The classic insurance trap

iStock 000003550102Small-65Life insurance has a definite cycle. We need different amounts at different stages of our life but sadly, the majority of New Zealanders get it wrong and end up having insufficient cover when they most need it, then pay too much when their insurance needs are reduced. When we most need life insurance, many cannot afford the premiums for the amount covered so we end up taking big risks- the scale of these not fully becoming evident until something goes wrong and we experience the pain of being underinsured. However, the nature of many life insurance policies results in the insured value increasing along with premiums and we end up getting to a stage where we can afford those premiums but the level of cover might be more than what we really need. Along the way, some unscrupulous insurance agents sell to unwitting New Zealanders policies that just make no sense at all.

When thinking of personal risk insurance, many think only of life insurance.  However, the reality is that providing adequate protection against the highest risks requires a combination of life insurance, income protection insurance, medical insurance plus trauma cover and total permanent disablement cover. Developing the right combinations to meet the known and likely needs of New Zealanders is not an easy task- especially when financial constraints are omnipresent. An experienced financial adviser is usually required as online insurance sales sites primarily focussed on reducing premiums but not necessarily providing the most appropriate cover, are unable to adequately do this.

In this article, let’s just look at life insurance.

Different commentators have different terms and approaches to the stages of life insurance. However, broadly, they can be described as:
  • Pre-children: There are no dependants and the level of debt might be low. Therefore it could be debated as to whether life insurance is necessary. However, if a house has been purchased then there needs to be at least enough insurance to cover the mortgage. When the person is young, they are less likely to have pre-existing conditions so youth and good health result in cheap premiums.
  • Children: This is when the person is in a relationship, has a mortgage and a family. Now the need for life insurance is extreme to cover debt, cover funeral expenses and provide a level of funding to support the family on the death of the insured. The premiums will have increased with age but the real killer now is the amount of cover required. Often, it could be in the vicinity of $1m. At this critical time in life, the financial pressures of raising and educating a family are such that people take risks and prefer to spend money on things like holidays, new cars and other lifestyle expenses rather than covering the absolute necessities like insurance in the case of death. Interestingly, we all take out home and contents insurance plus insure our cars. The risk of your house burning down is less than that of you dying under the age of 65. However, we will insure our house before we will adequately insure our lives.
  • Empty nesters: This is where the children have left home (or in theory are old enough to look after themselves financially), your mortgage and other debt have reduced to a fraction of what it was when the kids were young, and you have accumulated a level of investments. At this stage in life, insurance premiums are becoming very expensive due to advancing age. Many will have insurance policies where the amount of death cover has increased annually with inflation. This can result in you now having more cover at age 55 than at age 35 even though the need for that cover has reduced. It is common to see people with life insurance well in excess of what their debt level is. This is fine if the extra cover is to provide a quality of life for the spouse or other loved one on death. However, consider offsetting this additional cover against the level of accumulated investments. The more you accumulate in investments and the more you reduce the debt, then the lower the level of insurance required.  People at this stage of life should be talking to their financial adviser about what is an appropriate level of cover. If talking about changing insurers to reduce insurance premiums then take care with what is being recommended. Do you actually need that level of cover? Are you aware of stand down periods, policy exclusions or premium loadings due to pre-existing conditions? Do you need level premiums or stepped premiums, and avoid level premiums which will go well beyond the age you possibly might need any life insurance at all. A reputable financial adviser will explain all these potential pitfalls and navigate you through this minefield of choice.
  • Retired: At this stage in life, there is likely to be no debt and just you or your spouse or possibly, you might even be living alone. By now, insurance premiums are very expensive unless you are on a level premium type contract. The level of life cover retained is likely to be determined by how much you wish to leave your estate on your death. Many are comfortable to leave little or no proceeds from an insurance policy - preferring to leave accumulated investments for their spouse to live on. Frequently, we might suffer a terminal illness before eventually dying. Having the correct life insurance policy is critical at this point as it would enable you to receive your pay-out while you are still alive - much better having the money when you can benefit from it rather than on your death.
On the surface, life insurance might appear simple and straight forward. However, the reality can be quite different. Advice is required through all life stages to ensure you have purchased the right level and type of insurance from the right insurance company. The level of cover and the premiums paid need to be managed depending on the changing risk associated with changing lifecycle. This is where a professional financial adviser is worth the fee they charge as their advice can not only save you money but more importantly, help prevent you from making a disastrous mistake just when you can least afford it.