Weighing up the value of life insurance

It probably comes as no surprise to anyone that there is a significant underinsurance gap between what we would need to maintain our standard of living, should the unthinkable happen, and what we are actually covered for in the way of insurance.

Australia is one of the most underinsured nations in the developed world, ranking 16th for life insurance coverage.i

There are lots of reasons people give for not buying life insurance, but top of the list is invariably cost. Sounds reasonable enough, especially when households are under pressure from increasing costs of living. But dig a little deeper and it turns out the way we weigh up decisions when outcomes are uncertain, is not always in our best interests.

According to ‘Prospect Theory’, people fear a certain loss more than they value a larger but uncertain gain. We tend to view money spent on insurance premiums as a loss, unlike money spent on a daily cup of coffee, a pair of shoes or a weekend away, which deliver immediate rewards.

There’s also a disconnect between what we say we value and what we spend our money on.

Thinking about the unthinkable

When asked, most people say the thing they value most is family. Yet when it comes to insurance, many of us cover our car and our home but overlook our most important assets – our life, our ability to earn an income, and the wellbeing of the people who depend on us.

Thinking about being diagnosed with a terminal disease, suffering a disabling accident or contemplating your own death, or that of your partner, is uncomfortable. Seeking cover for those possible eventualities is something that is very easy to put off or avoid altogether.

The real value of life insurance is the peace of mind that if we die or become seriously ill and are unable to work, then the right amount of money will go to the right people when they need it most.

Types of life insurance

There are different types of life insurance. Death cover provides a lump sum if you die or are diagnosed with a terminal illness. Total and permanent disability (TPD) pays a lump sum if you are permanently disabled due to an accident or illness and unable to work again. Trauma Insurance (critical illness insurance) pays a lump sum on the diagnosis of one of a list of specific illnesses such as a heart attack, cancer or a stroke. Income protection provides a monthly payment if you can’t work due to illness or injury.

The amount of life insurance you need depends on your family circumstances, your income and lifestyle. While many working Australians have default cover in their super fund, that’s no cause for complacency. It’s often a basic level of cover, which may need to be topped up outside super.

Take Chris, aged 30. He has a partner, two children and the median level of default life insurance cover in super for someone his age. That is, $211,000 in death cover, $162,500 for TPD and $2,250 a month for income protection. According to a recent report by Rice Warner, the amount someone in Chris’s position needs is closer to $704,000 in death cover, $910,000 in TPD cover and $4,150 a month in income protection.ii