Selecting A Policy
Life and Disability insurance are topics which are often overlooked by many otherwise financially responsible adults. After all, thinking about your own death or serious illness is a little morbid and it’s human nature to want to believe you’ll live a long and healthy life. The blunt reality, however is that according to research conducted by the National Centre for Social and Economic Modelling (NATSAM) at the University of Canberra; one in five Australian families will suffer the death of a parent or a serious illness that renders a parent unable to work. This statistic is alarming in itself, but what’s worse is that over 80% of Australians are drastically underinsured.
The research was completed in February of 2010 as a public awareness initiative aimed at encouraging Australians to protect themselves from financial hardship that can result from accident, sickness, or death. According to IFSA’s Chief Executive John Brogden: “Australia’s ‘she’ll be right’ attitude stops most people confronting the very real possibility they will suffer an insurable event during their working life that has the potential to leave them financially ruined at an already difficult time.”
How Much Insurance Do I Need?
The answer depends on your responsibilities and the amount of up-front and long term costs you anticipate. If your income is not required to support a partner or child, the answer is very little. If you are the sole provider for a household, that number increases greatly. There are two approaches to estimate how much life insurance you need: the needs approach and the replacement-income approach.
o Needs Approach: To use the needs approach; add up the amounts that represent all the needs your family will be responsible for. These include funeral and burial costs, uninsured medical expenses, and estate taxes to name a few. The determining factor here is that needs are predominantly one-time expenses.
o Replacement-income Approach: The replacement-income approach requires you to calculate all the expenses listed in the needs approach as well as calculating the amount of income you will no longer be able to generate. For example, if you earn $50,000/year and expect to work an additional 15 years until retirement, you will need $750,000 of additional life insurance to make up for the loss of income.
There are several additional factors to consider for the replacement-income approach. Suppose, for example, that you could safely expect a 5% return on the balance of your life insurance policy. Using the same analogy as above ($50,000/year for 15 years), you would only need roughly $520,000 of additional life insurance to cover the same period. Your life insurance provider should be able to assist you in determining the value that is right for you. An easy formula to determine the coverage you need can be summed up as follows:
Short-term needs + long-term needs – resources = how much life insurance you need.
Supplemental Life Insurance
If your employer offers supplemental life insurance as a benefit, you should maximize this coverage as much as possible. Typically employer life insurance policies are cheaper than individual plans. Talk to your human resources department about the options available to you.
Disability Insurance
Calculating how much disability insurance you need uses similar principals as those listed above. Fortunately, disability insurance is typically an inexpensive add-on to Life Insurance. Most people set their disability insurance to the same amount as their life insurance policy. However, this decision is up to you.
Do not let a tragedy such as loss of life or serious illness impact your family more than it has to. By preparing now, you can help to ensure the financial stability of your loved ones even in your absence.