What should you consider when setting up life insurance?

When setting up a life insurance plan there are several points to consider. We’ll look at three of the most important to get right.

The first thing to consider is the amount of life insurance you want (the lump sum that you choose to insure). With most life insurance plans you can choose any amount you like – so the actual sum of life insurance you get is totally over to you. Most people either use an online life insurance calculator, or discuss their situation with a life insurance adviser – both can be good options for deciding the correct amount of cover for you. Either way, common considerations are debt (for example using life insurance to take care of a mortgage), providing for family members (for example a replacement income), and proving for education costs for children. Once you’ve considered each of these areas, you will have a pretty clear idea of the amount of life insurance cover that is right for you.

The next point to consider is the type of life insurance plan you’d like. One consideration will be the type of premium to choose. When you start a life insurance plan you can usually choose “stepped” or “level” premiums (the stepped premium increases with age, while the level premium does not). The level premium will cost more at first, but in the long term will save you money. So deciding the kind of premium you’d like is important, as this could save you a lot over time. You’ll also need to choose if you’d like to add extra cover to your life insurance – for example it’s very common to have part or all of your life insurance pay out if you suffer a major health issue (like cancer, stroke, etc).

Finally, you need to choose the right insurer. With life insurance you are making a long term commitment – and so you need to select a financially stable insurer that is well priced and offers you as much flexibility as possible. While life insurance plans are similar, insurers can vary a lot – so selecting the right one for you is important.

What is a life insurance “Special Events benefit”?

Most New Zealand life insurance plans include a free feature called a “Special Events Increase”. This can be a vital part of life insurance – we’ll take a quick look at how it works.

Let’s say you have a life insurance policy that is worth $400,000. Then, because you have increased your mortgage, you want to increase your life insurance by $100,000. Usually, in this situation, you would need to provide information about your current health to the insurer (by completing a new application). The insurer would then assess this information and increase your cover. Often this is simple, however if you have experienced any health issues since you originally started your life insurance, the insurer might not allow you to make the increase (or they might allow the increase, but only at a much higher than usual premium). The reason for this is that any increase is treated by the insurer as a brand new application – which they might or might not approve.

However if your policy has a “Special Events” benefit, you can increase your cover without having to provide any health information at all to the insurer. So you’d simply make a request for the insurer to increase the insurance, and you wouldn’t have to complete an application form. And the most important part is that even if you’ve suffered a health issue, the insurer can’t deny your increase, or charge you higher than usual premiums. Even in situations where a person has become very ill, the Special Events benefit means that they are guaranteed to be able to increase their cover if a special event arises (typical special events are taking out a mortgage, having a child, moving house etc).

Special Events benefits have some limitations – there is usually a cap on the amount of the increase you can make, and people over a certain age are not eligible – however this can be an extremely useful benefit. So, if you’re thinking about starting a life insurance plan, make sure any plan you’re considering includes this.

How to choose the right amount of life insurance?

When setting up a life insurance plan you can usually choose any amount of insurance you’d like. So, how do you choose the right amount for you? We’ll look at five key areas people consider when choosing the right amount of life insurance.

Mortgages
For people with a family or who share a mortgage with a partner, life insurance is usually crucial. Most people in this situation choose to make sure they have enough life insurance to ensure their mortgage is paid off if they pass away.

Other debt
If you have debt that you would not like to be left to family or a partner, than including provision for this in your life insurance is a good idea. This makes sure that your partner or family are not left in financial trouble if you pass away unexpectedly.

Replacement income
This is particularly important for the main income earner in a household. If they were to pass away, there could be a huge financial impact on the other family members. For this reason, people often choose to add a sum for a replacement income into their life insurance. For example, a person might decide that they want to provide an ongoing income of $50,000 to surviving family for a period of 15 years (in many cases until children are grown). This makes sure that the financial impact of death is greatly lessened.

Education
A child’s education can be very costly. To provide for this kind of cost, an amount can be added to your life insurance – meaning that funds are available for education in the future.

Funeral costs
If you don’t have adequate savings for these, then you could choose to use life insurance to cover this expense. Also most life insurance plans have an immediate funeral grant – which can help with funeral and final costs.

Life insurance - saving money with stepped or level premiums.

In New Zealand, when you start a life insurance plan you usually can choose from two premium types: “stepped” premiums or “level” premiums. The difference is simple. Stepped life insurance premiums are designed to increase with age – so as you get older the cost of your insurance will increase every year. On the other hand, a level premium does not increase with age – so you getting older makes no difference to the cost of the life insurance.

Which is better? The answer depends on how long you are likely to need your life insurance for. At first glance a level premium looks more expensive – and in the first years after setting up your policy, it will be higher (around twice to three times the cost of a stepped life insurance premium is a good rule of thumb). However, because a level premium doesn’t increase with age, it can become much cheaper over the long term (say over 10 years).

So while a stepped premium is cheaper in the short term, in the long term it can cost a lot more. And in the very long term (say when you are in your 60s or 70s), a stepped life insurance premium is likely to be totally unaffordable.

In New Zealand, people have financially dependent children and debt for much longer than in the past. For this reason a level premium can sometimes be the only affordable long term life insurance option.

So, if you’re deciding between a stepped and level premium the main point to consider is how long you might want to keep your life insurance. If you might need it for only the short term (say less than 5 years), it’s highly unlikely that a level premium will be cost effective. In this case, a stepped life insurance premium will probably be the best option.

However if you might have a long term need for your insurance – for example you have young children or a long mortgage term, then look into level cover. You can ask your life insurance broker to compare the costs of both options for you – and you’ll easily see which makes more sense for you.

Level life insurance - where the smart money is

Are you finding that every year your life insurance is getting more and more expensive? After the age of about 35, that’s what tends to happen with life insurance premiums. In fact, at some point they will become unaffordable.

You see, a life insurance premium is calculated by actuaries who consider only one thing – the “numbers”. The numbers tell them that when you are 25 years old, there is a very low probability of you passing away. So when you are 25 years old, the cost of your life insurance reflects this. At the age of 50, the numbers tell them that the probability of you passing away has increased significantly, so they charge accordingly. By the time you are 60, the probability of you passing away is relatively high – you know where this is going. (see http://www.stats.govt.nz/analytical-reports/nz-life-tables-2000-2002/default.htm)

There is one way of avoiding this situation though. If you need your life insurance long term, you can choose a “level premium” option. This simply means that you choose a term when you start the contract - 10 years, 20 years, or even to the age of 80. Your premium is then calculated over the term of the contract and aggregated so that the cost stays the same – no annual increases. You don’t have to commit to the full term that you choose – you can still cancel the contract at any time. But it is a great way of ensuring that your cover is sustainable.

Level premiums are more expensive at the start (normally around double the cost), but in the long term they work out to be far more cost effective. This is particularly evident if you start a level premium when you are young – it’s the smartest way to do it.

Some insurers (see www.inform.co.nz) can guarantee your premium until your 80th birthday. That means that if you are 30, you would know exactly what the cost of your life insurance would be to the age of 80 – and it’s probably not as expensive as you think at this age.

If you want to set your cover up to be sustainable, investigate level premiums. It’s where the smart money is.