Which type of life insurance will provide the right cover for you?
Unlike many other types of insurance, life insurance can be very personal. The insurance relates to your life, death, income and the comfort of your family after your passing. For this reason, taking out life insurance is a personal decision, and one that you should thoroughly research before signing a contract.
Ultimately, life insurance products are designed to protect you and your loved ones from unexpected events. However, the term ‘life insurance’ is merely an umbrella that encompasses not only death cover, but other forms of insurance over the course of your life. Some of the are different types of life insurance policies include:
- Life cover;
- Total and permanent disability insurance;
- Trauma insurance; and
- Income protection insurance.
Each type of insurance serves a different purpose. This article will run through these types of life insurance and how they operate, so that you’ll be able to identify the right type for you.
Types of life insurance
There are four main types of life insurance on the market that suit four different purposes. Have a read through each to see what cover suits your needs best.
Life cover is the standard type of life insurance that is the most commonly known. It is designed to help your family or other nominated beneficiaries with a lump sum payment upon your death. If you fail to nominate a beneficiary, your estate may decide where the money goes.
As the most typical form of life insurance, life cover is therefore the most popular form of cover. A 2017 survey estimated that 94% of working Australians have some form of life cover. However, most people do not have adequate coverage. Consider taking out life cover if you have a partner, children, or other family and loved ones that may need financial assistance after your death.
Total and permanent disability insurance
You may have heard of this type of insurance when referred to as the acronym ‘TPD insurance.’ TPD insurance pays a lump sum benefit in the case that you are totally and permanently disabled due to sickness or injury. The disability will prevent you from returning to work. A professional medical opinion will usually be required to confirm your inability to return to work. Each insurer will have a different definition of total and permanent disability. Due to this, it is wise to ensure that your policy provides a level of cover that will adequately protect you.
Typically, TPD insurance can cover you for either your own occupation, or any occupation:
- Your own occupation: the inability to return to work in a job that you were working in before your disability.
- Any occupation: the inability to work in any job suited to your education, training or experience.
The first type of TPD cover is usually more expensive. The latter is cheaper, though there is often a higher threshold to reach. As a result, a claim for any occupation is less likely to be successful than one for your own occupation.
Less Australians have TPD insurance than life cover. The same 2017 survey referenced above estimates that the total population of working Australians that have TPD cover is approximately 81%.
You may have heard trauma insurance being referred to as ‘critical illness’ cover or ‘recovery insurance’. Trauma insurance pays a lump sum amount upon suffering a critical illness as defined in the insurers PDS. This includes medical conditions such as cancer, stroke, a heart attack or head injury. Note that trauma insurance often does not include mental health conditions. The benefits of trauma insurance are generally tax-free and usually paid irrespective of whether you are able to work or not.
The purpose of trauma insurance is to cover medical treatment expenses not covered under Medicare or other private health insurance. It is designed to help you avoid the financial stress that is added onto your physical stress. In addition, many injuries may require home renovations and modifications (think wheelchair access), or therapy and other rehabilitation costs. Trauma insurance can help cover these costs.
Income protection insurance
If you are unable to work due to sickness or injury, income protection insurance can provide you with a dependable income stream. In many cases, it may cover up to 85% of the income that you were earning prior to the sickness or injury. The average, however, is around 75% of your income. Payments are calculated on your pre-tax income. They are typically paid on a monthly basis, as opposed to a lump sum payment.
Definitions of illness and injury will differ between different income protection insurance policies. These definitions and subsequent thresholds can vary significantly, so ensure you know what you are signing up for.
Around one third of Australia’s working population have income protection insurance. This percentage is significantly less than for the first two types of life insurance mentioned above. However, it is wise to consider taking out income protection insurance if you:
- Have family or other dependents that rely on your income;
- Are self-employed or a small business owner, and may not be eligible for sick or annual leave; or
- Have debts (such as a mortgage or car loan) that you will need to continue repaying even when you don’t have an income.
Consider how much of your fortnightly or monthly income you spend on bills and other expenses. Prepare a budget so that you know how much you will need to cover should you not be able to earn an income.
Are there any more?
The types of life insurance mentioned above are the four main types that you will likely consider during your life. However, there are a number of other types of life insurance worth mentioning, such as:
- Funeral insurance;
- Accidental injury / death insurance; and
- Business expenses insurance.
The cost of your funeral can be covered by taking out funeral insurance. Typically, funeral insurance can be up to $15,000. This will provide some immediate financial assistance to your loved ones so that they can organise your funeral. Funeral insurance is especially helpful as other forms of insurance may take some time to claim and payout.
Where injury or death is caused by an accident, accidental injury / death insurance will provide cover. Though similar to life cover, injury or death from a sickness cannot be claimed under this type of insurance due to the ‘accidental’ requirement. For this reason, it is a less popular option than life cover.
Business expenses insurance provides ongoing benefits to keep your business running if you suffer an illness or injury and cannot work. If you have fixed business expenses such as staff you need to pay, outgoing expenses to take care of, rent to cover and fixed leasing costs, you may want to consider taking out business expenses insurance. This type of insurance is particularly popular for sole traders, whose business heavily relies on their work and presence. Note that business expenses insurance may not cover your own salary as a business owner, capital costs, depreciation costs or any other costs not classified as fixed operating expenses.
What to check before purchasing life insurance
No matter what type of life insurance you take out, it’s always wise to scrutinise your insurance policy. Your insurer will legally be required to give you a product disclosure statement (PDS). You can read through to ensure everything is as you agreed and there are no hidden costs, requirements and fully understand all exclusions as part of the policy.
Bundle life insurance
If more than one type of life insurance sounds suitable for your needs, you may be able to bundle your insurance. For example, many Australians bundle life cover with TPD insurance, or one of the other types of insurance mentioned above. Insurers are often willing to tailor your bundle of cover to your needs, recognising that one size does not fit all.
Life insurance is offered either as a stepped or level premium. Stepped premiums are insurance premiums that are recalculated every year upon each policy renewal. Thus, the premium will start off quite low. However, it will increase each year as you get older and your health declines. Alternatively, a level premium will be a set premium that is not impacted by your age or other factors. However, the premium may still increase slightly over the years due to inflation or changes to the insurer’s fees. Due to this, level premiums will cost more than stepped premiums initially.
Most policies will have some exclusions that you must be aware of. These exclusions will include events under which cover will not extend. Not being aware of the exclusions of your policy can cause significant financial distress. It is therefore wise to read over these before agreeing to an insurance policy.
Death caused by an intentional, self-inflicted act may exclude benefit for many types of life insurance. It can sometimes exclude benefit entirely, or only if the death is within the first 12 months (or some other time frame) of cover. Similarly, injuries or illness resulting from illegal, criminal or dangerous activities will often be excluded.
For TPD insurance in particular, benefit may be excluded if you do not survive for at least 14 days after suffering the illness or injury that causes the disability. In cases of trauma insurance, cover may not extend to illness or medical conditions arising out of a pre-existing condition.
The cost of life insurance is impacted by many factors. These include (but are not limited to):
- Smoking status;
- Health and medical history;
- Occupation and associated risks; and
Generally, the younger and healthier you are, the less you will pay for life insurance. Whether you smoke is the other big factor in the price of life insurance. Insurers may also consider the risks associated with your job, and the risks associated with your hobbies outside of work. Check out our article regarding life insurance costs for a more comprehensive discussion about the price of life insurance.
Firstly, check to see whether you already hold some form of life insurance through your superannuation. More than 70% of Australians hold their life insurance through their super. You may be eligible for cheaper premiums this way, though the cover may be limited. Review your policy to ensure that the insurance is adequate for your needs.
Alternatively, Australians may choose to obtain life insurance through a financial advisor, an insurance broker or directly through an insurance company. Each has its benefits, though consider your knowledge on the subject beforehand. You may prefer to get professional financial advice from an advisor that can guide you towards their recommended insurance policies. If you already know what you’re looking for, direct purchase through an insurance company may be the easiest method for you.
Looking to do more with your finances?
At Oiyo, we’re trying to help shift the conversation around how we all spend and utilise our money. We’re not financial advisors, but we can offer helpful insights and information to help you navigate your finances. Browse some of our relevant articles to find out more about life insurance.