Saving money on life insurance

Life insurance is essentially a bet that you will hopefully lose. It is my firm intention to waste a portion of my money every year on my life insurances. Paying for a life insurance policy will be a waste of money in the event that:

a) you don't get sick; and
b) you don't die young.

So waste, waste, waste is my motto.

But it is important to only waste the necessary amount. Clients are often surprised by two approaches that we take to life insurances, particularly in the area of income protection insurance.

Income protection insurance is insurance that pays the holder a regular income if they unwell and can no longer work. It is sometimes called income continuance insurance or disability insurance. We regularly recommend that clients implement two strategies to reduce their income protection premiums.

The first is to take a 90 day waiting period (or longer if the client wishes). As the name implies, a waiting period is the period of illness before which the insurer will not make a payment. A 90 day waiting period means that the policy holder needs to have not earned income (including sick leave if they are an employee) for 90 days before the insurer will start to pay them. The insurer will start paying from the 91st day that the policy holder is unable to earn income due to an illness or injury that is covered by the policy (typically everything that is not self-inflicted or pre-existing).

Most advisers recommend that a 30 day waiting period be used. And if you get sick for 45 days, then you may be grateful for a such a policy. But the fact is that a period of 90 days off work is unlikely to cause extended financial duress for most of our clients. A period of less than 90 days can be coped with. It might mean talking to the bank manager about reducing/suspending loan repayments, using up savings or even popping things on the credit card. But none of these things are hard or expensive. Therefore, a short illness is rarely a calamity.

What is a calamity is when the client becomes unwell for an extended period which cannot be covered by the bank manager's goodwill and accumulated savings. And this is what should be insured against: economic calamity, not short term inconvenience.

On a similar theme, especially for our higher income clients, we sometimes recommend that they insure an amount less than 100% of their income. Most income protection policies will only pay 75% of the pre-claim income anyway, but we typically suggest that a doctor earning, say, $300,000 consider insuring only $150,000 of income. In the event of a claim, this lower amount will be paid. But again, $150,000 is a high income to receive and thus economic calamity is typically avoided. Once again, remember that the client is so unwell as to be unable to continue to work.

Many clients choose to insure every last available dollar of income. This is fine too - as long as they are doing it deliberately.

Both of our typical recommendations have the same effect on premiums. Premiums for 90 day waiting periods are considerably lower than for 30 day wiating periods. This is for the obvious reason: very few people are unwell for more than 90 days. Similarly, the amount that the insurer might need to pay in the event of a claim will determine the premium that they charge. So, our recommendations reduce the premium you pay on the bet you hope to lose.

Remember, most financial advisers are paid a percentage of the amount that their customers spend. Therefore, a cynic might suggest that there is little incentive for a commission-based adviser to recommend cheaper policies...