Smart Investor, Getting Started: August 2012

Smart Investor – Getting Started, August 2012

It is the ultimate emotional sell. Get life insurance, because if you don’t, it’s the ones you leave behind who will be hurt. And there is, of course, some truth in that: life insurance means that if you’re no longer around, your family will have enough to get by, unencumbered by debt. But selecting the amount of life insurance, the provider, and the type of policy can be something of a minefield, and it’s all too easy to end up with coverage you don’t need.

Before you get to the minutiae of a policy, a bigger question: do you need life insurance at all? If you don’t have any dependents, then the answer is probably no.  If you’re not the main breadwinner for your family, the answer might also be no, but will depend on your and your family’s circumstances. Life insurance is typically a necessity for a person whose salary pays the bills, feeds the family and sustains an education.

If you do need life insurance, then how much? Opinions vary here. In America, for example, the norm is between five and 10 times annual salary; brokers in Australia tend to say 10 times, plus your mortgage and various outstanding bills and funeral expenses.

A third question: do you, in fact, already have life insurance? Many super funds carry a life insurance benefit, often including total and permanent disability cover (and, better still, it generally comes out of your pre-tax income). If not through super, then many companies include life insurance cover for their employees, or if not, then they may have a discounted company life insurance plan. So before buying a new policy, be very clear on what you’ve already got.

Now, time to look at policies. This is a little simpler than it used to be, since whole life insurance – which combines a death benefit with a cash value, an investment policy that can be cashed in at any time – is no longer really offered in Australia. Instead, you are limited to term life insurance. Which leads you to your first question: what term to go for?

In deciding this, let’s think about what life insurance is really asking you to do. It needs you to consider, in some detail, your own death and its consequences; that’s never comfortable. Deciding on a term is, in part, a question about how long you expect to live for. After all, the longer the term of the policy, the more likely it is there will be a benefit to your having had one.  But when you have a long term policy, you will also pay more in premiums.

Once you’re clear on what sort of term you want, the next thing is to compare the policies and quotes on offer. These days, the norm is to do this through one of the many internet compare-and-contrast aggregators, which will give you a guide to the various rates on offer; you can then confirm it with the insurer itself.

Costs will vary according to your own personal details, most obviously your age – let’s face it, the older you are, then logically the closer you are to the exit – but also things like your weight and whether you smoke. (Also, women often get better deals, as statistically they live longer.) An insurer is making a calculation on your likely life expectancy, and its ability to turn a profit out of insuring you.

Be aware that, as is so often the case in financial services, cheaper is not necessarily best. One policy may have a lower rate than another because it doesn’t have exactly the same coverage. A key example here is terminal illness cover: some insurance policies cover you for terminal illness, and some do not. It is very important to make sure you are comparing like policies.

Other points of difference can be buried deep in the policy wording. For example, what happens if you miss a payment? Is there a grace period? What are the consequences? If the big moment arrives – let’s not beat about the bush, we’re talking about our death – then how long is it expected to take for the payout to be made to your family, and exactly what is needed to trigger it (usually a death certificate)? How many beneficiaries can be named on your policy – and is there a fee for adding more?

They say the only certainties in life are death and taxes. Life insurance policies show you that even death isn’t that straightforward.

BOX

Stepped or level?

Premiums are often offered in two different forms. Stepped premiums start off low, then start increasing as you get older. They might increase by 3% a year in your 30s, for example, before ramping up dramatically later in life – increases of 15% from one year to the next in your 60s are not uncommon.

Level premiums stay the same the whole way through. The effect of this is that you end up paying more in your youth and less later in life. (That said, even level premiums tend to turn into stepped premiums over the age of 65.)

BOX: Four forms

Death cover: life insurance as we all picture it – a lump sum paid out when you die.

Total and permanent disability: again a lump sum payment, this time payable if you are disabled and unable to return to work.

Income protection: If illness or injury makes you temporarily unable to work, this policy will pay out, often up to 75%. However, the length of time you receive these payments will depend on the cover you have opted for – some might be for two years, others five, and still others up to a particular age.

Trama: This covers serious illnesses, and pays out a lump sum if you contract a particular illness. These illnesses will be spelt out in the policy but typically include cancer, stroke and heart attack.