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Life Insurance- Are you Wasting your Money?
It’s an important decision to protect yourself and your family against personal risk events such as death, disability or medical trauma, but fundamental for anyone with family responsibilities or a mortgage. Statistics tell us that the majority of Australians do not have sufficient protection and remain exposed throughout their working lives to the possibility of losing everything they have worked so hard to build. Given how long it takes and how hard it is to claw our way to a position of financial security, it seems unbelievable that most Aussies are prepared to risk it all by not insuring themselves.
But I digress. I haven’t written this article in an attempt to do the near impossible (selling the idea of insurance). My one aim is to make the point that if you ARE putting your hard earned into life insurance premiums (especially if it’s default cover through Super) then for goodness sake make sure you are not throwing your money away.
If you are under 45 and have any existing life, disability or income protection cover, statistically there’s at least an 80% chance that what I have to say could apply to you.
The first point, however, must be that everyone’s circumstances are different. No one solution fits all. However, if you think what you read below may apply to you, and you wish to make sure you are not tearing up your retirement savings, you should seek professional advice before making any decisions.
So here’s the situation. The great majority of life insurance policies nowadays are “group policies” held within a Super fund. Usually, the fund provides life cover by default, sometimes based on nothing more than your age.
Many people think default group cover is cheaper than stand-alone policies. Not necessarily. Underwriting is generally more relaxed in group insurance arrangements, which means group policies can include people with existing medial conditions or a medical history that may otherwise preclude them from getting a stand-alone policy. Any group “discount” may easily be offset by the increased cost to underwrite a pool of people of unknown medical risk.
Whilst better than no cover at all, default group cover is no way for a healthy, intelligent, responsible adult to own insurance.
Almost invariably, premiums for these group insurances are paid out of your fund balance on a “stepped” basis. This means the cost of cover is re-calculated each year based upon your age. Naturally, as one gets older the chance of a claim increases, and so does the cost of cover. The escalation is most pronounced for those over age 45. Stepped policies also account for over 2/3 of new stand-alone (not group) policies. In the long run, stepped can also be the MOST EXPENSIVE way to buy cover.
We’ll get to the cost of stepped premium cover later. Let’s first discuss the psychology of the “stepped premium”. There is no “price penalty” next year for not taking out cover this year. Premiums are re-rated each and every year. (Being a loyal customer for the past 20 years is irrelevant.) This effectively encourages us to delay taking out cover in the hope that nothing happens to us over the next 12 months. For clairvoyants, this approach works a treat, but for the rest of us it’s a dangerous game of Russian Roulette.
Stepped premiums also become simply unaffordable in later years, not just encouraging us but compelling us to allow cover to lapse as we get older. Russian Roulette is even more dangerous to play in later years- it’s like loading an extra bullet or two into the revolver. It’s a sad fact that policy lapses peak between age 45-50, and just a few years later (in age brackets over age 50) the majority of claim events occur. (Source: CommInsure)
What we really need is a way to make sure cover can be affordable throughout all age brackets- and especially later on when a claim event is more likely. The good news is retail insurance companies do offer an alternate premium payment plan…
With this type of policy (assuming your sum insured does not change), the annual cost of cover is fixed for the life of the policy at commencement. Typically, a level premium policy will cost little more initially than stepped, but the longer the policy is held the better off you are, relatively speaking.
Perhaps the best way to illustrate my point is by example…
Tracy, a 29 year old female, white collar worker has $1M Life and TPD cover in her Super Fund (one of Australia’s largest Industry Funds). Tracy’s premium this year is an affordable $993 but this will increase annually to almost $10,000 pa by age 60. (By retirement at 65, she will have paid over $137,000 in premiums.)
If Tracy chooses instead to take out a level premium policy (with one of Australia’s leading retail life insurers), her premium and each subsequent year would be only $870 pa…. payable annually via an automated annual partial rollover from her Super Fund until the policy expires at age 65. (Her total cumulative cost to age 65 is now only about $31,327- a saving of over $105,000!)
Either policy provides $1M of protection for the next 36 years, but at a vastly different cost to Tracy. Imagine all that extra money (plus interest) adding to the balance of her Super Fund at retirement!
Fact: The younger Tracy is when she chooses a level policy, the less she pays over the life of that policy.
On the other hand, the most expensive approach she can take is to have stepped cover from an early age. Ironically, by default, this is exactly what the vast bulk of us are doing!
Of course, Level Premium insurance is not right for everyone, but if it’s right for you, you can make sure you are properly protected over the long- term and may be able to save some big money into the bargain.
A financial planner can work with you to make sure you structure your life, disability and income insurance arrangements as effectively as possible. If you have any questions, please feel free to contact Sean Southwell at [email protected] or on 9938 3833.
Sean Southwell*CFP® Dip FP
Financial Planner, RI Advice Brookvale
T 02 9938 3833 | E [email protected] | AFSL 238429
Financial Planning for Individuals & Small Business Owners
Personal Risk Insurance – Protecting your Income & Wealth
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*Sean Southwell is an Authorised Representative of RI Advice Group Pty Limited ABN 23 001 774 125, AFSL 238429. This editorial does not consider your personal circumstances and is general advice only. You should not act on the information provided without first obtaining professional financial advice specific to your circumstances. The taxation information contained in this editorial is provided as a guide only and should not be relied upon. You should seek independent tax advice from a qualified tax adviser.