Looking for life insurance?
Trying to figure out your life insurance needs can be like a walk in the wilderness without a map – especially if you look to the insurance industry for guidance. Online insurance company calculators, for instance, can give widely varying results (see below). And insurance salespeople – or make that financial advisers who deal in life insurance – have been known to put their own interests ahead of yours.
Generally speaking, a life insurance payout should be about 10 times your annual salary, but that's just a rough formula. Being more precise requires a forensic investigation of your financial circumstances and an understanding of what kind of world you want your loved ones to inhabit once you're gone.
Want your partner and kids to maintain the same standard of living in your absence? One recent analysis suggests a family of four with young children will need at least $1m in life insurance.
But that's only if you depart prematurely and leave things like child rearing and home ownership costs behind. A financial adviser acting in your best interests can help fit all the pieces of your personal puzzle together, but it can be hard to know where their loyalties lie.
Do life insurance calculators work?
We put three life insurance calculators from major providers to the test using the scenario of a family of four with two children aged eight and 10. The father, aged 35, was looking to take out a life insurance policy and fed the following details – based on averages figures from government and other research data – into the calculator:
- Current mortgage balance: $400,000
- Current total loans: credit card debt, $4000; car loan debt, $19,000
- One-off costs – children's education: $300,000 (six years' private secondary school for two)
- Funeral costs – $9000
- Current total savings: $15,000
- Value of current assets: $370,000
- Current superannuation balance: $38,000
- Annual income: $120,000
When we entered the details for our fictitious father into the Allianz calculator it said he would need a whopping $3,306,651 in life cover and $3,297,651 in total disability cover. When we dropped the private school costs, it came back with $3,006,651.
Suncorp's life insurance calculator required us to add our dad's weekly spend, which we put at $1670 (about average for Australians). After processing most of the same details we entered into the Allianz calculator, Suncorp said he would need a comparably paltry $425,100 in life cover but added that the payout would only be enough to cover a "proportion" of his survivor's living expenses and education costs.
The Real Insurance calculator, on the other hand, told our increasingly befuddled father that he'd need $811,817 in life cover, but it also factored in a number of assumptions, including lower funeral costs ($8000 instead of $9000), public school for the kids, and a limit to how long the insurance payout would cover his survivors' living expenses. Without kids, Real Insurance payouts are calculated to support a surviving partner for two years.
So there's the rub. Some calculators, it seems, take your survivors' future income into account, while some don't. To add to the confusion, the Allianz calculator disclaims its reliability, saying in fine print that the information on the website "does not take into account your individual objectives or financial situation". Allianz recommends you "seek advice from your financial adviser before deciding on appropriate insurance cover".
Beware the insurance salesman
Financial advisers who deal in insurance products – and most do – have a powerful incentive to sell you more life insurance than you need or convince you to get a new policy.
More than eight out of 10 advisers take a hefty upfront commission, up to 130% of the annual premium followed by ongoing (or trailing) commissions of up to 10%. The more insurance policies they sell, the more they add to their commission income stream. Hey, nothing personal – it's business. And that's why you need to set your consumer radar to high alert when shopping for insurance.
How to tell if you're getting bad life insurance advice
There's plenty of documented evidence about people who end up with the wrong life insurance policy because the financial adviser who sold it to them was more interested in snagging a commission than doing the right thing by their client.
ASIC recently looked into the life insurance advice given by 200 small, medium and large financial services firms and found that a third of the advice (or 37%) didn't comply with laws stipulating that it had to match the client's needs. ASIC deputy chair Peter Kell said the investigation highlighted an "unacceptable level of failure".
According to the related ASIC report, commissions have a big influence on which insurer an adviser recommends.
To avoid being on the receiving end of such failure, make sure your life insurance adviser isn't just chasing commissions. A little background knowledge can go a long way.
Automatic online approval
Many online application forms are designed for easy approval because the process sidesteps tricky questions that are particular to your circumstances. It's a quick way for advisers to generate new business, but you may end up with unsuitable cover.
Do they know your needs?
If your adviser avoids probing questions about your personal circumstances, they're probably more of a salesperson than an adviser. Analysis of your needs should be deep and comprehensive.
Product bundling and upselling
Be especially wary of advisers who push life insurance and related products when you already have a policy. You may end up paying for more insurance than you need.
Using your super
Be even more wary of advisers who recommend using a big chunk of your superannuation contribution to pay a life insurance premium. ASIC calls this "a warning sign that the advice is not in the best interests of the client". And if you have an industry super account (as opposed to retail super), some life insurance is likely already included.
If your adviser isn't crystal clear about the pros and cons of the life insurance strategy they recommend – such as whether to pay for it inside or outside of super – find another adviser.
Commissions – fact and fiction
Just in case you have any illusions about the way commissions work, we outline a couple of eye-opening facts.
Fiction: Commissions are paid by the life insurance provider (also known as the licensee, or holder of an Australian Financial Services licence) to the financial adviser.
Fact: The commission is woven in to your annual premium and the financial adviser gets a cut. In other words, you pay it.
Fiction: Advisers earn higher commissions for complex advice situations.
Fact: The size of the commission doesn't have anything to do with how hard the adviser has to work.
Fiction: Advisers keep their commissions even if you bail out of the policy.
Fact: Insurers can 'claw back' commissions if the client drops the cover in a given time frame, usually the first 12 months. A high clawback rate suggests the adviser is giving bad life insurance advice and churning customers.