Insurance is one of those areas that we all love to hate. So what are the facts? How does a financial planner deal with insurance issues?
Facts on Life Insurance
Here is a recently released video from Comminsure on the facts about insurance in Australia today. It focusses on life insurance but briefly covers areas such as income protection and critical illness (also called ‘trauma cover’). It’s brief and very well put together. i think you’ll enjoy it.
I once read that there were three areas a financial planner needed to work on –
- Accumulation of assets, income and wealth
- Preservation of assets, income and wealth and,
- Distribution of assets, income and wealth.
For some people, the distribution of wealth through their estate is just a matter of x to that beneficiary and y to this beneficiary. However, many people have not yet finished their wealth accumulation years, and they will often have a shortfall between their preferred estate distributions, and the actual money available for distribution. This is where life insurance comes in.
A brief aside…
Once upon a time, a snotty-nosed young fellow turned up for a job interview where he was parked in a waiting room, to sit and stew while the powers-to-be did whatever they did to make interviewees nervous. As he looked around the wood-panelled walls he noticed folders with “Life Assurance” written on the spine. “Why would i want to work here?” he asked himself. “Why would i want to work for people who can’t even spell ‘insurance’!”
Now the more knowing and sage amongst you would be nodding benevolently at this youngster’s ignorance of a basic fact of life – if you have insurance cover that pays when you die then it is not ‘insurance’ – as you are not insuring on the possibility that a specific event is going to happen… you are paying a premium for a future payment that is assured of being made. Science has made wonderful leaps and bounds but we cannot yet keep Death from eventually knocking on the door.
Fortunately, your correspondent went on to learn quite a bit about the pooling of resources to provide cover that cannot be effectively self-insured…
Financial Planning – Insurance
Firstly, not all planners deal with life insurance. Many will focus on specific areas of expertise such as retirement planning, investment, superannuation administration or strategic advice. The financial planning group that i operate within does offer life insurance advice, and does set itself with the task of comparing between the many, many offerings in the market. So let’s look at the financial planner’s job, as it relates to insurance.
It seems so easy, doesn’t it? If you want $1 million of life insurance cover, you just dial up rates from a few companies, make the comparison and fill out the forms of the cheapest. Please allow me a moment to close my eyes, lean back and breathe a sigh of contentment as i fantasize that this is all that needs to be done… *sigh*…. Nope, it’s a lot more involved than that, and here’s just a peek into the world of an advisor looking at insurance cover for a couple…
Step 1 – How much cover is required – if any?
Firstly, there is the amount. How much is ‘enough’? Here’s an old listing that stands the test of time : enough money to clear debts, pay final expenses such as taxes, medical bills and funeral costs, put aside money for any future education needs for children, allocate specific payments you would like to see made to family or friends, and leave a pool of assets big enough to replace your financial contribution to the future plans of the family. In other words, what financial holes do we need to account for if you are removed from the picture? Many, many men have batantly told me that their partner can simply “find another man” when they are gone. Therefore there is no need for them to take care of anything for their estate. It’s an interesting proposition but arguably not the most prudent way of dealing with financial affairs and relationships… Once you know how much you need for all of these things, you can subtract any existing assets that are available or become available for cash – such as superannuation, insurances, sales of second cars and so on. If there is a shortfall then you either accept that the shortfall will be there or you consider using insurance to fill the gap.
Step 2 – Will you qualify for insurance cover – and under what terms?
Step 2 is considering your health, job and lifestyle or hobby risks and seeing how different companies will treat these issues when underwriting any insurance for you. No matter how you feel about the effect of smoking on your health, life insurance actuaries calculate that it will, on average, result in them paying money out sooner than if you were a non-smoker, and so there will be an increased premium [tricky point: some ‘group’ life cover such as that found in employer or industry super funds, make no distinction between smoker and non-smoker premium rates]. If you are an underground worker, chances are that you will have more trouble finding anyone to insure your life. Cover will be available somewhere but there will be fewer companies prepared to offer it, and there is likely to be an extra premium charged for the risk (it’s called a “loading” in insurance industry jargon). If you skydive, race cars/bikes/boats, do deep-sea diving or any of a long list of activities then you can expect that there will be lots of questions asked about these hobbies. There may be extra premiums charged or you may find that there is an “exclusion” applied – in other words, the company will not make a payment of the insurance cover if the insured event (death) is caused by or related to, those activities. Logically, an insurance company prefers to charge an extra premium than to have to refuse to send out a cheque because a person died “the wrong way”.
Step 3 – Compare insurance cover available on the market
Once you get over the fact that you may not be the perfect insurable interest for every company out there or that you are going to be charged extra/excluded because of your work, hobbies or habits, it’s time to start comparing just what is available from those insurers prepared to offer you cover.
This may seem quite straightforward… let me explain why it is not.
You want $1 million of life assurance cover. There are two main ways in which that cover can be arranged:
- As a basic life insurance cover
- Within a superannuation fund
Let’s say you have just read an article that emphasises the tax benefits of insurance in your super fund. Off you go, and insure yourself through the fund. You think you’ve saved money, and are comfortable that your beneficiaries will receive tax-free lump sums in the event of your demise… Only a more thorough investigation finds that cover outside of super includes a discount for larger amounts, and the $1m cover you are applying for would result in a lower premium outside of super – even after allowing for a tax deduction. Oooops. You may also find that you would receive discounts from having a combined policy, which covers both yourself and your partner. Ooops.
Comparing insurance cover options is a tricky business…
More investigation again may find that not all cover is the same. Now wait just a minute Michael, i hear you shout…! Surely a death is a death? How can a company get away with not paying if you die? Well, there are things called exclusions, and sometimes you will find strange and quaint definitions and exclusions tucked away in this part of the policy wording. i remember one company that did not cover death caused while on a motorcycle. That may be a bit more unlikely in todays’ super competitive world but exclusions need to be looked at carefully.
Another brief aside…
How about those u-beaut “sign up now and we’ll provide you with immediate cover” offers? Look carefully and you will often find that you get accepted without a medical and with a minimum of fuss – because there is a clause that excludes ANY payment of the insurance amount if there is a claim for “pre-existing conditions”. It’s a tricky term, and one that you should think about carefully, if you are tempted by these offers.
You will also find that some companies bundle up a few extra “goodies” with their basic life insurance cover. Some will make a full or partial payment of the amount of insurance cover, in the event of a series of major events – such as blindness or paraplegia.
Step 4 – You’ve decided on the company – now what?
Now the fun really starts. Well, a nerdy kind of fun for masochistic anal-retentives, at least.
You need to decide who is going to own the insurance policy. If it’s in super then your fund trustee will own the policy, so you need to nominate who is going to receive what if you are no longer around. You’ll need to either leave that up to the Trustee or you may ask for a binding nomination, which will need renewing from time to time. If it is outside of super then are you going to own the cover – or your partner – or in joint names? This will have an impact should your relationship break up or should you want to change that ownership at a later time. Many people think that this is something that can be left for later – but you cannot always be sure of your future ability to get insurance, in which case this current policy may turn out to be the only cover you can have – so it will very much count as to just who owns it.
You will also find that outside of superannuation, many companies will offer you the choice of “level premium” or “stepped premium”. In other words, you could take the ‘standard’ cover, which is “stepped premium”. This will see your premium change each year as you get older. Eventually, the premium will lift quite a bit, as you are entering the age brackets where mortality rates increase. Alternatively, you can elect a “level premium”, which means that the rate of insurance is basically set at the age that you take it out. It will cost more for the first 7-10 years (usually) but will work out cheaper after that. The longer you keep the cover, the more you save.
There will now be these tricky discounts that are available for holding more than one type of cover in a policy. For example, having trauma cover in the policy or perhaps having your partner’s cover in the same policy. This saves a ‘policy fee’ for each new account that you do not need to set up. Policy fees usually come in at $60-$80 a year, so the discount can really add up.
For the moment, i’m going to avoid covering the full extent of that particular can of worms.
Step 5 – Getting accepted
It’s not as easy as it seems. Believe it or not, insurance companies do not enjoy being put in the position of being unable to pay a claim. Aside from being bad karma, it does nothing for the business image to have Claims Officers being chased around the carpark by journalists looking to claim a 6:30 pm scalp.
The insurance company will operate on the principle of uberrimae fidei – “utmost good faith”. IF you have told the truth when applying for the policy and IF the insured event occurs then they will pay the claim. They won’t send knuckle-draggers out to harrass your family and friends to verify that you are a good risk or to check whether you are running out back for a quick cigarette. This puts the emphasis on YOU to tell all that you could reasonably know when asked a question by the insurance company. Lie or hide something and you provide a reason for the insurance company to claim “non-disclosure”, and refuse to pay a subsequent claim. Over the years, you get to see quite a bit of this. Some people try to hide a recently diagnosed illness out of fear that they won’t get the cover or for some other reason. There are quite clear legal thresholds for when a claim can be avoided, and non-disclosure is one of the big ones.
Let’s say you complete the pages and pages of intensely personal questions. You may need to go for blood tests or provide financial proof that your situation justifies the level of insurance you are asking for. You may need to undergo an insurance medical to clarify some previous medical condition or because of some medication you are on. You pay the initial premium and submit the policy to the company.
You will often be provided with an “interim cover”. This doesn’t mean the company will pay on a claim. It means that they MAY pay on a claim, provided that your cover would have been accepted on standard terms anyway. Once again, nothing is simple and it pays to have a very good read of any such terms.
You aren’t actually covered until the company “accepts the risk”. This means that they have satisfied themselves that they have met appropriate due diligence, and have accpeted you into the risk pool at a premium rate and under terms that will not unfairly disadvantage other members of the pool. It is often forgotten that insurance is a social experiment in sharing money, so that those who have an trigger event occur can meet something that they would otherwise not be able to afford. If the risks for each member of the pool are not correctly calculated then this will impact the ability of the group to meet the promised payments to those who have a valid claim.
Step 6 – You’re in!
OK. You have your cover. You now need to make sure you keep it. That’s not as easy as it may seem. Modern insurance cover tends to have clauses which force it to “lapse”, should premiums become more than 30 days overdue. There may be a little bit of leeway in certain circumstances – but don’t count on it! Miss those renewals and you may find you can’t get the cover back or that you must pay higher premiums for conditions or job risk or hobbies that you now have but did not have when the policy was first started.
Michael – you’re making it seem harder than it is…
No, i’ve taken the easy route by not covering trauma or income protection insurance. It’s Friday, so all i will say is that i am actually making it sound easier than it is. Enjoy your weekend!