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The objective of having insurance cover for your life and your assets is to protect yourself and your family from financial distress in the event of death, illness or accident. Where such an event occurs, there is often considerable emotional distress. Financial planning aims to remove the financial distress at such a time. 

There are two ways you can manage this type of risk: 

One way to financial risk is by self-insuring, which is where you set aside provisions to protect yourself against an incident that results in financial loss. As self-insuring generally occurs through lack of planning, it is therefore, not an ideal solution. In order for self-insuring to be truly effective, a disciplined approach needs to be taken as the consequences of being under-insured can be enormous.  

There are many instances where people effectively elect to self-insure through lack of planning. This means that when an event occurs which causes financial distress, people manage on what they have set aside. Other ways of self-insuring are by planning and setting aside funds for protection in such an event. The most common form is, however, to recognise the risk and evaluate how much protection is required and then transfer that risk to an insurance company. 

The most common (and arguably most effective) way to manage risk is to recognise the risk and evaluate how much protection is required and then transfer that risk to an insurance company, as insurance cover has been specifically designed to protect you from the devastation that these events can inflict on your family's wealth. 

There are four major types of personal insurance to consider: Term Life insurance; Total and Permanent Disability (TPD) insurance; Trauma insurance and Income Protection insurance.

Term life insurance

Term life insurance is the most common form of insurance policy. It pays a tax-free lump sum upon death or diagnosis of terminal illness. 

Term life insurance is necessary to ensure that sufficient funds are made available to support your family and should allow them to continue their current standard of living in your absence.  

Your sum insured should be adequate to cover outstanding debts and provide an adequate lump sum to cover your dependants’ income needs for the remainder of their lives.  

Generally, it is most tax effective to hold your death cover within your superannuation fund. 

TPD insurance is designed to provide you with a lump sum if you were to suffer an illness or injury which renders you totally and permanently incapacitated. It is usually offered as a "rider" on a term life policy; however, it can also be offered as a stand-alone policy. 

There are a number of definitions that TPD can be paid under, which include:

  • Any occupation: provides a pay out in the event that you are unable to ever work again in any occupation for which you are reasonably suited by education, training or experience (with the insurer having ultimate discretion)

  • Own occupation: the insurer pays an agreed benefit when your total and permanent disablement prevents you from working in your own occupation, making it an easier definition to meet. However, TPD cover with an own occupation definition comes at an additional cost and may only be available for those in certain professions or industries and where applicable under the term of the insurance policy.

  • Activities of Daily Living (ADL) / Loss of independent existence: this definition was introduced when paid employment ceased to be a prerequisite for making contributions to superannuation. It is generally met when you are permanently unable to perform two of the following five activities without someone else's physical assistance: bathing and showering; dressing and undressing; eating and drinking; using a toilet to maintain personal hygiene; getting in and out of bed (or a chair or wheelchair) or moving from place to place by walking, wheelchair or walking aid,

  • Home duties: a relatively new definition, which provides a lump sum benefit in the event that you are incapacitated to the extent that you are unlikely to ever engage in normal domestic duties. This definition is similar to ADL.

  • Cognitive loss (dementia-type illnesses): if you were to suffer cognitive loss as a consequence of illness or injury and it was determined by the insurer that you are unlikely to ever engage in any gainful occupation as a result, you would receive a benefit payment. To meet this definition, you generally must suffer a total and permanent loss of intellectual capacity that requires you to be under constant care and supervision by another adult for a minimum of six consecutive months and be likely to need continuous ongoing care for the remainder of your lifetime. 

The waiting period on TPD policies is between three and six months (depending on the insurer and chosen policy). However, you may qualify to receive payments during this waiting period if your injuries are deemed severe enough.

Trauma insurance (also known as Critical Illness insurance) pays a tax-free lump sum on the diagnosis of a defined medical event to the insured. Examples of such events are heart attack, cancer and stroke. 

Trauma cover is regarded as the most expensive type of personal insurance - with good reason, because it covers events that are relatively likely to occur and some policies are very broad in their coverage of events. 

It can help you to pay off your debts, cover the cost of your medical treatment, fund costly rehabilitation programs and refit your home in the instance you require home aids (such as handrails) as part of your rehabilitation process.

Income Protection insurance (also known as salary continuance insurance) provides you with a regular (usually monthly) taxable income in the event that you become sick or injured. 

Income protection cover aims to ensure that your assets aren't sold or spent to replace lost income, helping you and your family to continue to enjoy the standard of living you have become accustomed to. Most policies allow you to insure up to 75% of your pre-tax salary, however some policies allow you to insure up to 85% of your income. 

The benefit periods available on income protection policies can either be for a set number of years (i.e., two or five years) or until you reach a certain age (i.e., age 65 or age 70), and will have a large impact on the overall cost of the policy. The premiums paid on an income protection policy are tax deductible and can help to reduce your personal tax liability (or the tax within your account if held inside superannuation). 

Premium structures

There are three main types of insurance premium structures: stepped, level and hybrid, with stepped being the most common of these. 

Stepped premiums are calculated on your age and will increase as the likelihood of making a claim increases. The sum insured may be fixed, may increase (where an indexation option has been selected) or may decrease (in the case of unitised cover). 

As you are only paying for the level of risk associated with your current age, an insurance policy with a stepped premium structure will be more affordable in the short-term. However, the cumulative premiums will eventually eclipse those paid on an equivalent level premium policy, making this type of premium more expensive in the long-term. 

Contrary to a stepped premium structure, level premium rates are based on your age at the time of application, thereby giving you a more consistent premium over the duration of the policy. It is important to note that level premiums may still change in the future due to changes in the Consumer Price Index (CPI) and increases in your sum insured, although any rises are likely to be considerably smaller than those experienced under a stepped premium structure. However, in order for a level premium policy to become cost-effective, you will need to continue to hold the policy with the same insurer for the long-term (i.e., a minimum of ten years) and will generally not be able to make significant changes to the sum insured or policy options. 

In addition to stepped and level premiums, some insurers offer a third, less common option known as hybrid (or optimum) premiums, which begin on a loaded stepped structure and then convert to a level premium at a future anniversary date. Although you will pay less over the long run than you would under a stepped policy with the same sum insured, the premiums paid under a hybrid policy will exceed those paid under a traditional level premium policy. The below graph illustrates the cost differences between stepped, level and hybrid premiums: 

stepped, level & hybrid premium table

Source: Life Insurance Finder, 2016, Differences in Cost Overtime Between Stepped, Level and Hybrid Premiums, accessed 18 April 2016, https://www.lifeinsurancefinder.com.au/life-insurance-premiums/ . 

Please note - the above is to be used as a guide only and should not form the basis for selecting your premium structure. 

Insurance in your super 

The following arguments can be made for owning a Life and TPD insurance policy within the super environment as opposed to in your personal name:

  • Provides an opportunity to reduce the net cost of your insurance premiums. Premiums for Life and TPD insurance held outside of superannuation are paid with after-tax dollars, whereas Life and TPD structured inside superannuation allows for the payment of premiums from pre-tax sources such employer contributions and salary sacrifice.

  • Gives you the ability to be insured under a group insurance policy. Group policies are low cost and can provide cover for those individuals who would normally be unable to obtain insurance. 

As a result of the reduction in the net cost of your Life and TPD premiums achieved by holding your cover inside superannuation, it may be possible to increase the sums insured by a considerable amount for no additional cost. 

The premiums paid on Income Protection policies are generally tax deductible on policies held both inside and outside of superannuation therefore it is important to consider the merits of each. 

While there is no impact on your personal cash flow, holding Income Protection via superannuation can slowly erode your balance over time, therefore it may make sense to hold cover outside of the superannuation environment. 

The Stronger Super rules that came into effect on 1 July 2014 prohibit a superannuation trustee from providing Income Protection policies to members that do not align with the conditions of temporary incapacity. Consequently, policies available through superannuation after this date are likely to be inferior to those entered into prior to 1 July 2014, which may make ownership outside superannuation more attractive. 

However, if you do not require the additional features and benefits offered by non-superannuation policies, Income Protection via superannuation may still be appropriate, particularly if you have inconsistent or constrained cash flow.

Whole of life policies 

Whole of Life policies were removed from the marketplace in 2006 predominantly because they were very expensive and widely unpopular. 

How these policies worked: 

Whole of life policies provide life insurance cover with the opportunity to accumulate savings over the term of the policy. Part of the premium provides for the insurance cover and the balance is invested by the life insurance company. 

The benefit of a whole of life policy is the sum insured plus accumulated bonuses is paid on death or maturity, whichever occurs first. Whole of life policies usually have a surrender value after the first two or three years. Whole of life policies can also be made ‘paid up’, whereby premiums cease, and benefits are reduced accordingly. 

Togethr Financial Planning Pty Ltd (ABN 84 124 491 078, AFSL 455010) trading as Equip Financial Planning and Catholic Super is a subsidiary of Togethr Holdings Pty Ltd (ABN 11 604 515 791).  It is a related entity to Togethr Trustees Pty Ltd (ABN 64 006 964 049, AFSL 246383), the trustee of the Equipsuper Superannuation Fund (ABN 33 813 823 017) whose divisions include Catholic Super.

This information is general information only. It has been prepared without taking into account your personal investment objectives, financial situation or needs. It is not intended to be, and should not be construed in any way as, investment, legal or financial advice.