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Information Modules :: Personal Insurance
Module 1 :: All about Term Life Insurance
What is Term Life Insurance?
Term life insurance is a form of personal insurance that pays a cash lump sum upon death of the person insured. The amount paid is agreed to at the time a policy is taken out and normally involves a sum which relates to the value of the risk it is covering, namely any liabilities and the income generating potential that your life represents.
Similar to car or home insurance, term life insurance works on a ‘pay as you go’ system, whereby cover continues as long as premiums continue to be paid and will lapse if premiums cease.
There is no investment or savings element to life insurance – you are only paying to cover the insured event, (your death), making it a highly cost efficient way of securing the financial position of your dependents.
QUALITY CHECK
Apart from providing cover upon death, a good policy will also offer early payment upon diagnosis of a terminal illness. Check the policy you are considering to see if it includes this provision and under what terms such a benefit will be paid.
Why do I need it ?
Nothing could be more dramatic or emotionally devastating to a family than to lose a loved one prematurely. And while the emotional impact is overwhelming, the impact on finances can be equally dramatic.
A way of understanding the magnitude of the risks involved is to consider how much you earn a year and multiply it by the number of years to your retirement. The amount is probably staggering, and will be even greater with inflation and other income increases. The sheer size of the amount can often deter people from giving it serious consideration…but ignoring it effectively means that you have made a decision to live with the risk.
Term life insurance, therefore, is not just a lump of cash, it represents food on the table, a comfortable home, a school of choice for your kids, a reliable car…in fact everything that makes up your lifestyle.
The alternatives to properly insuring your life may be either inadequate or impractical. Saving to provide an emergency nest egg may not accumulate enough funds in time. Relying on Social Security will provide at best a basic survival income. Term life insurance may be the only efficient way of creating the ready funds to replace your ‘life value’.
Even if you are not an income earner, there may still be compelling reasons to consider term life. A homemaker, for example, has a role that represents an enormous dollar value in terms of replacing what they do. As a full time carer for children and manager of a wide range of domestic duties, it would cost a significant sum each month to pay someone to carry out such responsibilities.
Who will receive the money & what are they allowed to do with it?
The beauty of term life insurance is that there are no strings attached to either its payment or its uses. The benefit paid is of an agreed value and is paid in one lump sum to whoever is nominated on the policy. Typically in a family situation this is the spouse.
The beneficiary is then free to invest or spend as they choose. Funds are often used to pay out large debts, such as a mortgage, and the balance invested to provide an ongoing income for the family.
How much do I need?
We mentioned earlier the method of calculating your ‘life value’ based on any liabilities and your future income earning potential. This is a useful rule of thumb, but a proper assessment of your insurance needs is strongly advisable. This can be performed by a qualified financial adviser who will generally use a process which takes into account:
- your debt reduction/needs;
- future provision for major purchases;
- future education expenses for children; and
- ongoing income generation needs.
The relatively low cost of term life insurance means that a large sum insured can still be very affordable.
What about my work Superannuation Benefits?
Many people have life cover under their employer’s superannuation scheme and feel that such cover makes it unnecessary to have their own personal term life plan. While employer schemes can offer low cost cover and are often able to offer cover with less assessment of an individual’s risk factors, there are some critical issues that must be considered before you leave your family’s security in the hands of your employer.
The first issue is how much cover your employer sponsored superannuation scheme provides. Most schemes calculate benefits by simply multiplying your salary a few times. This will generally fall well short of the actual amount you need to properly protect your needs.
Many schemes will also be structured so that cover reduces with age (as a result of increasing risk). This may mean that your cover is reducing at a time when your needs require an increase in cover.
An often overlooked question is what happens when you change jobs? You may be offered the option to continue cover after leaving the scheme, but if not, you may find yourself without cover as soon as you leave that employer.
Employer schemes do not normally allow you to tailor a package of cover that includes total and permanent disability, trauma or income protection, in the same way that you can with personal cover. Packaging personal cover can also save you money in total premiums paid.
How much will it cost?
The cost of term life may come as a pleasant surprise. Despite the large sums insured, premiums are relatively economical and in some cases comparable to general insurance prices. When you consider the difference in what you stand to receive, term life represents good value for money.
To keep premiums to an absolute minimum, most term life plans have what are known as stepped premiums. This means premiums are related to the level of risk at particular ages. Alternatively, some companies offer a level premium which has higher premiums in the younger years to subsidise the increased risk in later years.
QUALITY CHECK
Look for a policy that offers both stepped and level premiums and ask your financial adviser to calculate the best option for you.
How do I apply?
Applying for term life insurance normally requires answering some questions about personal circumstances in the areas of occupation, sports and pastimes, medical history and family history. A financial adviser can offer you assistance in completing the application.
Your application will be assessed by the insurance company to determine whether there is any increased risk in insuring your life. In the majority of cases cover is offered under normal terms. In some cases, however, there may be an extra premium known as a loading required to cover an increased risk, or cover may be excluded from certain events in order to offer normal premium rates. In a small proportion of cases, cover may be refused or deferred.
What happens if my circumstances change & I need to upgrade my cover?
As life changes, your insurance needs change. New responsibilities or liabilities may require an increase in your level of cover.
Most plans will offer an indexation option to increase cover annually in line with inflation. In some cases, however, there may be a need to obtain a quantum leap in cover. Regular review is required by a financial adviser to properly cater for such eventualities.
QUALITY CHECK
Look for a policy that offers the option to increase cover without extra medical evidence. Such an option will normally provide an upgrade opportunity for special events, such as marriage, the birth of a child or taking out a mortgage.
What happens if I die overseas?
Term life cover is not restricted by the case of death (as per the policy terms and conditions) or the location. Cover is equally valid overseas. However, if you do have any intention to travel, this should be disclosed when you apply.
What is Total & Permanent Disability Insurance?
Many term life policies will offer total and permanent disability (TPD) insurance as an optional benefit. This benefit pays a lump sum if you become disabled to the point where you are unable to work again and you satisfy other specific criteria.
QUALITY CHECK
Look to see how the policy you are considering assesses your ability to perform an occupation. Some will specify ‘any’ occupation, while others will say ‘own’ occupation. It might also be important to have a definition which recognises ‘homemakers’. Look for a policy that gives you a choice so that you can tailor a plan to suit your needs.
Why do I need it?
TPD is designed for circumstances in which you may suffer a financial impact not dissimilar to the impact of you dying. Income flow is stopped just as abruptly and just as permanently.
A comprehensive protection plan will include a TPD benefit which complements your life, trauma and disability income cover, in order to fully protect you and your dependents.
When will I get paid?
The fact that a TPD benefit will generally pay a large lump sum means that the insurer must be sure that all criteria are met. There will normally be detailed medical evidence required to assess the claim and in most cases a waiting period of six months must elapse before it is agreed that a TPD situation exists. The insurer will then pay a claim if all information has been reviewed and meets the policy criteria.
This information is for general information only and does not constitute financial or investment advice, taxation or recommendation, nor should it be relied on as such. You should seek your own professional advice tailored to your individual investment objectives, financial situation and particular needs. Prior to making any decision you should read the Product Disclosure Statement.
