CHAPTER THIRTEEN:
Insurance
"Insurance: An ingenious modern game of chance in which the player is permitted to enjoy the comfortable conviction that he is beating the man who keeps the table."
—Ambrose Bierce
As you accumulate assets through the course of your life and your asset base grows, it is important to protect those assets against an unforseen event. The bigger your asset base, the bigger the potential loss if your asset base is affected. For example, if your house is broken into and your belongings are stolen the loss will be very different if you are twenty-two when living in a share house, than if you are sixty-five, living in your own home with a lifetime of antiques and treasures which you have accumulated.
Whilst having an adequate level of insurance is essential, you can also be over-insured and this can be a big waste of money. How much insurance you need depends on your particular circumstances.
Types of Insurance: Personal
Personal insurance is essentially insurance that is linked to you and your well being.
Insurance premiums for personal cover vary, depending on:
• Age, premiums will increase and cover decrease as you get older
• Gender
• Health and pre-existing conditions
• Whether or not you smoke
• Occupation; for example, a person working underground in a mine pays a very different premium to an office worker
It is also worth shopping around when looking for insurance as premiums vary significantly from one insurance provider to another. There is also a significant discretionary commission component in most insurance products that is generally negotiable and may be reduced. Most people do not ask and, as a consequence, pay too much. It is always worth asking your insurance adviser whether they reduce the cost to you.
i) Income Protection Insurance
Income protection insurance is essentially insurance which covers your salary and wages if you are unable to work due to illness or incapacity.
The main features of income protection insurance are:
• The premiums are tax deductible
• There is a waiting period that you need to serve before the policy comes into force. The longer the waiting period, the cheaper the insurance cover. Waiting periods generally vary from seven days to two years
• The older you get the more expensive this insurance becomes as there is a greater statistical likelihood you will use the policy. If you are over sixty, for example, most insurance companies will not consider insuring you
• You will only receive 75% of your income as there needs to be some incentive for you to return to work. For example, if you are earning $150,000 per annum and you are injured you will receive a payment of $112,500 i.e. 75% of $150,000 per annum until you return to work. It is worth noting that you can insure your income for less than 75% if you prefer. For example, if you earn $150,000 per annum you may only wish to insure your income to $40,000 per annum through an income protection policy
• Any payments which you receive are subject to tax, so the payment which you receive is a gross payment and you will need to liaise with the Australian Taxation Office on this issue
Without an income, it is basically impossible to reach your financial goals so insuring your main income source, your day-to-day income, is essential. Imagine you are thirty years of age, earning $150,000 per year, and you are in a car accident and cannot work again. If it is assumed that your income will not be increased until you retire, which is highly unlikely, you will miss out on $5,250,000 worth of gross income if you worked until sixty-five years of age. Having previously worked in the law and seen the stress that an injury can cause on family, friends and relationships, you do not want the added grief of worrying about money. It would be very hard adjusting to life on the disability support pension of around $14,000 per annum after you had been used to earning $150,000 per annum.
The inability to continue to work can occur at anytime and in any situation. There have been two major instances that I have been aware of, the first involved riding a bike and crashing, and the second involved falling off a roof whilst adjusting a TV antenna. In both cases the individuals were unable to ever work again.
When looking at income protection insurance, it is important to consider:
• What is covered, what is not, how much will you be paid after the claim and what will be the cost now and in future years
• Consider a non-cancellable policy, which will mean if your health, or other factors change, on each renewal the insurer may try to change the goal posts and increase the premium, or refuse to continue with the cover
• Check the offset clauses, as these allow most insurers to reduce the payout figure by offsetting this against any other income you may receive; for example, a Centrelink benefit or sick pay from your employer
• Check how long the payments will be paid for, as some policies limit the payment period to two years, whereas other payments continue until you attain retirement age. This can make a big difference to how much you actually receive
• Check the definition of your policy as some pay out a benefit if you are unable to perform your normal occupation, whereas others only pay if you cannot perform any occupation for which you are suited by education, training or experience. The narrower the definition of occupation, the better from your point of view
ii) Total and Permanent Disablement Insurance
Total and Permanent Disablement insurance, otherwise known as TPD cover, is simply a lump sum payment that you receive if you meet the TPD definition within your policy. Becoming totally and permanently disabled generally requires a detailed medical assessment, from two to three independent medical specialists over a reasonable period of time, advising that you will never be able to work for reward or engage in any gainful occupation for which you are reasonably qualified by education, training or experience.
It is important to note that to meet the TPD definition is difficult and your condition must be permanent. The test is usually more difficult than that for any benefits paid by Centrelink, Worker's Compensation or Veterans Affairs.
Most of us benefit from some form of sick leave entitlement from our employers, but this is generally insufficient to provide for your long-term financial security given its limited duration. TPD insurance can provide a capital sum to repay debt, meet medical expenses and provide a source of investment funds to ensure your long-term financial security in the event that you cannot return to work.
When taking out TPD cover you need to be careful with the definitions within the policy. There are generally two choices—own occupation or any occupation. The difference between the two terms is important as the latter is a lot broader and harder to satisfy. For example, under an any occupation policy if a heart surgeon has his eyes badly damaged and can no longer work as a heart surgeon, he will not satisfy the definition as he could work in alternative employment, such as a manual labourer. This is despite the fact that there will be a significant change in their potential earnings.
As a consequence of this stricter interpretation, an "any occupation" policy is up to 30% cheaper, but do not be fooled— being cheaper is not necessarily better. If you have a job that requires specific physical skills, it is worth considering an "own occupation" policy.
How much you need depends on your particular personal circumstances including your age, financial commitments, number of dependants and income needs. The lump sum payment needed should reflect the fact that you need to:
• Pay off your mortgage
• Pay off any other debts you have
• Provide for your children's education
• Provide for medical costs
• Create a lump sum for ongoing income. The more income you require the greater the capital sum you will need
• Provide for any planned capital expenditure such as home modifications
The younger you are, the greater level of cover you need. TPD insurance can be held either within superannuation or you can pay for this directly from your after tax monies.
Many superannuation funds provide a minimal level of cover such as $50,000 but as a general rule this is woefully inadequate. Many superannuation funds now have an automatic consumer price index or, inflation linked increase, in the level of TPD cover which you have each year. For example, in the first year you may be covered for $1.2 million, and in the second year this may be automatically increased by 3% to $1,236,000.
iii) Life Insurance
Life insurance will pay a lump sum in the event of your death, usually to your estate. However, if you would like this sum paid to a specified person this can also be done. Once again, the older you are, the more expensive the cover is, as you have a greater chance of dying. Many people forget this type of cover, but if you have a dependent family and you are the main breadwinner, it is an important part of your overall financial plan. If, for example, you are the main breadwinner, with three young children and a mortgage, your death without any life insurance could lead your wife and children to living a life of poverty. However, if a homemaker dies, leaving a partner and three young children, you will also need a lump sum to assist in running the household. If you do not have life insurance for a homemaker, you may need to give up work to care for the children.
The level of life insurance which you need will very much depend on your individual circumstances. For example, if you are single with no dependants and no debts you probably don't need any life insurance.
iv) Trauma Insurance
Trauma insurance provides a lump sum, which will be paid to you in the event that you are diagnosed with an insurable disease or medical condition specified in the insurance policy. Some of the common medical conditions include a heart attack, brain tumour, cancer or a stroke.
Trauma insurance is used to fill the gap between TPD insurance and income protection insurance. For example both TPD and income protection insurance have waiting periods, whereas trauma cover is paid as soon as you are diagnosed. This is important, as it allows you to focus on treating the illness without having to worry about not having the funds to do so.
v) Health Insurance
With the strain on the public hospital system likely to increase in the future, having private health cover is worth considering. The downside is that private health insurance is expensive and every year it gets more expensive. There is an old saying, "your health is your wealth" and, if you talk to anyone who has been seriously sick, they will agree with this. There are many of life's pleasures that are free, such as walking along a beach, getting a cuddle from your children or playing a social sport. However, if you do not have your health you cannot take advantage of these free pleasures life offers you. Having private health insurance gives you the ability to make choices. If you are sick you will want the best treatment as quickly as possible. Living with a serious injury, which requires a hip or knee replacement, and being on the public hospital waiting list would be a nightmare. The problem is compounded, as the waiting lists are getting longer every year.
Private health insurance enables you to choose your treatment, hospital, doctor and covers other ancillary costs depending on the terms of your policy. It is worth shopping around for a suitable level of cover as premiums vary significantly.
The government has introduced a number of measures to incentivise Australians to take up private health insurance including:
• The Lifetime health cover policy introduced in July 2000 now means, from age thirty-one onwards, those people that have not taken out private health insurance must pay a 2% loading for every year they delay. This means that the cost of private health insurance gets more expensive the longer you delay getting cover. For example, if you take up private health cover at forty years of age, you will have to pay a 2% penalty for each of the ten years where you didn't have cover; i.e. a 20% loading for the rest of your life. The maximum loading that you can be up for is 70%
• The private health insurance rebate offers a 30% discount on the cost of private health insurance premiums for appropriate private health insurance, hospital cover, ancillary cover or both. The benefit may be claimed regardless of the level of your taxable income
Should insurance be held within superannuation or outside of superannuation?
With many types of insurance such as death, TPD or income protection insurance you can have this cover either inside or outside of the superannuation environment. This is not a simple decision, as there are many factors that need to be considered, including cash flow, taxation, estate planning and the cost of the premiums.
The benefits of having insurance within superannuation
Most people hold their personal insurance cover where possible within the superannuation environment. There are a number of advantages to this approach, including:
i) The premiums are paid from a higher after tax amount
Any monies which are contributed to superannuation as an employer superannuation guarantee contribution or via a salary sacrifice arrangement are taxed at 15% on the way into superannuation. Self-employed people are also able to make what is known as a concessional contribution, which is also taxed at 15% on the way into the fund. The 15% contribution rate is often less than your marginal tax rate. What this means is that, in many cases, your premiums are paid from a higher after-tax amount.
Cover outside superannuation
Let us look at how this works in practice:
Cover inside superannuation
As you are no doubt aware a $1,000 concessional contribution30 to superannuation attracts a 15% contributions tax so you will have a lump sum of $850 available to pay the insurance premium.
30 A concessional contribution is a contribution made to superannuation by your employer, a salary sacrifice contribution or as a self employed person.
From the table above, you can see that the higher your income the greater the difference in what it costs you inside versus outside of superannuation.
ii) The premiums are often cheaper within superannuation
As insurance premiums are often cheaper inside of superannuation than if you were to have the same level of cover outside of the superannuation environment. The main reason for this is superannuation funds have access to group rates as they are often insuring large numbers of people within the one fund. What this means is that you can get cheaper premiums than you, as a single person, can ever hope to get.
By having a cheaper premium, you can then get a higher level of cover than you would ordinarily be able to afford.
iii) You are often able to obtain automatic cover
Many superannuation funds offer automatic insurance cover without any paperwork. This can be extremely beneficial if you suffer a pre–existing medical condition, which would have otherwise been declined, if you had to complete the paperwork and submit this to the insurer for their approval.
iv) The management of your monthly cash flow
When the premiums are paid from your superannuation, you will not need to make the payments every month to maintain the cover. It will happen automatically and from an administrative point of view this is very straightforward. If, on the other hand, these premiums are paid from your after-tax income, you may forget to pay the premium or, in times of economic uncertainty, it is often very tempting to see this as a discretionary expense and stop paying the premium. This is a very dangerous strategy and is effectively playing Russian roulette with your financial future.
Final Word
In summary, there are many issues that you need to consider on which entity is best to hold your insurance needs but as a general rule there are significant benefits in using superannuation for your insurance needs.
Endowment Life Insurance
Endowment Life Insurance policies, otherwise known as whole of life policies, were very popular in the late 1980s and early 1990s but nowadays they are rarely used. This is simply a life insurance contract with two main benefits:
• An investment component which is a lump sum payment of the sum insured plus bonuses at a specified policy maturity date, often sixty or sixty-five years of age
• An insurance component, which is a capital sum, which is paid in the event of the death of the life insured
With endowment policies, it is important to note that at some stage you will receive a benefit but there are a number of variables that determine the extent of this benefit.
Endowment policies also contain a savings element that may provide a surrender value once the policy has been in force for a specified period of time, usually two years. The earlier you surrender the policy, the lower the surrender value.
As a general rule, the investment returns from these policies has been disappointing when compared with alternative investment products. In addition to this many of these policies were sold during a period when the "traditional insurance salesman" tended to put "mayonnaise" on the story when describing the future returns to unsuspecting members of the public.
General Insurance cover
Contents insurance
No matter whether you live in rented premises or in your own home, it is important to have an adequate level of contents insurance as replacing these items can be an expensive exercise. These contents are often forgotten when thinking about our assets, but they assist you to enjoy life; for example plasma televisions, hi-fi equipment, appliances, clothes, furniture, art, jewellery and family heirlooms. It is worth having these items all covered for theft, loss or damage.
One of the areas of confusion is flood damage to your home contents. Generally, storm damage is covered, but if the damage is the result of a flooded dam or river it will not be covered. This issue was highlighted during the 2011 Queensland floods with some homeowners covered and others not.
There are a number of other exclusions in most policies including:
• Damage caused by terrorism
• If items are damaged or stolen by family members, guests, tenants or your cleaner
• Damage caused by pets
• Damage caused by tree lopping
Insurance companies can potentially be difficult to deal with when making a claim. To minimise this difficulty, you should consider taking photos of the more valuable items and storing these photos away from your premises. Proving you own an item and describing the missing contents is often an area of dispute when making a claim.
Most insurance policies will replace the items on a new for old basis where a claim is made. In other words, if your old television is stolen you are likely to receive a new television as a replacement. There are some items that may be depreciated when you make a claim such as an old fridge or carpet. As always, it is worth reading the terms of the policy to find out what is and what is not covered.
The main way to reduce the insurance premium is to have a higher excess amount, for example $500 versus $200, when you need to make a claim.
Building insurance
For most of us, our home is one of the largest single investments we will undertake in our lives, and given its importance in our lives, it should be insured. Most people have a combined home and contents insurance, which covers both your contents and damage to the building itself. However, it is important to constantly review the level of insurance cover which you have over your home, as the costs of rebuilding or repairing any damage are always increasing. Recent studies suggest that up to 80% of Australians have under-insured their homes, and this often arises as a result of insuring the home for a set value when you brought the property and never adjusting the value upwards. The onus is generally on you as the home owner to estimate how much it would cost if your home is destroyed and this can be very difficult. You are better off over-estimating, rather than under-estimating the rebuilding costs.
There are a number of variables which determine how much you would normally pay for your insurance, and these include:
• The sum insured—the larger the sum insured the higher the premiums you can expect to pay, however doubling your insurance will not necessarily double your premium
• Where you live—different suburbs have different risks for events such as floods, burglaries and bushfires based on past experiences. The higher the perceived risk, the higher the premium
• The amount of excess you are required to pay—the higher your excess when making a claim, the lower the premium
Key Person Insurance
Key person insurance is used in a business context to compensate for the financial losses that would arise from the death or incapacity of a key person in that business. A key person would include the founders of the business, partners, key shareholders, or the major fee earners within a business. The key person or persons must be specified in the insurance policy.
In a small business, the loss of a key person can be financially devastating. This type of insurance policy aims to compensate the business and allow the business to continue operating. The policy doesn't indemnify the business for actual losses but rather provides a lump sum payment that is outlined in the policy.
Key person insurance can provide a lump sum to assist in:
• The losses that may arise whilst the key person is incapacitated and unable to work, for example lost income from lost sales, or losses resulting from a cancelled or delayed project, loss of specialist skills or knowledge
• To protect shareholders or partnership interests in the business. This usually enables those continuing in the business to purchase the interests of the incapacitated or deceased key person
• Enables any business loans or banking facilities to be paid out. The amount of key person coverage usually equates to the value of the guarantee provided to the financial institution
Business Interruption Insurance
Business interruption insurance is simply a policy that provides cover in the event that a business is forced to cease or suspend operating. This policy will usually return to the insured business the amount of profit that would have been earned had there been no interruption to the business's operations. For example, after the Victorian bush fires in February 2008, many businesses were forced to close for extended periods and, without business interruption insurance, many suffered significant financial damage.
Landlord Insurance
Landlord insurance is aimed at providing security to property investors in the event the property is damaged by storm, fire or theft, or the tenants do not pay their rent. Some policies will even cover your legal and associated costs in pursuing the tenant for the outstanding rent.
Workers Compensation Insurance
Workers compensation insurance is covered by State legislation and is essentially designed to provide compensation for employees where they are injured in the course of their employment. The benefits that are paid differ slightly between the various States but in essence workers compensation provides for:
• Weekly payments in place of wages
• Compensation for economic loss, past and present
• Reimbursement or payment of medical and associated expenses
• Benefits payable to the dependants of workers killed during employment
Over time in many jurisdictions, the payments which are made are scaled back in an attempt to encourage workers to rejoin the workforce.
Travel Insurance
When you are travelling overseas, it is worth obtaining travel insurance before you leave. Having an accident overseas can be very expensive and without adequate insurance cover this could be an expense that could financially cripple you for life. As with most insurance policies, the terms and conditions vary significantly. The amount of cover you need depends on where you are going, for how long, and the exclusions.
Given the uncertain costs that you may incur whilst overseas, it is a good idea to have unlimited cover where possible. For example an overnight stay in hospital in the United States can cost $12,000, or being evacuated from a remote overseas country can cost up to $500,000.
Travel insurance policies usually cover your medical costs and an emergency evacuation if this is required. These policies generally do not cover any dental work, pre-existing medical conditions or a pregnancy situation. There are a limited number of countries where Australia has a reciprocal arrangement with Medicare, which basically entitles you to necessary public hospital medical treatment. These countries include Finland, the Republic of Ireland, Italy, Malta, the Netherlands, Norway, New Zealand, Sweden and the UK. This is, of course, no substitute to travel insurance.
There is generally limited insurance cover in the policy for your baggage, with a number of exclusions. For example, if you leave your baggage unattended in your hotel room and it is stolen, this is not covered.
Public Liability Insurance
Public liability insurance cover protects against being sued by a member of the public for accidental bodily injury or damage to their property. A claim may arise when someone is on your property, your business or in an area which you control. For example, if you are shopping at a large department store and you trip on a loose area of flooring public liability insurance would cover any injuries which you sustained.
The amount of cover which you need depends on what you are insuring. If you are insuring for public liability at an outdoor rock concert where alcohol is being served, the premiums will be a lot higher than obtaining cover for damage that may happen on your private land. Public Liability cover is generally capped in the millions; for example, a business may have public liability cover for up to $10 million. Although this sounds like a lot, if you have a number of multiple claims it can quickly add up.
I still recall a twenty-first birthday which I attended at a local hotel. For the evening the hotel was closed to members of the public for the function and there was a band playing. To create more room the staff at the hotel, unbeknown to the owners of the hotel, placed a wooden board over a spiral staircase that went to the cocktail bar, which was closed at the time. When the music started, a number of the guests moved to the dance floor and, given the crowd on the dance floor, a number of people started dancing on the wooden board over the staircase. This wooden board was next to the stage and provided an excellent view of the dance floor. This dancing continued for about fifteen minutes when, all of sudden, the board broke and eight guests disappeared down into the spiral staircase. Ambulances were called, as many of the guests suffered serious injuries and were taken to hospital, with a number still recovering today. As a consequence of the actions of two part time staff members, the owners of the hotel were subject to a number of public liability claims.
Public liability can happen anywhere to anyone at any time.
Insurance Tips
As has been explained previously, protecting your assets and income from an unexpected event is essential. The older you are the more important this becomes, as there is less time to make up for any unexpected loss. There have been many examples of financially successful people who have had their wealth destroyed by an unexpected event, where this could have been avoided with an appropriate level of insurance cover.
Even if you have insurance cover there are a number of traps that you need to be aware of which could still cause you grief if you make a claim under the policy. To avoid these traps, I offer the following suggestions:
1. Read the policy
The terms and conditions of an insurance policy are very important yet very few people actually read the policy. To the average person, reading an insurance policy is like watching grass grow or paint dry, but it is important to look at the definitions, exclusions, and general conditions of the policy. A short glance at the policy can potentially save you a lot of trouble in the future.
2. Shop around
As with most services, we need prices vary, so it pays to shop around and play one insurance company against another to secure a lower premium. There are a number of websites which enable you to compare various insurance policies, their features and prices.
The main websites are
• www.infochoice.com.au
• www.ratedetective.com.au
3. Choose an established insurance company
It is tempting when looking for insurance to make your choice solely on the basis of cost. However, whilst cost is a very important consideration, you also need to look at the reputation of the company towards paying a claim and their financial stability. There is no point having a policy if the insurer rarely pays a claim or does not have the capacity to pay a claim.
With the collapse of HIH in Australia in 2001, thousands of ordinary people were impacted when their claims could not be paid. This collapse was caused by a combination of under pricing, reckless management, fraud, greed, complex reinsurance arrangements, and an unsupervised delegation of authority. In the end this resulted in the Federal Government stepping in to provide limited assistance in the case of extreme hardship.
Some of the potential examples outlined by Joe Hockey the Minister for Financial Services and Regulation in May 2001 in his rescue package included:
An example of a third party beneficiary:
Mrs Hall slipped and fell in her local butcher shop. As a result of the fall, Mrs Hall broke her arm and required surgery. Mrs Hall claimed for damages against the butcher, who in turn made a claim under his HIH public liability policy. The scheme pays out the butcher as it is a small business and Mrs Hall in turn receives payment from the butcher.
An example of salary continuance and personal injury beneficiary:
Mr Jones worked as a senior executive for a large private sector organisation. As part of his remuneration package, his employer provided salary continuance insurance that was taken out with HIH. This cover provided Mr Jones with 75% of his salary until he reached sixty-five in the event he was incapacitated for work. In 1998, Mr Jones was diagnosed with a debilitating disease that forced him to leave the workforce permanently at the age of fifty-six. Mr Jones received payments from HIH up until it entered provisional liquidation. The proposed scheme pays out Mr Jones' claim in full.
An example of individual beneficiaries:
Mr and Ms Bishop, a retired couple who are keen sailors, lost their boat during a fire at the Sandringham Yacht Club Marina in 1999. The boat was covered by pleasure watercraft insurance policy taken out with a company in the HIH Group. The claim of $30,000 was still not paid out at the time of HIH's provisional liquidation. Mr and Mrs Bishop, who have a combined annual income of $45,000, would be eligible to have their claim met by the scheme at the rate of 90 cents in the dollar, i.e. $27,000 would be paid.
In summary, saving a few dollars on a premium is not worth it if you are not able to claim on the policy.
4. Complete the application forms honestly
Another trap that many people fall into is not completing the application form correctly by accurately including all information that will be relevant to an insurer in deciding whether or not to approve or renew the policy. In the event that you fail to disclose all of the relevant information and this is relevant to the claim, then there is a strong likelihood that the insurer will deny any future claim you make.
Some of the more common examples of non-disclosure are:
• Failure to advise of a pre-existing medical condition
• Failure to advise of previous insurance claims
• Failure to advise of family medical history
• Failure to advise of any previous offences; for example, drink driving, offences for dishonesty
You are required to disclose to an insurer any information they ask you for, and any information that you know or should reasonably know would be relevant to the insurer's decision to accept the policy. For example, if you advise you were a non-smoker when you are a smoker is clear non-disclosure. Be aware that an insurance company will investigate both you and the legitimacy of your claim. This investigation will often involve third parties such as a private insurance investigator.
5. Keep your insurance up to date
Your circumstances are always changing and it is important that where your circumstances change, you advise your insurer accordingly. Failing to keep your insurance up to date will not necessarily cause an insurance policy to be invalid but may mean, for example, that you do not have an adequate level of insurance cover.
Some of the more common omissions include:
• Failure to advise the insurer of a change of address
• Failure to increase your insurance to reflect your changed circumstances, for example, an increase in income or personal debt
• Failure to review your insurance policies to determine whether the policies you are paying remain competitive. Over time, existing policies are reviewed and adjusted to suit changing conditions and it is important that every two to three years you review your insurance cover
Useful websites
www.cannex.com.au and www.choice.com.au
Comparing insurance products.
Government insurance office which provides information about the different types of insurance such as car, home, contents etc.
Provides information from the Government about private health insurance