Personal insurance premiums for products such as income protection, life insurance, total and permanent disability (TPD) insurance, and trauma insurance have seen significant increases over the past decade. It’s not uncommon for these premiums to rise anywhere from 5% to 30% each year.
Insurance is essential when the financial risk is too great to ignore. For instance, if you have an accident and are unable to work again, the financial consequences will almost certainly be serious – you must not take that risk lightly. However, as insurance premiums continue to climb, it raises the question of whether it’s worth maintaining your coverage.
Many people tend to view this situation in black-and-white terms: either keep the insurance or cancel it altogether. But the reality is often more nuanced. A more effective approach tends to be to gradually adjust your coverage over time. This way, you can manage costs while still minimising the risk exposure for you and your family.
Insurance is the cheapest when you need it the most… but don’t get addicted
In this video, around the 6:50 minute mark, I discuss why people typically need the highest level of insurance coverage when they have young families. During this period, you often face significant financial responsibilities, such as a home loan and the ongoing commitment to raising children. However, as your financial situation strengthens and your children move toward financial independence, the necessity for insurance coverage tends to decrease significantly.
Fortunately, the timing of your insurance needs aligns well with its costs. In your 30s, when peak coverage is typically necessary, insurance is usually very cost-effective. Premiums are relatively low for comprehensive cover. For example, insuring a monthly income of $10,000 for a 30-year-old might cost around $1,500 per year. After accounting for the tax deductibility of the premium, the after-tax cost is less than $1,000 per year. Considering that this insurance protects an income stream worth about $3.6 million over the next 30 years, it’s clear how valuable it can be. In contrast, think about car insurance: you might pay a similar premium to insure a vehicle that’s worth only 2% of that future income amount. So, when you’re younger, it’s quite cost-effective to maintain comprehensive cover.
However, as you approach your 50s, insurance costs tend to rise significantly. By this time, your children are older, and your financial position is likely to be stronger, reducing your need for the same level of coverage.
However, ironically, many people become attached to their existing cover and hesitate to reduce it because they perceive it as too risky. After years of paying premiums, it’s easy to convince yourself of the insurance’s value.
Generally, I advise clients to fully utilise insurance in their 30s and 40s, but to start gradually reducing coverage in their 50s. The goal should be to aim for little to no coverage by the time they reach 60. And be mindful that you can get addicted to insurance cover but it’s important to acknowledge that your financial position is vastly different to when your cover was established.
If you don’t have much insurance now…
While it’s often a challenge to persuade clients in their 50s to reduce their insurance coverage, it’s equally difficult to convince someone in their 30s, who has never had insurance, that they need it. Younger people in this situation may experience cognitive dissonance. They genuinely want to feel responsible and secure, but they haven’t previously considered insurance, leading to conflicting beliefs. They could also be influenced by the status quo bias given not having insurance has served them to date. Of course, I’m not a psychologist, so I don’t know the exact reasons for sure, but I find this behaviour in financial decision-making both interesting and surprising.
The desire for insurance is heavily influenced by personal risk tolerance, which varies from person to person. Ultimately, the key question is how you plan to manage personal risks. For instance, if you couldn’t work for a few years, how would that impact your financial plan, and is that risk acceptable to you?
If you take the time to consider these factors in advance, even if you decide against getting insurance, you’re less likely to have regrets in the future.
Income protection insurance is most important… here’s why
Here’s how I rank insurance products in terms of importance and value for money:
- Income protection;
- Life insurance;
- TPD insurance; and
- Trauma insurance.
Income protection insurance is the most valuable personal insurance product because it safeguards your most important financial asset: your ability to earn an income. This type of insurance covers you in the event of an accident or illness. If you’re in your 20s, 30s, or 40s, the potential value of your future income is substantial, as income protection typically pays benefits until you reach age 65.
Next on the list is life insurance, which is crucial for protecting your loved ones in the event of your death. The pay-out can help replace your income, covering living expenses for surviving family, reducing debt, funding your children’s education, and assisting with your spouse’s retirement plans.
TPD insurance ranks third because it covers a very specific risk, which is why it tends to have the lowest claims history. TPD insurance pays you a benefit if you become incapacitated and unable to work in any occupation but are still alive. If you qualify for a TPD claim, you will likely also receive income protection benefits (if you have that coverage), creating some overlap between the two.
Finally, I see trauma insurance as the most optional coverage. This insurance pays a benefit upon the diagnosis of a “specified condition,” with policies usually covering 40 to 50 conditions. Statistically, the most common claims are for cancer and cardiovascular diseases, such as heart attacks. While the trauma benefit can help fund time off work or alternative medical treatments, the reality is that if I’m diagnosed with cancer or a heart condition, I will likely begin treatment right away. If that treatment prevents me from working, I can then claim on my income protection insurance. Again, there’s overlap here.
Reduce the least valuable insurance first
If you want to lower your personal insurance expense, you should usually start by reducing the coverage that poses the least financial risk. Typically, this means cutting back on trauma coverage first, followed by TPD insurance. After that, I would consider reducing life insurance, with income protection being the last product to cut back on.
I prefer to gradually decrease the benefit amounts over time to help manage costs. Eventually, it might make sense to cancel the coverage altogether.
It’s important to remember that everyone’s situation is unique, so don’t take this as absolute advice – it’s just a general guideline based on my observations.
Maximise tax-deductions
Maximising tax deductions can significantly reduce the after-tax cost of your insurance coverage.
Premiums for income protection policies are tax-deductible when they are owned in your personal name. This is often the best ownership structure, particularly if you have a high taxable income.
On the other hand, premiums for life and TPD insurance are deductible only if these policies are held within your super fund. If you own them personally, you cannot claim a tax deduction. Therefore, I recommend keeping all life and TPD insurance inside your super.
Unfortunately, premiums for trauma insurance are not tax-deductible, meaning there’s no way to enhance their tax efficiency.
Other ways to minimise the cost of cover
The main way to optimise the cost of trauma insurance, life insurance, and TPD insurance is by adjusting the benefit amount. The only exception to this is “own-occupation” TPD, which typically applies to specific professions. Even in cases where “own-occupation” TPD is relevant, I usually prefer to invest in better income protection coverage, as it offers much more comprehensive protection.
However, with income protection policies, there are several additional options you can modify, aside from just the benefit amount, to help minimise costs without necessarily increasing your risk:
- Wait Period: This is the duration you must wait before you can submit a claim. Most insurers offer various options: 30 days, 60 days, 90 days, 180 days, 1 year, or 2 years. Generally, a 90-day wait period is the most cost-effective. If your current wait period is 30 or 60 days, it’s worth requesting a premium quote for a 90-day period to see how much you could save. You might find that accepting an extra 30 days of risk could result in significant premium savings.
- Switch to Indemnity Value: If your policy was established before April 2020, it may be set up as an “agreed value” policy. This means that if you make a claim, the insurer will pay you a benefit based on the insured amount, regardless of your income before becoming incapacitated. In contrast, indemnity value policies pay benefits based on the lessor of your highest income over a consecutive 12-month period within the two years prior to incapacity (or similar definition) or the monthly benefit amount. If your income drops below the insured amount, you may not receive the full benefit. However, if your income is stable and expected to remain so, switching to an indemnity policy may not expose you to significant additional risk.
- Split Policy: Many insurers offer a split policy that allows you to hold most of your income protection policy within your super fund. While this doesn’t directly reduce the cost per se and may not provide the best tax deduction structure, it can significantly ease your personal cash flow.
A long-term plan provides useful context for insurance decisions
Creating insurance advice becomes much simpler when we have a long-term investment strategy in place as we prepare financial projections. These projections help us determine how much we depend on employment income (personal exertion) and, in turn, how crucial income protection insurance is. We can also calculate the amount of life cover needed to keep the financial plan on track.
This same approach can be applied when reviewing existing coverage, ensuring we maintain only the necessary level of protection and optimise our cash flow.
As the saying goes, insurance is a necessary evil! While it’s wise to protect ourselves and our families, we also want to avoid spending more than absolutely necessary.
