Life insurance is pretty straightforward, isn’t it? For all practical intents and purposes, it’s a commodity where price is the key factor. You die, your family receives a lump sum payment. Pretty basic really. That’s exactly what many people think when they take out life cover.
But it’s not that simple. Actually, it’s a potential minefield where many things can go wrong. And this is where a good insurance advisor is worth their weight in gold.
Consider this scenario.
24 hours from now you’re dead! It starts with a vague headache during your lunch break at the office. By the time you leave work, that vague headache feels like someone is hammering the inside of your skull with a jackhammer. You get home and take yourself off to bed. You lie down and drift off to sleep. But you don’t wake up…ever.
If this were to happen to you tonight, how would your family cope financially? Would they be able to pay for your funeral costs or for the ongoing household bills? How long would they be able to go on living in the house?
And by the way, you also run a small, car-rental business. Could your business survive without you long enough to find a buyer? Or would it have to be put into voluntary liquidation, or worse still, receivership?
No problem, you say. The $500,000 life cover you bought over the phone 5 years ago would pay out, the mortgage would be paid off, your business partner would continue to run the business until a buyer could be found, and your family wouldn’t have to worry about money for at least 10 years.
Let’s just stop here and check some of these assumptions.
Assumption 1: The life cover will pay out.
In our example you bought your insurance over the phone, possibly during a telemarketing phone call one evening while you were trying to cook dinner for the family. One of the main reasons you bought the policy was because it was quick, cheap, and didn’t require you to fill out a ton of forms or a medical declaration.
Warning bells should be sounding here…this sounds like accidental death cover only. If that is the case, your aneurysm wouldn’t be covered and the insurer wouldn’t pay out on the policy.
This is just one example of where a policy may not pay out. Here are a couple of others:
- When you took out the policy you forgot to mention your recent visit to the GP about headaches. Or what about that head injury when you were 14? If that comes to light in the follow-up enquiries by the insurer on your medical history, they could have an option to void the policy.
- You changed your address, forgot to notify your insurer, and your credit card details have expired. Your insurer was unable to contact you to update it and your policy was cancelled without you realising.
Assumption 2: The money will go to the right people
The effectiveness of your life insurance policy very much depends on ownership and your estate planning provisions.
If we assume the policy does pay out, let’s look at three factors which could affect where that payout goes:
- The policy has been reassigned to your bank to pay off your mortgage. While any surplus funds will eventually make it into your estate, control over how those funds are applied is lost.
- You don’t have a current will or you got married after you created the will. The will is therefore invalid and legislated estate distribution rules apply….50% goes to your spouse and 50% to your kids.
- This is your second marriage and your will is successfully challenged by your former spouse or children. In this case, a proportion of your estate including the life insurance proceeds could be awarded to other parties.
- You are divorced and your policy is still owned by your estranged spouse. Any proceeds from this policy will therefore be given to him/her.
Assumption 3: Your family will get the money right away
If you own the policy in your own name, the proceeds will be paid directly into your estate. Let’s consider a couple of timing issues that can arise regarding the timing of a policy payout:
The estate may not be distributed for 6 months. A prudent executor may choose to wait the statutory 6 months before distributing the estate in accordance with the provisions in your will. Or if you die interstate, to your legislated next of kin.
You didn’t die, but are diagnosed with a terminal illness. In this scenario, you are given 6-12 months. Wouldn’t it be good if your life insurance paid out now so you could do some of those things you’ve always wanted to. Many life insurance policies have a provision for early payout (or partial payout) in the event of this kind of diagnosis. Does yours?
Assumption 4: There is enough money to cover everything
When was the last time you checked your life insurance cover? Let’s assume everything else stacks up. But the cover was taken out 5 years ago. At that stage, you had a $250,000 mortgage.
You had assumed that the additional $250,000 would be enough for your partner and child – a reasonable assumption. However, since then you have had 2 more children and moved house, taking on an additional $200,000 debt.
After paying off the mortgage, your family will have a small surplus of $50,000. With two preschool kids, your $500,000 cover is beginning to look a little light.
What can we take away from this?
Hopefully, you can see how important it is to make sure the life insurance you have in place will work as you need to it, when you need it to – at claim time.
- Understand the options and variables of your policy. Make sure it will work when it’s needed, the way you want it to work. If you’re not sure, you should seek advice.
- The effectiveness of your policy can change over time. Key events such as marriage (or a breakdown), or the birth of a child, should be times to take stock of your life insurance needs and provisions. At the least, review your insurance and estate planning every 2-3 years.
- Seek advice from a professional. This is the best way to ensure that your life insurance programme delivers.