a way of obtaining cheap life insurance.
Industry funds are making the strategy difficult in a number of ways, such as refusing to pay claims or limiting cover in cases where the member has not made a contribution for a certain period, say six months or 13 months, or where the balance has dropped below a certain threshold.
Super insurance plans
One of the more recent changes in the industry is the rising use of super insurance plans. Under this model, rather than purchasing insurance through their super scheme, a super fund member can take out insurance with a separate super insurance plan, where the premiums are paid from super contributions. The insurance plan will direct the super fund to roll over the insurance payments.
The insurance-only plan will generally offer more flexible policies, such as the ability to pay level rather than stepped premiums, and to pay death cover as regular payments rather than a lump sum.
“You get access to better policies that aren’t cancellable and you get access to level premiums, which will mean insurance is affordable in the long term,” Fitch says.
“We are doing this for 90 per cent of our clients where we don’t recommend a full super fund rollover,” she adds.
These policies are “underwritten”, requiring a full health check, which is why they can be better tailored to the individual.
Policyholders are also able to shift super funds without having to move their insurance and risk having another health examination further down the track.
The insurance companies that offer super insurance plans that accept “rollovers” from super funds include TAL, AIA, OnePath and BT.
While income protection can be purchased through a super fund, it is tax deductible if you get it outside super.
Buying income protection outside super might make sense for individuals on higher marginal tax rates, who can claim a bigger deduction and who would like to direct more of their super contributions towards their retirement savings, rather than see insurance costs eat them up.
“It might be better to get income protection outside super to maximise your retirement benefits,” Fitch says.
Income protection policies obtained outside super also come with ancillary benefits that are not available on policies obtained through a super fund, such as rehabilitation, nursing and accommodation services.
A lot of advisers recommend buying split cover, particularly for TPD and income protection. Part of the cover is purchased through super, and part of it outside.
In the case of TPD, this allows you to obtain protection against becoming disabled and being permanently unable to work in your current occupation, known in industry circles as “own occupation”.
This type of TPD cannot be bought inside super. However, individuals can buy protection against being unable to work in any sort of job – referred to as “any occupation” through their super fund.
It is a model that McGowan uses a lot, even though TPD obtained outside super is not tax deductible. McGowan is a big believer in professionals and people with specialised occupations taking out own occupation TPD cover to minimise the uncertainty.
Cain adds: “Something is better than nothing.” “Start with a little [in own occupation] and build it up, based on what you can afford,” he says.
A typical structure might be to purchase two-thirds of TPD cover through super and one-third outside. Income protection can also be split between super and non-super premiums, although only a few insurers allow this, Cain says.
The benefit is that policyholders can get their basic benefits inside super and buy protection for ancillary benefits, such as rehabilitation costs, outside super.
On the one hand those with no financial dependants and no net debt probably have little need for life cover.
But on the other, they may have a greater need for income protection and TPD cover, because if something happens to them, they may not have others to look after them.
“If you can’t work, who are you going to rely on to fund your living expenses?” Fitch asks.
Individuals in this category should consider policies that offer TPD and income protection only, or offer more TPD cover than life cover.
AustralianSuperis among the handful of super funds that offer TPD-only cover.
Combined or linked policies are another option, where you pay just the one premium for a range of insurance types, which even could be technically held by different entities to maximise current cash flow. It is a strategy that will often result in cheaper cover, partly because if you claim on one part of the policy, the remaining cover on the other categories will be reduced.
For example, if under a linked policy you have $1 million of life cover, $500,000 of TPD and $250,000 of trauma cover, and you claim on the latter, your life insurance will be reduced to $750,000 and your TPD cover to $250,000.
“Generally, combined policies provide a great alternative to stand-alone policies for those wanting additional financial protection for their families and themselves without breaking the bank,” Cain says.
“In recent years insurers have taken further steps to increase the level of flexibility combined policies provide. This, together with their relative affordability, has seen them become an even more popular option with our clients,” he says.
Sally Patten, Smart Investor, 5 March 2015