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Insights

Insights

Personal insurance: what each type covers and why it belongs in a financial plan

Personal insurance is among the most consistently underexamined elements of a financial plan. The reasons are understandable: the events these policies are designed to address are unpleasant to contemplate, the products are not straightforward, and the default coverage available through superannuation creates an impression of adequacy that is frequently inaccurate.

There are four principal categories of personal insurance relevant to most working Australians. Each addresses a different risk. Understanding what each one does — and what it does not do — is the starting point for any assessment of whether existing coverage is appropriate.

Life insurance

Life insurance pays a lump sum to nominated beneficiaries on the death of the insured person. It is the most widely held form of personal insurance and the most broadly understood.

The purpose is to replace the economic contribution of the insured person to their dependants — to service a mortgage, support children through education, and provide financial stability to a surviving partner during a period of adjustment. The appropriate level of cover depends on the size of existing debts, the number and age of dependants, the income of the surviving partner, and the existing assets available to the estate.

Life insurance held inside superannuation is paid to the fund and distributed according to the fund's binding death benefit nomination rules, which may not align with the member's estate planning intentions. This is a detail worth examining.

Total and permanent disability (TPD) insurance

TPD insurance pays a lump sum in the event that the insured person becomes totally and permanently disabled and is unable to work. The definition of "totally and permanently disabled" varies between policies and is one of the most important variables when comparing cover.

An "any occupation" definition requires that the insured person be unable to work in any occupation for which they are reasonably suited by education, training, or experience. An "own occupation" definition requires only that they be unable to work in their own occupation. The latter is a materially broader benefit and is generally more expensive as a result. Many default policies held inside superannuation apply the "any occupation" definition, which can make claims more difficult to establish.

The purpose of TPD cover is to fund the costs associated with permanent disability: rehabilitation, modification of living arrangements, ongoing care, and the elimination of debt. It does not provide ongoing income replacement — that is the function of a different product.

Trauma insurance

Trauma insurance — also called critical illness insurance — pays a lump sum on diagnosis of a specified medical condition. The conditions covered vary by policy but typically include cancer, heart attack, stroke, and a range of other serious illnesses. Unlike TPD, the payment does not require that the insured person be unable to work — the diagnosis of a covered condition is sufficient to trigger the benefit.

The purpose is to provide capital at the point when the costs associated with a serious illness are likely to be highest: treatment costs, time away from work during recovery, and the modification of living and working arrangements. It is the insurance product that most directly addresses the financial impact of a health event that is survivable but materially disruptive.

Trauma cover is rarely available through superannuation because the superannuation legislation does not permit funds to pay benefits on the basis of diagnosis alone — a condition of release must be satisfied. It is therefore typically held outside superannuation.

Income protection insurance

Income protection insurance replaces a portion of income — typically up to 70% of pre-disability income — during a period of illness or injury that prevents the insured person from working. Unlike TPD, which addresses permanent disability, income protection is designed for temporary incapacity and pays a monthly benefit during the period of disability up to the policy's benefit period, which may be two years, five years, or to age 65.

Two features of an income protection policy are particularly important. The waiting period — the time between the onset of disability and the commencement of benefit payments — directly affects the premium and should be calibrated against the insured person's liquid financial reserves. A longer waiting period reduces the premium but requires a larger cash buffer to bridge. The benefit period — the maximum duration of payments — determines the extent to which long-term disability is covered.

Income protection policies can be structured as agreed value (where the benefit is fixed at the time of application) or indemnity value (where the benefit reflects actual income at the time of claim). The distinction matters for clients whose income is variable or has changed materially since the policy was established.

How the four products work together

These four products are not alternatives to each other. They address different risks and in a complete financial plan, the appropriate combination depends on individual circumstances: the level of existing debt, the number of dependants, the presence of other assets, the income level and its variability, and the adequacy of any cover already held through superannuation.

The most common gap we observe is not the absence of life insurance — most Australians hold some through their super fund — but the absence of trauma cover and inadequate income protection, particularly in terms of benefit period. The events most likely to affect a working Australian — a serious illness during working life that is survivable but disruptive — are precisely the events that default superannuation cover tends not to address adequately.

A review of existing insurance coverage costs little and provides a clear picture of where the gaps, if any, are. If you would like to work through your current position, we welcome the conversation.

Ben Widdup
Wealth Manager

1300 102 542 | 0402 633 205
ben.widdup@egu.au

Sources

This is general advice. It does not take account of your objectives, financial situation, or needs, and is not a substitute for advice that does. Before acting on anything in it, consider whether it suits your circumstances, and consider the relevant Product Disclosure Statement.

Ben Widdup