Insurance primer: Life insurance (Part 1)
- Why you need life insurance
- 'Must have' policy features and options to consider
- Beware policies that are not underwritten upfront
In Insurance primer: Income protection (Part 1) we explained that insurance policies come in all shapes and sizes and offer different features, benefits and prices. If you haven’t read that article we suggest taking a look before reading on.
This time we’re moving on to life insurance. Armed with the right information it’s possible for the savvy consumer to save on premiums by shopping around, plus get a policy that fits their needs and doesn’t contain nasty surprises.
In this article we’ll explain the ‘core’ features you should look out for, some of the bells and whistles and the tricks and traps to avoid.
Why take out life insurance?
Life insurance protects the future lifestyle of people who are financially dependent on you. If your spouse and children would face financial hardship if you died, life insurance should be a priority.
Think about how much your family would need for living expenses each year in the event of your early departure from this world (and the number of years before they would be self-sufficient), and purchase enough cover for them to meet those expenses. Factor in the cost of paying off any home mortgage, education costs, clearing credit cards, personal loans and funeral costs, too, as the unexpected items all add up.
As with income protection (IP), there is a personal choice to be made here. Some people will want the mortgage, for instance, paid off in full, while others will just want it paid down to a manageable level.
To estimate your insurance needs you can try using an online calculator – for instance, those of OnePath, AMP or AIA – or you can try the purpose-built site from the Financial Services Council: Lifewise. Love it. Protect it.
These types of calculators tend to work out how much you’d need to pay off your current debts and cover funeral costs, with money left over to cover your family’s living expenses until the youngest is over 18 or 21 (so the remaining spouse is not forced back to work). In other words, the amount of cover they suggest tends to be comprehensive.
What are the main types of life insurance policies you are likely to encounter?
Types of life policies
The first type of policy is term life insurance with fixed or indexed cover. It pays a fixed benefit if you die (that can be indexed each year), is renewed annually and lasts for a set number of years – usually until age 70, 75 or 99.
A fixed or indexed cover policy is very simple but more expensive than decreasing cover (more below). It’s best suited to people with dependents and those with a mortgage, living expenses or debts that may take many years to reduce (or increase over time).
The other main type of life policy is decreasing term insurance, where the cover decreases as you age. It’s the type of cover offered by many industry and employer super funds.
A decreasing term policy typically lasts until retirement and pays out if you die during that term. But for each year that passes the benefit is reduced.
Decreasing term life policies are far cheaper than fixed cover policies because they provide you with less overall cover. They’re most suitable for those who are paying down their debts, or dependents who can largely manage on their own.
What do I look for in a good policy?
The core features of a good life policy are similar to those of an income protection (IP) policy and consist of:
1. Stepped vs level premiums.
Level premiums are agreed upon when you start a policy and fixed throughout the term of the policy (unless you change the term or benefits of the policy). Stepped premiums are based on your age and increase substantially over time.
A good policy will offer you the choice between stepped and level premiums.
Stepped premiums are suitable in some circumstances (such as cover for a limited time period when you are managing a large loan) but for those planning on holding a policy over the long term, level is usually the best option. A quote will typically include a comparison of stepped and level premiums over 10 to 20 years and you can see the breakeven point to decide your preference.
2. Benefit flexibility.
Most policies will allow you to increase or decrease the amount of your benefit (cover) if your circumstances change, with minimum additional paperwork.
A good policy will include the ability to increase or decrease the benefit.
If you increase the benefit, you may have to provide additional medical evidence, but a really good policy will allow some basic ‘hassle free’ increases for life events (for example, taking out a mortgage or having kids) without the need for a new underwriting process.
Indexation is the ability to have your cover (benefit amount) increase annually in line with an index (such as the consumer price index) or a fixed percentage, so your benefit maintains its buying power as time passes. This reduces the effects of inflationThe gradual decline in the purchasing power of money over time. Alternatively, the general rate at which prices increase over time. In Australia inflation is typically measure by the Consumer Price Index (CPI). on your cover amount.
A good policy will provide the option to index your benefit.
Ideally, your policy will allow you to decline the indexation for a number of years, but still retain the option to accept it at a later point. However, some (policies) will only let you decline the option once and then never offer it again.
4. Terminal illness payment.
A ‘terminal illness payment’ is a feature specific to life insurance. It allows you to access the proceeds if diagnosed with a life expectancy of less than 12 months, providing funds to make preparation for your family’s needs or to pay for expensive alternative treatments.
Good policies should at least offer a terminal illness payment as an option.
5. Exclusions and restrictions.
Your policy should clearly state what is excluded and what restrictions are on the cover. This enables you to see what is and isn’t covered and enables you to compare alternatives.
There are also some lesser-known ancillary options worth considering in a life policy. We’ve highlighted the key ones in Table 1.
Now you know what to look for in a policy, let’s turn to the tricks and traps of life insurance.
Tricks and traps
Firstly, don’t be influenced by television advertising. You should get at least three different quotes as there can be huge variations in the premiums between life insurers and you should also check on any multi-policy discounts offered by other insurance companies you deal with. Advertised quotes are often based on an average person with limited underwriting; if you are healthy you may be able to find cheap, fully underwritten cover elsewhere.
What is underwriting? It’s where the insurance assesses your risk by asking a series of questions and, in some cases, getting you to undertake a medical examination. Having a policy underwritten at the time of application gives you the peace of mind of knowing it will be there for your family when they need it.
Some life insurance policies don’t require medical underwriting, instead relying on exclusions for things such as ‘pre-existing conditions’ that they check at the time you make a claim. This type of cover is often cheaper but can lead to nasty surprises down the track. For instance, a pre-existing condition might be anything that you have seen a doctor for in the past. Be careful about relying on this type of life cover.
In some cases (for instance, through super) group policies may offer basic underwritten cover without a lengthy medical process. If you are fit and healthy you may be able to save on premiums by buying a policy directly and being willing to undertake the medical questionnaires (and checks, if required).
All life policies have exclusions and you need to make sure you understand when you will and won’t be covered. For instance, ‘dangerous’ past times may include popular holiday activities such as tandem skydiving, or racing car joy rides and if you travel to a ‘hazardous country’ (as defined by the insurance company) you may not be covered even if you die in a car accident.
Finally, don’t confuse ‘accidental death cover’ with life insurance. It covers death by accident only and won’t cover death due to illness. Statistics show that less than 10 per cent of life insurance death claims are due to accidents. Accidental death cover is cheap but it should only be considered by those who can’t get life cover, or as an ancillary benefit to standard life cover.
Choose your insurer
There are many insurance companies offering life insurance in Australia, many household names owned by the larger financial institutions. But all companies selling life insurance are regulated by APRA (Australian Prudential Regulation Authority), which requires insurers to hold sufficient levels of capital to pay their claims. That offers you some peace of mind but you also need an insurer with a good reputation for paying out claims in a prompt and fair manner.
Liam generally recommends policies to his clients from one of the following insurers: AIA, AMP, Asteron, Macquarie Life, MLC, TAL or Zurich.
Whether you use this list or seek out your own insurer, be sure it’s got the right features and you avoid the tricks and traps. You don’t want your family knee-deep in paperwork, or fighting an insurance company while grieving.
The next question you’ll face is whether you should take out a life policy inside or outside super? It’s a tricky question, which we’ll tackle in Part 2 (Premium Members only) to be published shortly.
Liam Shorte is a principal of Verante Financial Planning Pty Ltd (www.verante.com.au), a corporate authorised representative of Magnitude Group Pty Ltd (AFSL 221557). This article is a general information article and to the extent it contains any financial advice it is general advice only. We recommend seeking personal advice on your own circumstances.
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