Life insurance 101: financial protection for all Australians

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Why are Australians so under-insured?

Life insurance and financial services are very much in the spotlight at the moment. The controversy can make it easy to overlook the very real benefits that life insurance provides.

Here, Suzie Brown, General Manager for Distribution at Integrity Life, outlines some of the key considerations for financial advisers when making life insurance recommendations and an overview of the upcoming legislative change – for advisers who are new to the life insurance space and looking to help their clients navigate this sometimes complex world.

What are the different types of life insurance?

We tend to think of life insurance as a payment made to a beneficiary upon death. However, the category of insurance commonly referred to as ‘life insurance’ provides a number of different types of cover: death cover, total and permanent disablement (TPD) cover, trauma cover and income protection cover. The key features of each are as follows:

Death cover

Also known as ‘term life insurance’ or just ‘life insurance’. Death cover pays a benefit upon the death of the insured person. This amount can often also be paid out before death, where the insured person is terminally ill. The benefit is paid to the beneficiaries nominated within the policy or to the estate. Where this cover is held within superannuation, the Trustee of the Fund can have input as to who receives the benefits.

Total and Permanent Disablement cover (TPD)

TPD insurance covers the cost of rehabilitation, debt repayment and the future cost of living if the insured person is totally and permanently disabled and unable to work.

The intention of this benefit is to pay an amount when a person will never ever work again. However, whether or not a client is deemed totally and permanently disabled depends upon the definition within the policy. These can vary from policy to policy, but usually fall into two categories:

  • the insured person is unable to work in any occupation; or
  • the insured person cannot work in their usual occupation.

Trauma cover

Trauma insurance provides cover where a person suffers a specified illness or injury, for example cancer, a stroke or a broken leg. Trauma insurance is also referred to as ‘critical illness’ or ‘recovery insurance’.

This cover pays a set amount, sometimes dependent upon the severity of the illness or injury – for example, the benefit would usually be larger for a severe stroke as opposed to a broken leg. The benefits are intended to cover items such as medical costs (over and above what health insurance will pay), an income stream if it is not possible to work, and the on-going cost of therapy and/or transport costs, as well as adjustment to housing and repaying debts.

Income protection

Income protection insurance replaces income lost through an inability to work due to injury or illness.

Income protection insurance can differ widely, and each policy will have its own definition of disability and range of benefits. In general terms there are two types of cover – one that pays an indemnity benefit, or what you are earning at the time of the claim, and a second which pays an agreed value, determined when you apply for the cover.

The maximum covered is typically 75% of gross wages. The benefit is deliberately designed to be less than 100% of wages, to encourage people to return to work.  Benefits are paid until recovery, up to a maximum time period, defined as a number of years, or until the person reaches a certain age.

How is life insurance structured in Australia?

Australians can access life insurance in three ways, and as a result, the industry is split into three distinct channels as follows:

Retail

Individual insurance policies purchased through an adviser (either a financial adviser or a risk adviser) are known as retail insurance. It is also known as advised insurance, because it usually involves the client seeking advice prior to purchase.

Detailed health information is provided in order to take out the cover, and the price will be in some part dependent upon the risk the individual represents – due to their health, pastimes and occupation.

Group

Group insurance is where multiple people are insured under a single contract. These ‘groups’ are usually employees of an employer or the members of a super fund. Group life insurance is the most common way for Australians to hold life insurance. Most Australians hold this type of cover which they receive automatically via their super fund.

Group insurers do not collect detailed information on each person insured, but rather make assumptions about the occupations and health of the group as a whole. As a result, group insurance can often be cheaper than retail. Due to the lack of individual risk rating, this type of insurance is advantageous for people who may not be able to obtain retail insurance – such as those in high risk occupations or with serious pre-existing health conditions, who may be denied cover during the retail underwriting process.

Life insurance purchased through a superannuation fund can however be less comprehensive than that purchased directly, in terms of amount of cover and the types of benefits offered and may not be adequate depending on the policy holder’s needs.

Direct

Life insurance purchased directly through an insurer is known as direct insurance. This kind of insurance is sometimes referred to as non-advised, because no personal advice is given. This type of cover is often purchased over the phone, via either inbound or outbound calls. For this reason, direct policies tend to be simpler.

Underinsurance is a major problem in Australia

Life insurance is an essential pillar of a financial plan, particularly for families, because most of us would struggle to pay our bills if we found ourselves unable to work, due to illness or injury. Yet despite the fact that 94%[1]  of working Australians have some level of death cover (usually through their superannuation fund), the amount is often woefully inadequate. The same goes for both TPD and income protection cover.

In its latest research into life insurance cover in Australia, Rice Warner[2] estimates that the insurance needs of a 30-year-old couple with children are:

  • eight times family income for death cover;
  • four times family income for TPD cover; and
  • 85% of family income for income protection cover.

The reality is that median levels of death cover in Australia are around only two times family income. TPD cover rates are around three rather than four times family income, and income protection cover is usually 75% of income, rather than 85%.

This means that if the average Australian were to claim on their death cover, less than half of their family’s basic needs would be met, and they would receive less than 30% of the amount required by their family to maintain their standard of living.

Why are Australians so under-insured?

A common misconception in the market is that life insurance is unnecessary, because health insurance provides the same cover.

While health insurance covers certain healthcare costs, including doctors’ expenses, the cost of going to hospital and some medicines; it does not cover other living expenses. This is where life insurance comes in. Living expenses do not stop, and more often than not they can increase, due to the need to bring in outside help, when someone is ill or injured.

Peoples’ knowledge about insurance is also generally low, making purchasing decisions without help difficult.

Your role as an adviser is crucial

Financial advisers are frequently on the front line – dealing with clients of a daily basis, and in a position to educate them about the options available to them, and to guide them as they make more informed choices about financial protection. It’s tricky though, because conversations about life insurance, disability and income protection can be difficult to have -people don’t tend to want to spend time contemplating their own death, and everyone think these things only happen to someone else. Bringing this topic to the forefront of discussions is therefore a key part of an adviser’s role.

Navigating the complexities is the other key role for an adviser. Understanding what is and isn’t covered, what is excluded and included, and even how much is needed is challenging for most clients. Policy conditions and features are (by necessity) covered in detail in a Product Disclosure Statement (PDS). However, many life insurers are not great at presenting the information in an accessible way. Most life insurance PDSs are dense, lengthy and complex documents – that make understanding and comparison between products difficult.

This is where clients will rely on you to guide them regarding what they need, how much they need, and being able to walk away from purchase actually understanding what they have just bought.

The regulatory landscape for life insurance: upcoming changes

There are a number of key changes that could affect your clients’ cover over the next few years. Awareness of these changes can help set up your clients to weather the upcoming storm.

Federal Budget changes to insurance in superannuation

In May 2018, then Treasurer, Kelly O’Dwyer, announced a range of measures that would reform insurance within superannuation. While the changes are not yet law, they have the potential to affect the level of cover that super fund members receive and may mean that some are left underinsured or need to look at their options for a policy outside super.

The key change is that insurance within super will become opt-in (rather than default or opt-out) going forward, for members:

  • under 25;
  • with balances under $6,000; and
  • whose account has not received a contribution for 13 months (‘inactive’).

For members with account balances under $6,000 and those with inactive accounts, cover will be removed (if they don’t elect to keep it in writing) when the changes are implemented. Ongoing, all types of cover (voluntary and default) will be removed where a members account becomes inactive. The start date of these changes is unclear.

These changes will have unintended consequences for younger members who do have families that need the support of insurance cover, and those who may be unable to get opt in cover due to higher risk occupations or health issues. Exemptions for members in these situations have been requested by various industry groups but may or may not eventuate.

Productivity Commission changes to insurance in super

In December 2018 the Productivity Commission released its final report on the efficiency of Australia’s superannuation system. The report included recommendations for the way insurance inside superannuation is managed, as well as who is insured through their super. Key findings included:

Multiple and duplicate insurance policies are eroding the balances of members;
Superannuation trustees need to do more to provide value for money in insurance and prevent fees eroding balances; and
fees from duplicate insurance is “by far the most egregious driver” of super funds’ balance erosion.

The Productivity Commission recommended:

A public inquiry to be held within four years, examining whether life insurance should be included within superannuation on a default basis;
An overhaul of the Life Insurance Framework, directed by APRA and ASIC; and
Endorsement of the Government’s proposed changes to insurance in superannuation, as outlined earlier.

Royal Commission final report recommendations

On Friday 2 February, Commissioner Kenneth Hayne delivered his final report and recommendations on the Banking Royal Commission, following his year-long review of the financial services sector, including life insurance. These findings were released on 4 February.

The recommendations on life insurance included:

  • The removal of the exemptions on commissions on the sale of life (and general) insurance. However, these changes would depend on a review of the sector by ASIC in 2022, meaning there would be no immediate changes.
  • The removal of commissions on all insurance products, including life insurance.
  • The banning of phone sales or ‘hawking’ of insurance.
  • The reclassification of funeral insurance as a financial service, meaning it now falls under ASIC’s regulatory regime.
  • More oversight of the group life insurance market.
  • Consumers to be better protected via an amendment to the Insurance Contract Act, replacing “duty of disclosure” with the “duty to take reasonable care not to make a misrepresentation to an insurer”

Key considerations for advisers

There are many questions which need answering before you can be sure you have recommended the right insurance cover for your clients. Key questions are:

  • What level of health insurance does your client have? In the event of serious illness or an accident, what will be covered over and above what Medicare offers? Will life insurance need to supplement medical costs or is this already covered via private health insurance?
  • Are ancillary benefits important? For example, some policies will offer travel assistance so loved ones can be by your side and even counselling services and financial planning services to manage benefit payments. What level of support does your client have around them and what will need to be funded when they are ill or injured?
  • What other family members rely on your client? What support will they need?
  • Are rehabilitation benefits covered under your income protection policy – are they wanted?
  • What is excluded? There are typically three kinds of exclusions.
    • Outright exclusions that apply to everyone, for example non-payment if the cause of injury or illness is suicide.
    • A general exclusion in relation to any condition that already exists when cover is taken out (called a ‘pre-existing condition exclusion’).
    • Specific exclusions may also apply where the client has been medically underwritten for cover. For example, the client has had previous back surgery, so their cover excludes all future back related conditions.
  • Are stepped or level premiums a better fit? Stepped premiums start low and rise over time as the risks associated with the policy rise with the age of the policy holder. Level premiums do not change over time, but typically start higher.
  • Is insurance inside or outside superannuation better for the client’s circumstances? The source of premium payments and the tax consequences of benefit payments need to be considered.
  • What is covered by any group policies, particularly through superannuation? How do any additional policies work together? A key issue for many clients is that they have cover via a number of superannuation accounts. This can cause issues in relation to income protection cover in particular. These polices pay a maximum of up to 75% of income and will offset other policies providing similar income benefits. Care needs to be taken that members don’t hold a number of these policies, some of which may yield zero benefits at claim time due to offsets.
  • What happens to life insurance if your client moves super funds, or starts an SMSF? Will the life insurance come with them, or will they need to actively move the insurance in order to maintain continuity of cover?
  • What could be the outcome for your client if the proposed budget and productivity commission changes are implemented? Will your client lose cover? It is likely many client’s arrangements will require review at this time. Preparation now could relieve workloads when these changes occur.

By Suzie Brown, General Manager for Distribution

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[1] Rice Warner: Underinsurance in Australia 2017
[2] Rice Warner: Underinsurance in Australia 2017

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