Insurance is a tool to help protect your lifestyle and wealth creation if misfortune strikes.
This article provides a brief overview of the four main types of personal risk insurance. Commonly these are referred to under the umbrella term of “life insurance” but they each serve distinct purposes. Think of each type as a different strand in your safety net.
For more detail on each cover please browse through my article archive. The archive includes articles on:
- Why you would have each cover
- How to work out how much cover you may need
- Statistics on the likelihood of events occurring
- The cost of items and services you may need if you were seriously ill or injured
Life (or Death) Insurance
Pays you a lump sum benefit on your death. Modern, quality policies often include a feature that gives you an advance payment if you are diagnosed with a terminal illness.
In my experience premature death is the life event most considered by people when they think of personal insurance. However it is perhaps the least likely event that can have a serious impact on your wealth creation. Therefore the next three types of life insurance cover are critical to understand.
Income Protection Insurance
I consider income protection insurance to be the most important personal insurance for anyone who is not yet financially independent. So that’s most adults.
Income protection insurance pays you a regularly monthly benefit while you are temporarily unable to work due to injury or illness.
Short term incapacity is one of the most likely events. And since many people would fall behind in loan repayments and bills if they were out of work for just one or two months, the impact of short term incapacity is high.
You can also receive a partial benefit when you are partially disabled and only able to work part time. This is a very crucial point as partial disablement is probably more likely than total disablement. So it is great to get some benefit to top up your part time income.
Income protection insurance generally pays up to 75% of your total remuneration package (including superannuation and non-cash benefits.) You can choose the waiting period before a benefit will be paid. Plus you can choose for how long the benefit will continue to be paid if you are long term disabled. Commonly financial planners recommend a waiting period of 30 days and a benefit payable up to age 65.
One bonus is that premiums for income protection insurance are tax deductible.
Total & Permanent Disablement (TPD)
Many people have some Total & Permanent Disablement insurance within their employer superannuation but it is rarely close to enough cover.
Total & Permanent Disablement insurance pays a lump sum benefit if you (as the name suggests) are totally disabled and are expected to be for the rest of your life. The rest of your life part is as determined by specialist medical practitioners.
Total & Permanent Disablement is a compliment for income protection insurance. Whilst there is some overlap having TPD is not a replacement for having income protection insurance.
When you are long term disabled you have extra expenses compared with being short term unable to work. For example you may require modifications to your car and house. You may also need to pay for a carer and other household services. If your partner becomes your carer then you’ll need to replace their former income instead.
Total & Permanent Disablement insurance can be used to top-up the extra 25% of your income not covered by income protection insurance. Plus you’ll need some money to cover the saving and investment you would have being doing if you worked your whole life. This can be used to meet your expenses from age 65, which is the maximum age for most income protection policies.
Trauma or Critical Illness Insurance
In my experience another life event that occupies people’s mind is ‘what if I get cancer or have a heart attack?’
Trauma insurance pays you a lump sum if you suffer a serious illness.
Importantly it has nothing to do with your ability to work as a result of the illness. As long as the illness is serious enough to meet the minimum medical definition (in your policy) then you can claim a benefit.
The four most common illnesses covered under these polices are cancer, heart attack, stroke and coronary bypass surgery.
Commonly you could use this benefit payment to help you meet the costs of medical treatment including medication.
Also, if faced with a serious illness many people would like to choose to stop working to focus their efforts on beating the illness. If you medically are able to work but choose not to work then income protection insurance won’t pay you a benefit. So you can use your trauma insurance to replace your income for a year or two while you choose not to work. This can also apply to replacing your partner’s income as many partners may like to be able to be by your side to support you.
You can claim on all four types
It is important to note that you can ‘simultaneously’ claim each of income protection, trauma and TPD insurance for the same illness. Here’s an example how:
- You suffer a serious stroke. It meets the medical definition so you claim your trauma benefit.
- Immediately you can’t work or do much at all so after 30 days you claim your income protection benefit. This keeps paying you each month while you continue to be disabled.
- After 6 months (or 12) you have not recovered your ability to return to your occupation and the doctors unfortunately say that you never will. You make a claim for your TPD benefit and receive a lump sum payment. This claim does not wipe out your income protection, which you continue to receive.
- Many years later you pass away and your partner receives a benefit from your life insurance. (At this point the income protection benefit does stop.)
How much cover?
To assess how much cover you need for each of the four types of personal life insurance you need to consider your personal life choices. These are individual to you so there is no set rule of thumb.
Insurance fills the gap between the wealth you need to find your desired life, and the wealth you currently have. So your required level of cover (sum insured) changes over time.
To get the cover right first you must consider the life choices you would make in each of the circumstances. Next you work out how much it would cost to fund those life choices.
The calculations can be difficult so use a financial planner to guide you through the process.