Part Three: Personal Insurance 101
Welcome to Crayon’s mini-series on personal insurance. Throughout this series, we’ll explore how it could work for your family and give tips from our experts to make it easy, actionable and effective.
Main types of personal insurance policies
Personal insurance provides you and your family with financial protection in the event of death, illness or injury. Here, we’ve provided a summary of the main types so you can assess if and how it applies to your family. More variations are available (the finance industry is inventive, if nothing else), and a good advisor can talk you through the nitty-gritty details.
Life insurance
TL:DR: provides a one-off payment in the event of death. Many policies provide early payment if you are diagnosed with a terminal illness and have less than 12 months to live.
Decisions to make:
Who are you going to insure? Generally, this will be you, your partner or both.
How much are you going to be insured for? We address this below.
Top 3 reasons for life insurance claims (Fidelity Life):
Cancer (36%)
Cardiovascular conditions, e.g., heart attack and stroke (19%)
Respiratory conditions, e.g., pneumonia (14%)
Income protection
TL:DR: provides a regular payment if you cannot work due to illness or injury. You can claim income insurance more than once.
Decisions to make:
Who are you going to insure? Generally, this will be you, your partner or both.
How much are you going to be insured for? Generally, the maximum coverage you can get is 75% of your income.
Policies vary in how they handle ACC (Accident Compensation Corporation) payments. Some will offset ACC, e.g., you could be insured for 75% of your income, but if ACC is paying 80% of your income, then your insurer might not pay out. And others will pay your income insurance regardless of ACC, i.e. you could receive income insurance on top of ACC.
How long will you wait between when you become disabled due to illness or injury and when you start receiving insurance payments? This can range from two weeks to two years, and the longer you choose to wait, the lower your premiums.
How long will you be paid? The standard options are two years, five years or until the retirement age of 65 years old. The longer you want to be paid for, the more expensive your premiums.
What type of policy? In New Zealand, there are three types to choose from:
Agreed value: you are covered for a specific monthly amount, typically set to a percentage of your income when you initiate the policy. This policy works well if your income is variable (such as a tradesperson) since it gives you the certainty of payment regardless of how much you’ve earned immediately before the claim.
Indemnity value: you are covered for a percentage value of your income at the time you claim. This policy works well if your income is stable or you’re a salaried employee.
Loss of earning insurance: the amount you receive is based on the shortfall between what you are actually receiving (e.g., you may be able to work part-time or receive ACC payments) and your income. ACC will pay 80% of your income for injuries only - not illness - up to a maximum of $2,350.62 per week at the time of writing (1 July 2024). A loss of earnings policy can work well for those earning more than that threshold, which equates to $140,000 per year.
Top 3 reasons for income insurance claims (Fidelity Life):
Injury to bones, muscles, limbs & joints (48%)
Cancer (11%)
Spinal injuries (8%)
Good to know: your income protection premiums may be tax deductible. On the flip side, some payments you receive may be taxable, so ask before you take out the policy.
Trauma insurance
TL:DR: provides a one-off payment if you suffer a critical illness.
Decisions to make:
Who are you going to insure? Generally, this will be you, your partner or both.
How much are you going to be insured for? We address this below.
What medical conditions do you want to be covered, and to what severity? Some policies cover 40 conditions, while others cover closer to 70. Furthermore, some will only pay if it’s more severe (e.g., Stage 4 cancer). In contrast, other policies will make a partial payment if you receive a less severe but still serious diagnosis (e.g., Stage 2 or 3 cancer), with the rest of the benefit being paid out if the illness reaches the severity required to trigger a full claim.
Top 3 reasons for trauma insurance claims (Fidelity Life):
Cancer (58%)
Cardiovascular conditions, e.g., heart attack and stroke (20%)
Neurological conditions, e.g., dementia and multiple sclerosis (7%)
Working out your coverage
You’ll notice that we haven’t provided guidance on how much to insure yourself for. The most important question you want to answer is: In the event that I need to claim, how much does my family need to be comfortable?
Royden highlights the most common mistakes people make when determining coverage:
1. Using rules of thumb: quick ‘rules of thumb’ are often bandied about the industry, e.g.,”‘your life insurance policy should be equivalent to the amount of your annual salary multiplied by the number of years you have to work before retirement”. This can be problematic because these ballpark estimates may not accurately reflect how much your family needs to maintain the desired quality of life in the event you need to claim. If you are underinsured, your family may still face financial hardship even if they receive the insurance payout. And if you’re overinsured, you’ll pay too much in premiums.
2. Only insuring the main income earner: it often makes sense to insure the parent who is not the main income earner but does the lion’s share of childcare and household work. In fact, outsourcing the responsibilities of a stay-at-home parent in New Zealand is estimated to cost $142,000 a year. So, would you need extra paid assistance if the lead parent were no longer around? Or would the main income earner need to work fewer hours? Commonly, people assume their parents or whanau will help. This may be true for a while, but will they realistically be available as a reliable resource for the medium to long term?
3. Insuring both parents for the same amount: sometimes, parents default to picking the same coverage. Instead, you must work out your financial vulnerability if something happens to each parent - which may necessitate different insurance amounts.
4. Not considering how inflation affects your coverage: you’ll need to decide whether you want your insured amount to increase every year in line with inflation. This protects the purchasing power of your insurance policies but at the cost of higher premiums. If your policy is not inflation-adjusted, then the dollar value of the insured amount will stay the same, but it could be that if you claim the track, that money won’t go as far ($100,000 in 2002 could buy you a lot more than $100,000 today).
So, do inflation-adjusted policies make sense? Well, it depends.
Inflating income insurance can make sense if you have an agreed value policy and you expect your income to increase over time. Not keeping tab with inflation or not reviewing your cover could make for a disappointing result if you need to claim.
Inflating life and trauma insurance should take into account:
Financial progress you foresee making over time - if your mortgage balance is falling or you’re building up a financial buffer in the form of more savings or investing, then your ability to absorb a financial shock improves, reducing your need to rely on insurance.
The counterpoint is that medical costs have historically increased more than inflation, which is worth considering if you plan on using your trauma insurance to cover medical expenses.
Also, insurance gets more expensive as you get older (unless you have level premiums - something we cover in the next section), so if you add inflation adjustments on top of that, the costs may become untenable.
You can address each of these pitfalls methodically, and a good insurance advisor can help ensure you have adequate coverage.
In Part Four of the series, we provide a guide on how to take out a policy.
This is part of Crayon’s mini-series on personal insurance:
Now for the important legal part: The information we provide is general and not regulated financial advice for the purposes of the Financial Markets Conduct Act 2013. Please seek independent legal, financial, tax or other advice in considering whether the content in this article is appropriate for your goals, situation or needs. The information in this article is current as at 15 November 2022.
Royden Shotter
Financial Planner and Founder, Planolitix
Stephanie Pow
Founder and CEO, Crayon
