_DFP Module 4 by zhangyun

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									               Module 4

               Insurance




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TABLE OF CONTENTS

               1.0       INTRODUCTION                                 5


               2.0       LEARNING OUTCOMES                            6


               3.0       RISK AND INSURANCE                           7
                         Classifications of risk                      8

               3.1       Handling risk                                9
                         Avoidance                                   10
                         Retention                                   10
                         Non-insurance transfers                     10
                         Loss control                                11
                         Insurance                                   11

               3.2       Basic characteristics of insurance          12
                         Pooling of losses                           12
                         Payment of fortuitous losses                13
                         Risk transfer                               13
                         Requirements of an insurable risk           13
                         Adverse selection and insurance             14
                         Life insurance rating factors               15
                         The role of the underwriter                 15
                         Reinsurance                                 15


               4.0       GENERAL INSURANCE                           16
                         Liability insurance                         17
                         What is negligence?                         17
                         What are the elements of a negligent act?   18
                         Defence against negligence                  18
                         Types of damages                            18
                         Types of liability insurance                18
                         Trends in liability cases                   20


               5.0       PERSONAL INSURANCE                          21
                         Endowment policies                          21
                         Whole of life policies                      22




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               6.0       TERM INSURANCE                                                                    23
                         How do you choose how much cover is sufficient                                    23
                         What factors affect insurance premiums?                                           24
                         How to choose a life insurance policy?                                            26

               6.1       Term life insurance inside superannuation                                         27
                         Pro's of having term life insurance inside super                                  27
                         Con's of term life insurance inside super                                         27
                         Who is entitled to your death benefit when term life insurance is inside super?   28
                         Taxation of death benefits inside super                                           28
                         Term insurance add-ons                                                            30


               7.0       TOTAL AND PERMANENT DISABILITY INSURANCE                                          31
                         Definition of total and permanent disability                                      31
                         How much TPD insurance is necessary?                                              33
                         TPD Insurance buy back options                                                    33


               8.0       INCOME PROTECTION INSURANCE                                                       35
                         Agreed value insurance                                                            36
                         Indemnity value policies                                                          36
                         What is the cost of income protection insurance?                                  37
                         Stepped or level premiums?                                                        38


               9.0       TRAUMA INSURANCE                                                                  40
                         Who should consider trauma insurance?                                             41
                         The statistics are scary!                                                         41
                         trauma insurance and ‘buy-back options’                                           43
                         Waiting Periods apply                                                             43
                         insurable interest                                                                43
                         key person insurance                                                              44


               10.0      HEALTH INSURANCE                                                                  46


               11.0      APPLICATION OF LIFE INSURANCE                                                     47
                         Eliminating debt on death or disability                                           47




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               APPENDIX 1 - INSURANCE PDS


               APPENDIX 2 - INSURANCE PERSONAL STATEMENT




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1.0            INTRODUCTION

               In Module 2, we provided several definitions of risk. We described risk as being the
               variability of returns where the risk was that actual returns would be different from
               expected returns. We also described risk as being the loss of purchasing power -
               'inflation risk' - or the loss of capital value - 'market risk'. In each description, it is the
               element of uncertainty that gives rise to the risk. In this module, risk is again seen to be
               based on the concept of uncertainty, this time uncertainty concerning the occurrence of
               loss.

               Financial advisers, when discussing the potential for the ‘occurrence of loss’ with clients
               in an insurance context, require significant skill to professionally deal with the emotional
               and financial issues. This module identifies and explains the connecting issues in relation
               to insurance from a knowledge and skill perspective, and equips you with the tools to
               provide personal insurance advice to clients.




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2.0            LEARNING OUTCOMES

               When you have completed this module, you should be able to:

               • Explain the relationship between risk and insurance.

               • Describe the basic characteristics of insurance.

               • Identify and explain how different types of insurance contracts operate.

               • Understand how term life insurance and TPD contracts operate, and explain the
                   relevance of term life and TPD insurance to financial planning.

               • Understand how critical illness (trauma) insurance contracts operate, and explain the
                   relevance of critical illness insurance to financial planning.

               • Understand how income protection insurance contracts operate, and explain the
                   relevance of income protection insurance to financial planning.

               • Identify insurance needs, and be able to match a type of insurance to that need.

               • Apply knowledge and skills to make insurance recommendations in a financial
                   planning context.




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3.0            RISK AND INSURANCE

               It is possible to see the words risk, peril and hazard as being synonymous with each
               other. For the purposes of insurance, however, each of these terms has a specific
               meaning.

               • Risk is the uncertainty concerning the occurrence of a loss.

               • Peril is the cause of a loss.

               • Hazard is a condition that creates or increases the chance of a loss.

               Peril

               An example of a peril is a house burning because of a fire: the fire is the peril or cause of
               the loss. Common perils that cause property damage or loss include fire, lightning,
               storms, hail, earthquakes, theft and burglary.

               Hazard

               There are three major types of hazard:

               • physical hazard is a physical condition that increases the chance of loss, eg icy roads,
                   defective electrical wiring, defective lock on a door

               • moral hazard is dishonesty or character defects in an individual that increase the
                   frequency or severity of loss, eg faking an accident to collect insurance money,
                   submitting a fraudulent claim, inflating the size of a claim. The effect of moral hazard
                   is to increase the cost of insurance to all policyholders

               • morale hazard is carelessness or indifference to a loss because of the existence of
                   insurance. Some people may be careless because they are insured, eg leaving keys in
                   a car, leaving a door unlocked, turning a corner on a change from amber to red light.
                   Such acts increase the chance of loss.




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CLASSIFICATIONS OF RISK

               Risk can also be classified in various categories:

               • pure risk is a situation in which there are only the possibilities of loss or no loss, eg
                   premature death, disablement, damage to property from flood

               • speculative risk is a situation in which either gain or loss is possible, eg purchase of
                   shares provides for an upturn in price or a decline in price.

               Pure risk

               Pure risk may be classified according to three types:

               • Personal risk

               • Property risk

               • Liability risk

               Personal risk

               Personal risk directly affects an individual involving the possibility of loss of income or
               assets. There are four major personal risks. They are:

               • risk of premature death of the main breadwinner with unfulfilled financial
                   obligations. A mortgage to be paid off or children to educate or support will create
                   financial hardship. Four costs results from a premature death: loss of future income
                   of the breadwinner; additional expenses which may be incurred in the short term;
                   the family's income from all sources may not be adequate to meet basic needs; non-
                   economic costs such as emotional grief and the loss of role model

               • risk of old age, a concern when employment ceases and there is insufficient income
                   to meet retirement income needs

               • risk of poor health, another personal risk. Such risks include the cost of surgery and
                   rehabilitation and loss of temporary or long term ability to work and earn an income

               • risk of unemployment, another major threat to personal financial security. This can
                   arise from downsizing, labour costs, technology requiring fewer workers, global
                   wages cost competition, privatisation, replacement of permanent staff with casual
                   employees. The threat of reduced income is a financial concern for many people




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               Property risk

               Property risks can be either direct loss and indirect or consequential loss. Direct loss is a
               financial loss that results from the physical damage, destruction or theft of the property.
               Indirect or consequential loss is the financial loss that results indirectly from the
               occurrence of a direct physical damage or theft loss, eg a restaurant would suffer loss of
               profits from trading if it was unable to operate for a period due to a fire, as some
               expenses would still continue while no revenue was able to be brought in

               Liability risk

               Liability risks are also regarded as pure risks that people face. A person may be held to
               be legally liable if they do something that results in bodily injury or property damage to
               someone else. This risk may carry heavy costs as there may be no upper limit on the
               amount of the loss, future income may be committed to the judgement as well as
               current assets, and legal costs can be substantial.



               Review

               Provide three examples of pure risk and three examples of speculative risk



3.1            HANDLING RISK

               There are five major methods of handling risk so that risk is less of a burden to the
               individual and society.

               • avoidance

               • retention

               • non-insurance transfers

               • loss control

               • insurance




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AVOIDANCE

               This is simply the choice of not doing something. Avoidance of risk is sometimes
               impracticable, eg it is difficult to avoid travelling in a car to avoid all risk of being
               involved in a car accident



RETENTION

               Retention is where an individual or business may retain some of the risk. Retention can
               be active or passive:

               • active retention is where the individual is aware of the risk and takes a deliberate
                   action to retain all or part of the risk. An example is where an individual accepts a
                   level of an excess to be paid before the insurance company is required to act, or a
                   shopkeeper accepts a level of risk of theft by not employing a security guard. Active
                   retention is used to save money on the premium or where insurance is not available

               • passive retention is where the risk is retained because of ignorance, indifference or
                   laziness

               Risk retention is appropriate for high frequency but low severity risks where potential
               losses are relatively small. Low frequency but high severity risks, eg earthquake, long
               term disability, liability lawsuit should not be covered by retention



NON-INSURANCE TRANSFERS

               This involves the transfer of risk to a party other than an insurance company. Risk may
               be transferred by contract, eg warranty repairs, a long term lease avoiding the risk of a
               sharp increase in rent, fixed price contracts

               Hedging is also a form of non-insurance transfer. It is a technique for transferring the
               risk of unfavourable share price fluctuations to a speculator by purchasing and selling
               futures contracts on an organized exchange. This portfolio insurance is not formal
               insurance but is a risk transfer technique that provides protection against a decline in
               stock prices.

               Incorporation of a business firm can be a useful method for protection of the owner’s
               personal assets from creditors, ie this is a transfer of risk from the owner to the creditor



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LOSS CONTROL

                Loss control involves the activities to reduce the severity and frequency of losses. There
               are two objectives of loss control: loss prevention and loss reduction.

               Loss prevention aims at reducing the probability of loss so that frequency of losses is
               reduced, eg a driver takes a safe driving course, a person gives up smoking, regular
               safety inspections, elimination of unsafe work practices.

               Loss reduction aims at reducing the severity of a loss, eg the installation of a sprinkler
               system may reduce a potential loss, the use of fire retardant doors can restrict a fire
               from spreading, and adding security bars to windows at premises can reduce the
               likelihood of theft.

               Loss control is desirable from society’s viewpoint for two reasons:

               • the indirect costs of losses may be large and in some cases exceed the direct costs

               • the social costs of losses are reduced.

               To illustrate these two points, consider the case of an injured worker. The firm
               responsible for the accident may be required to pay medical and salary costs. In
               addition, indirect costs may be incurred such as: a machine may be damaged and may
               need to be shut down for repairs, costs may be incurred in training a new worker and a
               contract may be cancelled because a delivery could not meet its shipping time. If the
               worker had died, society is deprived of that worker’s productive capacity and the
               worker’s family must suffer the grief and loss of earnings. An effective loss control
               program can reduce such social costs



INSURANCE

               Insurance transfer of the risk to an insurance company is often the most practical means
               of handling a major risk. The benefits of pooling the risk over a large number can make
               the insurance very cost effective.

Case study 4.1

               Brendon and Martine are considering the purchase of a townhouse in Noosa. They plan
               to spend the Christmas vacation and two weeks each winter in the townhouse. For the




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               remaining time, the townhouse will either be rented out, or remain vacant. Brandon
               and Martine are concerned that, if the townhouse is vacant, it may be broken into.

               Review

               If Brandon and Martine wish to avoid the risk of the townhouse being broken into,

               a) What should they do?

               b) What can they do to control the risk?

               c) What can they do to transfer the risk?



3.2            BASIC CHARACTERISTICS OF INSURANCE

               The basic characteristics of insurance are:

               • the pooling of losses

               • the payment of fortuitous losses

               • risk transfer

               • indemnification.



POOLING OF LOSSES

               This is the heart of insurance. Pooling is the spreading of losses incurred by the few over
               the entire group, so that in the process, average loss is substituted for actual loss.
               Pooling implies the sharing of losses by the entire group and the prediction of future
               losses with some accuracy based on the law of large numbers. For example, if 1000
               households agree to contribute to the loss of a house in the event of fire and each home
               is valued at $75,000 then the maximum amount to be paid by each owner would be $75

               Thus, the pooling results in the substitution of an average loss for the actual loss of
               $75,000. The law of large numbers says that the greater the number of exposures, the
               more closely will the actual results approach the probable results that are expected
               from and infinite number of exposures, eg it can be predicted with confidence that a
               certain number of travellers will, unfortunately, lose their life as a result of a car
               accident over the Easter period.




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PAYMENT OF FORTUITOUS LOSSES

               A fortuitous loss is one that is unforeseen and unexpected and occurs as a result of
               chance, i.e. the loss must be accidental and occur randomly.



RISK TRANSFER

               Risk transfer occurs where a pure risk is transferred from the insured to the insurer, who
               typically is in a stronger financial position to pay the loss than the insured, eg death
               insurance, loss of property, liability lawsuits.



INDEMNIFICATION

               Indemnification means that the insured is restored to his or her approximate financial
               position that existed prior to the occurrence of the loss. This is based on the principle
               that you cannot make a profit on a loss.



REQUIREMENTS OF AN INSURABLE RISK

               There are six requirements that must be fulfilled before a pure risk can be privately
               insured. They are as follows:

               • there must be a large number of exposure units, ie a large group exposed to the
                   same peril. This enables insurers to predict loss based on the law of large numbers

               • the loss should be accidental and unintentional. This means that the loss should be
                   fortuitous and outside the insured’s control. If intentional losses were paid, moral
                   hazard would be increased and premiums would rise. The loss should be accidental
                   because the law of large numbers is based on random occurrence of events

               • the loss must be determinable and measurable, ie the loss must be definite as to
                   cause, time, place and amount. Some difficulty is encountered when estimating the
                   loss from a disability policy

               • the loss should not be catastrophic. This means that a large proportion of exposure
                   units should not incur losses at the same time. If a simultaneous loss occurs, then
                   the pooling technique breaks down and becomes unworkable



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                   Two approaches are available to meet the problem of catastrophic loss:

                   – firstly, reinsurance can be used. This involves the shifting of part or all of the risk
                       from one insurer to a number of insurers

                   – secondly, insurers can disperse their coverage over a large geographical area

               • the chance of loss must be calculable. The insurer must be able to calculate both the
                   average frequency and the average severity of future losses with some accuracy.
                   This is required so that a proper premium can be charged that is sufficient to pay all
                   claims and expenses and yield a profit for the insurer during the policy period

               • the premium must be economically feasible. The insured must be able to pay the
                   premium. Generally, the chance of loss must be relatively low.



ADVERSE SELECTION AND INSURANCE

               Adverse selection is the tendency of persons with a higher-than-average chance of loss
               to seek insurance at standard or average rates, which if not controlled by underwriting,
               results in higher-than-expected loss levels, eg high-risk drivers seeking car insurance at
               low-risk rates, people with health risk seeking premiums of a lower health risk person.

               Adverse selection can never be completely eliminated but it can be controlled by careful
               underwriting.

               Underwriting is the process of selecting and classifying applicants for insurance. If the
               underwriting standard is not met then the insurance is denied or an extra premium must
               be paid (often called a ‘loading’). Policy provisions are also used to control adverse
               selection. For example, the suicide clause in life insurance policies generally means that
               a policy holder (or insured) is not paid a benefit until the policy has been in existence for
               at least 13 months. Generally, this means that a person contemplating suicide but who
               wants to ensure a life insurance payout is made to their beneficiaries, has over a year to
               think about it! While this may seem flippant, this is the reality in the insurance business.
               Insured persons with pre-existing conditions such as a bad back or depression will either
               be denied insurance completely (depending on the severity and type of insurance
               sought), or have certain conditions excluded in their insurance policy. Alternatively, if an
               insurer isn’t able to adequately exclude a high risk pre-existing medical condition, then
               they are likely to apply a loading which increases the total premium, in line with the
               higher risk of the insured, relative to the average risk of persons insured within the pool.




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LIFE INSURANCE RATING FACTORS

               Rating factors are used to determine the level of premium to charge for a risk that a life
               insurance provider carries on a particular policy. Premiums will vary, depending on:

               • age

               • sex

               • occupation

               • existing health condition.



THE ROLE OF THE UNDERWRITER

               The role of the underwriter is to evaluate applications for insurance to decide if the
               applicant meets the criteria necessary to join the relevant insurance pool. As higher risk
               applicants may disadvantage the pool, it is the underwriter's role to protect the
               insurance company from unnecessary risk. The underwriter assesses an individual's
               overall risk profile and makes a decision regarding an application. The underwriter may
               determine that an applicant should only be accepted as an insurance risk if a loading is
               included in the premiums.



REINSURANCE

               Reinsurance is an arrangement whereby an insurance company who has a direct
               relationship with clients places the full or partial risk with a reinsurer in order to spread
               the risk. The direct insurer is insured by the reinsurer. The reinsurance market is one
               that only accepts risks from other insurance companies. They do not deal directly with
               clients.

               Review

               a) Explain the meaning of 'adverse selection'.

               b) Why are insurers concerned about adverse selection?

               c) How can underwriting be used to control adverse selection?




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4.0            GENERAL INSURANCE

               Insurance other than ‘Life Insurance’ falls under the category of General Insurance.
               General Insurance includes insurance of property, household contents, motor vehicles,
               caravans, boats etc. against fire, theft, damage and loss. It also includes personal
               insurance such as accident and health insurance and liability insurance.

                In respect of insurance of property, it is important that the cover is taken for the actual
               value of the property to avoid a penalty being imposed should there be a claim. Where a
               property is undervalued for the purposes of insurance, the insured will have to bear a
               rateable proportion of the loss. For instance if the value of a property is $500,000 and it
               is only insured for $300,000, in the event of a loss to the extent of say $100,000 the
               maximum claim amount payable would be $60,000 ( 40% of the loss being borne by the
               insured for underinsuring the property by 40% ). This concept is quite often
               misunderstood by parties wanting insurances.

                The Australian Prudential Regulation Authority reports that Australian insurers pay an
               average of $95 million in claims each working day to the Australian community. This
               significant daily injection of funds, compensating individuals and businesses for losses, is
               often described as the economic oil that keeps the community functioning. Without this
               daily recovery effort in Australia, many businesses would fail and individuals would find
               themselves with no way to replace their hard earned possessions and lifestyle.

               Insurers will not pay for claims that fall outside of the terms and conditions of the
               insurance policy or claims that are made fraudulently.

               Policy terms and conditions exist to protect the consumer. Insurance policies cover a
               wide variety of circumstances and issues that policyholders seek to protect themselves
               from through purchasing insurance. It is important, for both the insurer and the
               policyholder, to carefully define and understand what is covered under the policy and
               what circumstances are not covered.

               For example, some insurance policies exclude some forms of flooding as damage that
               can be claimed under the policy – Consumers who identify that they need a particular
               type of flood cover should research different products until they find a policy that offers
               cover for this risk.

               Under Australian Law insurers must make available a Product Disclosure Statement
               (PDS) to policyholders so that these terms and conditions can be read and understood.




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               Consumers should read the PDS before purchasing a product to ensure that they
               understand how the product operates and what their entitlements to make a claim
               are.

               Most Australians experience a financial loss at some point in their lives. Insurance is
               about protecting yourself and your family from a loss that you would otherwise not be
               able to financially recover from.

               Most Australian’s do not routinely have enough savings to rebuild a house or pay off a
               mortgage if your current property is destroyed. Some consumers feel that they have
               paid premiums for years without any need to make a claim, but insurance is about
               protecting yourself against large financial impacts that may only occur once or twice in a
               lifetime if you are prudent.

               Managing your risks, avoiding accidents, protecting and maintaining your property to
               lower the probability of having to call upon your insurance demonstrates sound
               judgement, something that is usually reflected in your insurance premium.



LIABILITY INSURANCE

               People have a responsibility to avoid causing injury or damage to others. If someone
               happens to cause an injury to another person, they may be liable to pay compensation
               for their behaviour. Often, the person who caused the injury was not at fault to any
               great extent, but nevertheless may be liable to make good the damage so caused.

               This section looks at the area of insurance which provides financial protection against
               personal loss if the actions of a person cause damage or injury.



WHAT IS NEGLIGENCE?

               The concept of negligence is based on the notion that a person or business owes a duty
               of care to others.

               Negligence is generally not regarded as a crime. Criminal acts are breaches defined by
               law as an offence against society and may be punishable by fine or imprisonment.




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WHAT ARE THE ELEMENTS OF A NEGLIGENT ACT?

               A negligent act consists of three main features:

               • a duty of care is owed by the person or business to others

               • the duty of care has been breached

               • damage or injury has resulted from that breach of duty.

               • the damage or injury can be causally linked to the breach, and it is not deemed too
                   remote.



DEFENCE AGAINST NEGLIGENCE

               A common defence used in negligence cases is the argument that the other party was
               also at fault, and was negligent to some extent. It is then up to the courts to decide to
               what degree each party was responsible for the damage which resulted. This is known
               as contributory negligence.



TYPES OF DAMAGES

               The different types of damages which may be sought against the wrong-doer include:

               • special damages. These are damages to pay for specified costs, eg medical and
                   physiotherapy expenses, lost wages, property costs

                  general damages. These are payments for losses which cannot easily be assessed in
                   monetary terms, eg payments for pain and suffering, and loss of enjoyment of life
               • punitive damages. These are payments imposed by the courts as a punishment and
                   as a deterrent to others against such wrong-doing. There is usually no financial basis
                   for punitive damages; sometimes they can be severe and at other times may be
                   regarded as a token.



TYPES OF LIABILITY INSURANCE

               Three types of liability insurance are available. They are:




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               • product liability insurance

               • public liability insurance

               • professional liability insurance.

               Product liability

               This form of insurance provides protection for manufacturing businesses which produce
               goods made available to the public. In case a fault in the manufacturing process causes
               a product to be faulty and a member of the public is injured as a result of the faulty
               manufacture, it is advisable for manufacturers to take out insurance against such
               possible claims. In recent times, we have seen success in the courts for victims of the
               drug thalidomide and faulty silicone breast implants (Dow Corning).

               Public liability

               Householders usually have insurance for public indemnity built into their home
               insurance policy. Should a visitor to a house trip on a broken step, fall and break a leg,
               then a claim may be made against the house owner for being negligent in not warning
               the visitor of the danger.

               Public liability should be held by individual home owners, renters that have legal
               responsibility for maintaining the state of a rented premise, even if that involves
               ensuring furniture is not a hazard to entrants, as well as business owner’s regardless of
               whether they own a property or lease it. A famous case involving McDonalds (...for all
               the wrong reasons) highlights the importance of ensuring appropriate public liability is
               held.

               In February 1992, Stella Liebeck ordered a cup of coffee to go from McDonalds. Liebeck
               was sitting in the passenger seat of her nephew's car, which was pulled over so she
               could add sugar to her coffee. While removing the cup's lid, Liebeck spilled her hot
               coffee, burning her legs. It was determined that Liebeck suffered third degree burns on
               over six per cent of her body. Originally, Liebeck sought $20,000 in damages. McDonalds
               refused to settle out of court. However, they should have. Liebeck was ultimately
               awarded $200,000 in compensatory damages, which was reduced to $160,000 because
               she was found to be twenty per cent at fault. She was also awarded $2.7 million in
               punitive damages.




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               Bizarre cases continued

               In 1997, Larry Harris of Illinois broke into a bar owned by Jessie Ingram. Ingram, the
               victim of several break-ins, had recently set a trap around his windows to deter
               potential burglars. Harris, 37, who was under the influence of both alcohol and drugs,
               must have missed the warning sign prominently displayed in the window. He set off the
               trap as he entered the window, electrocuting himself. The police refused to file murder
               charges. Harris's family saw it differently, however, and filed a civil suit against Ingram. A
               jury originally awarded the Harris family $150,000. Later, the award was reduced to
               $75,000 when it was decided Harris should share at least half of the blame.

               Professional liability

               Professionals such as doctors, lawyers and accountants are advised to have a
               professional indemnity policy. Such a policy is designed to provide a claimant with an
               amount of damages if the professional is found to be negligent in the carrying out of his
               or her duties.

               Professionals need to guard against giving wrong advice, carrying out a wrongful action
               or failing to carry out a specific duty. A number of negligence cases have been brought
               against doctors, for instance, for not diagnosing an illness while carrying out duties in
               their professional capacity. Obstetricians have one of the highest professional indemnity
               premiums because of the risks and frequency of problems associated with child birth
               also.



TRENDS IN LIABILITY CASES

               In the past few years, there has been a trend throughout the world towards seeking
               negligence claims against manufacturers, individuals and especially against professional
               people.

               Review

               Over time, products liability and professional liability lawsuits have increased
               substantially. What do you think might be the reason/s for this?




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5.0            PERSONAL INSURANCE

               Protecting the lifestyle of the insured and/or dependants and/or business partners is
               one of the main aims of personal insurance (ie. the role of insuring oneself). When a
               person's lifestyle is adversely affected by sickness, injury or death, the emotional
               consequences that follow are often exacerbated by the financial trauma that may result.
               The choice of personal insurance products has grown significantly, and the options
               available amongst personal insurance products (offered by life insurance companies)
               can be complex.

               We will consider two of the traditional life insurance products: Endowment, and Whole
               of Life, and the modern incarnation of life insurance products these days, which is term
               life insurance.



ENDOWMENT POLICIES

               An endowment policy is a policy in which a certain sum will be paid at the end of a
               stated period of time. These policies are still in existence as legacy policies however as
               discussed, they are generally not offered anymore. Often the policy included bonuses
               which accrued over the period of the policy. In the past parents may have purchased an
               endowment policy to mature when their children reached, say, 21 years of age. If the
               person whose life was nominated on the policy died before maturity, the sum assured
               plus bonuses were paid to the estate of the deceased. Usually the policy is paid for with
               a regular fixed rate or premium. A policy may be surrendered prior to maturity date for
               a cash sum or converted to a paid-up policy to mature at the end of a fixed period, say
               five years. In some instances, the insurer also allowed a loan against the value of the
               policy.




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WHOLE OF LIFE POLICIES

               A whole of life policy, also tend to be legacy policies, rather than offered as new policies
               these days. Whole of life policies were designed to be paid at a certain age, usually at an
               older age, say 85 or 95, or when the policyholder (insured) dies. These policies may
               have included bonuses as well as the sum assured which was determined at the
               commencement of the contract. The premium is paid at a fixed rate over a lengthy
               period of time. Whole of life policies are very similar to endowment policies.




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6.0            TERM INSURANCE

               Term insurance may be regarded as temporary insurance, as the policy must be
               renewed each year. If the owner of the policy does not pay the premium within the
               stated time, or chooses not to renew the policy, then the policy will lapse. In this way,
               term insurance is similar to car insurance: it covers a person’s life for a stated period of
               time.

               A person may choose to insure their life with a different company from time to time.
               This decision may be based on the level of premium charged or other features the policy
               owner finds attractive. However, depending on the level of cover required, or on
               certain health characteristics, the life insured may have to undertake a number of
               medical tests (ie. the underwriting requirements) before a proposal is accepted by the
               other life company. Once a policy is written, the option to renew is in the hands of the
               policy owner regardless of a change in health circumstances of the life insured.

               A feature of term insurance is that it is ‘guaranteed renewable’. This means that the
               policy owner is not obliged to continue with the contract but the insurer is obligated to
               continue to offer the contract for as long as the policy owner wants it, ie up to a
               maximum age (for example 65 or 70).

               Premiums on term insurance are generally not tax deductible, and the benefits paid to
               the policy owner do not form part of taxable income.



HOW DO YOU CHOOSE HOW MUCH COVER IS SUFFICIENT

               There is no general rule of thumb in the insurance industry as to how much life
               insurance to carry, people disagree often. However to seek coverage for an amount 10
               times your annual salary plus your mortgage, all credit card bills, personal and car loans,
               and funeral expenses is one unscientific method some in the industry rely on. The
               decision as to the appropriate amount of cover also depends on how many dependents
               a client has, among many other key factors.

               Things to consider:

               • The amount of your mortgage and other debts.

               • Whether you have a spouse, children or other dependants.




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                  • The age of your children and the costs which would be required for them to finish
                      school and continue their education.

                  • Whether your dependants have special needs.

                  • Whether assets or other investments could provide some financial security by
                      covering some costs after your death.

                  • Your current wage and how much you expect to earn in the future.

                  • The amount your family needs to maintain their current lifestyle.

                  As well as considering the fact that more people are taking on greater levels of debt,
                  larger mortgages and having children later in life, when deciding on how much insurance
                  you need, consider the value of home duties performed and whether you may want to
                  cut back on full time work hours to spend more time with your children if you lose your
                  partner. You may find that the level of cover required for the person based at home is
                  significantly higher than you expected!



WHAT FACTORS AFFECT INSURANCE PREMIUMS?

                  The premiums for life insurance policies are usually based on a range of factors
                  including:

                  • Your age, as premiums can increase or decrease as you get older1.

                  • Your gender as women typically live longer than men and so pay lower premiums.

                  • Whether you are a smoker.

                  • Your job and its level of risk, for example a construction worker can pay higher
                      premiums than an office worker. Those that work in high risk occupations within the
                      mining industry sometimes find it difficult to obtain cover at all!

                  • Your general health.




1
    Whilst this is counter-intuitive, believe it or not there is a higher risk of death or accident when an insured is 18-24 years
of age, than from 25 to 29 years of age. It is called the insurance hump and it is the only anomaly to the actuarial doctrine
that the risk of death or injury increases with age. It is because of a higher incidence of car accidents, other accidents and
suicide in this earlier age group.




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                  • Any pre-existing medical conditions.

                  • Genetics tests you’ve had, as these may show you are more likely to develop a
                      certain condition.

                  • Hobbies and pastimes: for example if you indulge in amateur motor racing on the
                      weekends, death or injury resulting from doing this will generally be excluded by the
                      underwriter within the policy.

                  You can also choose when you want your insurance premiums to be more affordable by
                  choosing either stepped or level premiums.

                  Stepped Premiums

                  Stepped premiums start out as very affordable but increase each year. This can make
                  stepped premiums very expensive as you age because while premiums may decrease
                  when you are in your 20s2, the premiums can increase by as little as 3% in your 30s to as
                  much as 30% each year when you are in your 60s.

                  Level premiums

                  Level premiums stay the same for the entire time you hold your life insurance policy so
                  you can plan and budget for the cost into the future3. For example, a 35 year old male
                  requiring $500,000 worth of life insurance would initially pay higher premiums if they
                  chose level premiums compared to stepped premiums. Nevertheless, if the insured
                  maintained the policy beyond 9-12 years (the general break-even point for stepped vs
                  level premiums), they would be much better off with level premiums as they would
                  become much cheaper (relative to stepped premiums) beyond this time. The problem
                  for many insured people is that they switch insurance providers, or cancel their policies
                  prematurely negating some of the benefits of taking out insurance with level premiums.




2
    Whilst this is counter-intuitive, believe it or not there is a higher risk of death or accident when an insured is 18-24 years
of age, than from 25 to 29 years of age. It is called the insurance hump and it is the only anomaly to the actuarial doctrine
that the risk of death or injury increases with age. It is because of a higher incidence of car accidents, other accidents and
suicide in this earlier age group.

3
    This is not entirely accurate because level premiums can increase if the ‘base rate’ that insurers charge across the board
for a given policy type (eg. life insurance or income protection) increases. The point is, that level premiums do not increase
with age, they only increase if the base rate of premiums for everyone in the pool (regardless of age) increases.




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HOW TO CHOOSE A LIFE INSURANCE POLICY?

               To make sure you’re getting the right life insurance policy for your needs, there are a
               few questions you should ask your adviser before you sign:

               • Find out exactly what is covered. Make sure you are covered if you die due to an
                   illness, as well as from accidental causes. Also, suicide is generally not covered for the
                   first 13 months.

               • Know how much will be paid for a claim. Clarify how much you will be paid as well as
                   the conditions of payment, for example will the claim be paid if you are diagnosed
                   with a terminal illness?

               • The cost of the premiums. Knowing how much you will be paying now and into the
                   future allows you to budget, as well as decide whether a level premium or a stepped
                   premium is better for you depending on your age, and how your financial
                   circumstances are likely to change in the future.

               • How can the cover amount be increased? If your circumstances do change and you
                   feel you need a higher amount of cover because you have taken on a larger mortgage
                   or started a family, find out whether you need to complete a new health check.

               • Switching and transferring policies. If you already have a life insurance policy and you
                   want to switch to a new provider, you may not need to undergo another health
                   check if your old insurer assessed your health within the last five years. Also make
                   sure you cancel your old insurance policy only after your new policy has been
                   accepted.

               Sometimes term life insurance is taken out when someone is diagnosed with a terminal
               illness and is likely to die within 12 months or a similarly short period of time. Policies
               can help to pay for funeral expenses, secure a business or help to cover mortgage
               payments and other bills. Companies will generally not offer term insurance to an
               applicant of more than 80 years of age. Furthermore, suicide would almost certainly not
               be covered under a term life insurance policy, although accidental death would result in
               an immediate payout.




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6.1            TERM LIFE INSURANCE INSIDE SUPERANNUATION

               Over the past few years, the Life Insurance industry has seen an increase in term life
               insurance (death benefits) being written within superannuation as more people have
               recognised the attractiveness of funding life insurance premiums via superannuation.



PRO'S OF HAVING TERM LIFE INSURANCE INSIDE SUPER

               Premium affordability is often the key motivator that attracts individuals to place their
               term insurance via superannuation. Premiums can be paid from existing superannuation
               savings, non-concessional (undeducted) contributions, salary sacrifice arrangements in
               the case of employees, or tax-deductible contributions by the self-employed
               (concessional contributions). This allows term life insurance to be put in place with little
               if any impact on a member’s cash flow. In particular circumstances, the government can
               also assist with the payment of premiums through various concessions, such as
               government co-contributions for low-income earners, along with spouse contributions.
               These incentives are not available when purchasing insurance outside of the
               superannuation environment. Superannuation fund trustees may claim a tax deduction
               when they pay life insurance premiums that provide death benefits.



CON'S OF TERM LIFE INSURANCE INSIDE SUPER

               With the impact of the Global Financial Crisis (GFC) still being felt, many people are
               focusing their attentions on using their superannuation contributions to rebuild their
               nest egg. Every dollar that is used to pay for term life insurance inside superannuation is
               one less dollar that can be used to invest in a concessionally taxed investment
               environment (taxed at a maximum rate of 15% inside super, versus a maximum rate of
               46.5% outside super).

               Affordability is just one part of the term life insurance inside super decision. Two other
               issues involve who is entitled to receive the death benefit, and how much of the benefit
               is eroded due to taxation.




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WHO IS ENTITLED TO YOUR DEATH BENEFIT WHEN TERM LIFE INSURANCE IS
INSIDE SUPER?

               The following individuals are entitled to receive the benefit under the SIS Act: members
               may nominate in any proportion they deem appropriate their legal personal
               representative, spouse (legal, de-facto, same-sex), child (stepchild, adopted, ex-nuptial
               child of any age), part of an interdependency relationship, or any person who is
               financially dependent at time of death.

               The only problem is that if the nomination is not correct, then the trustee of the super
               fund determines who receives the death benefit. There are three types of nominations.
               With a non-binding nomination, a trustee may consider a member’s nomination, but the
               trustee still has ultimate discretion. A binding nomination remains in force for three
               years from date of signing, but it must be witnessed by two independent witnesses and
               the percentage of benefits paid to the beneficiaries must be clearly specified, if the
               nomination does not comply, then any payments are subject to trustee discretion. Non-
               lapsing death benefit nomination is a binding death benefit nomination that does not
               lapse, remains in force until amended or revoked, but needs to be diligently monitored.



TAXATION OF DEATH BENEFITS INSIDE SUPER

               When a lump sum death benefit is paid from a superannuation fund to the member, it is
               necessary to understand that there may be a tax liability. The amount of tax depends
               upon the age of the member, service period start date, and date of death, and who the
               beneficiary is. It should be noted that taxation dependants are different to
               superannuation dependants. Under taxation law, children over 18 are non-dependants
               unless financially dependent or can demonstrate an interdependency relationship.

               The following examples are taken from Comminsure. The examples provided are based
               on tax calculations which are beyond the scope of this course. The purpose of providing
               these examples is to highlight the impact of tax on death benefits inside super.

               Example 1

               John, 51, is a doctor. He has $500,000 death cover plus $200,000 in asset balance (all
               taxable component). John dies of a heart attack at age 51 years, and his wife, Helen (age




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               49), lodges a death claim. She receives a tax free lump sum death benefit of $700,000.
               This is a great result for the grieving widow.

               Example 2

               John, 51, is a doctor. He has $500,000 death cover plus $200,000 in asset balance (all
               taxable component). John dies of a heart attack at age 51 years. John’s wife
               predeceased John (he is a widower), and nominated his nondependent son, Frank aged
               26), to receive the entire superannuation payout. Frank can only receive the death
               benefits as a lump sum, but how is it taxed?

               CALCULATE THE TAX FREE ELEMENT*
               $700,000 x (5,112/12,784) = $279,912.39

               $279,912.39 x 31.5% = $88,172.40

               CALCULATE THE TAXED ELEMENT
               $700,000 - $279,912.39 = $420,087.61

               $420,087.61 x 16.5% = $69,314.46

               Total tax paid = $69,314.46 + $88,172.40 = $157,486.86

               Net death benefit = $700,000 - $157,486.86 = $542,513.14

               If the term life insurance premium paid on this policy was $2,000 per annum, and the
               tax deduction at the highest marginal tax rate was 46.5% (or $930), then the client
               would have had to pay premiums for over 160 years for the tax savings from the
               premium payments to be greater than the tax liability when the benefits are paid!

               Example 3

               Same as above, but John owns a Personal Insurance policy outside superannuation.
               Whether he nominates his wife, Helen, or his son, Frank (or a combination of the two),
               the entire death benefit will be paid tax free.

               Pro tip

               Although tax deductibility of premiums within superannuation is attractive, it hides a
               sting in the tail – taxation of death benefits to non-dependants. Advisers should
               carefully consider all of the advantages and disadvantages when determining if term
               insurance is placed inside or outside superannuation.




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TERM INSURANCE ADD-ONS

               Some policies may include other features with term life insurance, such as total and
               permanent disability (TPD) cover or trauma insurance, but usually these will increase the
               premium. Term life insurance is a very competitive area, with dozens of companies
               contending to provide cover.

               Anyone with dependants and/or debts should consider life insurance, as a lump sum
               payout that could allow the family to continue a reasonable standard of living. If clients
               are thinking about taking out life insurance, it’s best to assess what their situation is,
               paying particular attention to their financial responsibilities and other parties reliant on
               them. If they have a young family, for example, and you don’t think they can afford
               premiums on a full term life insurance, a better option may be to protect themselves
               over a ten or 20 year term in the first instance so that you safeguard the immediate
               crucial period.




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7.0               TOTAL AND PERMANENT DISABILITY INSURANCE

                  Term life policies usually have an option for inclusion of total and permanent disability
                  insurance (TPD). TPD insurance, as the name suggests, provides cover when the insured
                  is both totally disabled and permanently disabled. The cover pays a pre-agreed lump
                  sum benefit to the policy holder which is generally the insured4. The lump sum benefit
                  paid is often used to eliminate debts, pay for medical expenses or fund permanent
                  lifestyle changes. For example, moving to a home or making changes to an existing
                  home to ensure it is more accessible given the disability. Generally, the permanence of
                  the disablement must be verified by at least two doctors and the insurer.

                  Premiums on TPD insurance are generally not tax deductible, and the benefits received
                  do not form part of assessable income.



DEFINITION OF TOTAL AND PERMANENT DISABILITY

                  The definition of what a ‘total and permanent disability’ is will vary depending on the
                  particular product and insurance policy. Most companies allow you to choose whether
                  you want coverage against:

                   being unlikely to be able to work again in your 'own occupation’ following an illness
                      or injury or,
                   being unlikely to be able to work again in 'any occupation’ following an illness or
                      injury.

                  For example, if a chef injures her hands badly in an accident and cannot cook, she may
                  receive a payout under an ‘own occupation’ definition as she’s unlikely ever to work
                  again as a chef. However, she might not receive a payout under an ‘any occupation’
                  definition as she can still work in a consultative manner as a chef based on her
                  education, training and experience.




4
    It is important to note that policy holders don’t have to be the insured, but they often are. This issue is covered in more
detail in the section under ‘insurable interest’ later in the module.




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               TPD cover provides payment of the sum insured should you become totally
               incapacitated through injury or illness, and the policy's definition of TPD is satisfied. The
               main condition of TPD insurance is that the insured is unable to return to work.

               Generally there are three TPD occupational definitions available from which to select
               cover:

               • Standard unable to perform the duties of any occupation for which you are
                   reasonably suited by reason of education, training or experience.

               • Own Occupation unable to perform the duties of their own occupation (generally
                   available to certain white collar professional lives only and incur a 50% loading on
                   premiums).

               • Homemaker unable to perform full time unpaid domestic duties.

               In addition most TPD policies will also offer a 'Loss of limbs and/or sight' disablement
               definition. Under this definition the life insured is entitled to a TPD benefit if they suffer
               one of the following:

               • permanent loss of use of both arms; or

               • permanent loss of use of both legs; or

               • permanent and total loss of sight in both eyes; or

               • a combined loss of one limb and sight in one eyes

               TPD cover normally ceases at age 65 but many insurers are now extending cover beyond
               this age, where the benefit is paid when the insured is totally and irreversibly unable to
               perform a specified number of 'activities of daily living' such as:

               • bathing and showering

               • dressing and undressing

               • eating and drinking

               • using a toilet to maintain personal hygiene,

               • moving from place to place by walking, wheelchair, or with assistance of a walking
                   aid.




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HOW MUCH TPD INSURANCE IS NECESSARY?

               How much TPD insurance is required depends largely on your client’s personal situation.
               The right amount of cover means that, in the event of serious illness or injury, there will
               be sufficient funds available to:

                  Pay off the mortgage and other debts

                  Make home modifications or pay for rehabilitation

                  Pay for nursing or other medical care

                  Meet ongoing household expenses

                  Pay for your children’s education.



               TPD insurance is usually sold as a 'rider' (additional benefit) in addition to a term
               insurance policy.



TPD INSURANCE BUY BACK OPTIONS

               When establishing term life insurance and TPD insurance it is necessary to decide
               whether to take out cover as linked policies, or as stand alone policies. As a stand alone
               policy if there is a claim on one insurance the other insurances are not affected,
               however when linked cover is established you need to take into consideration the
               following:

                With linked cover the claim for one insurance will usually reduce the other insurance
                   cover that carries forward. For example suppose you have $500,000 life insurance
                   and $300,000 TPD insurance, and you make a claim on the TPD Insurance. After the
                   claim, your life insurance will be reduced to $200,000 to reflect the claim that has
                   been made. This is if the cover is linked.

                Stand alone cover might provide the ability to claim on different covers without
                   affecting others, however the premiums with stand alone cover will be higher.

               A buy back for TPD insurance can be offered as standard by some companies, and others
               will offer it as an addition that will increase the premium. The TPD buy-back option is an
               added benefit that can be purchased under a linked term life and TPD policy. After you
               have been paid a claim under your Total and Permanent Disablement policy this gives



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               you the option to buy back the amount that has been deducted from your life benefit.
               You have the option to exercise the TPD Buy-back twelve months after your claim was
               paid.

               TPD buy-back options are not available if the TPD is standalone or linked under a trauma
               benefit. It has to be linked to a term life insurance policy.

               In the above example where TPD insurance is taken out as a linked policy with term life
               insurance, you may be able to buy-back the $200,000 claimed. Generally after 12
               months you can reinstate the term life insurance back up to the original amount - in this
               example $500,000 of cover. You are unlikely to be able to claim TPD insurance for a
               second time, but if you die, the policy holder would receive the full $500,000.




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8.0            INCOME PROTECTION INSURANCE

               This form of insurance is not an insurance which is paid on death like term insurance.
               This form of insurance is paid when a person is unable to continue in their work for a
               lengthy period of time due to some form of disability, injury, physical illness or mental
               illness.

               The income protection benefit can be up to a maximum of 75% of the earned income of
               the insured and is generally paid monthly.

               It is important to consider what the costs are of meeting a mortgage and other debts;
               providing for a spouse, children or other dependents; and maintaining assets and
               investments. The point of income protection insurance is to provide an income stream if
               you can no longer work.

               Premiums on income protection insurance are tax deductible, and the benefits received
               form part of assessable income.

               Most income protection policies are flexible and can be tailored to suit your personal
               circumstances allowing the policy owner to tailor their insurance needs to their existing
               benefits, such as any employer sick leave or long service leave entitlements.

               Tailoring an applicant’s needs means they can generally choose:

               • A ‘waiting period’ between fourteen days and two years. This is the time between
                   you becoming disabled, injured or sick and receiving your first income protection
                   payment. A shorter waiting period usually means a higher premium.

               • A ‘benefit period’ of two or five years, or up to age 65. This is the period during which
                   you receive your income protection payments.

               • How much income protection insurance you require, although the maximum is
                   generally 75% of your gross income.

               • An 'agreed value' contract or an 'indemnity' contract.

               There are two types of income protection insurance: indemnity and agreed value.
               Indemnity policies can be provided by superannuation funds and premiums are
               deducted straight from the member’s account.




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AGREED VALUE INSURANCE

               Agreed value insurance policies are the most expensive option, pays out the benefit
               agreed to reflect your income at the start of your policy, and is not affected by any
               fluctuations in income.



INDEMNITY VALUE POLICIES

               Indemnity value policies, which are more common and less expensive, verify your
               income at the time of making a claim and may adjust your benefit accordingly. This can
               be an issue if your salary fluctuates, for example if you have taken maternity leave,
               worked part time or become unemployed.

               Policies provided through superannuation funds are the cheapest option, are indemnity
               value-based, and offer fewer features and less flexibility.

               Agreed value vs Indemnity policies

               There are benefits to each type of policy. Agreed value, which will cover you regardless
               of employment status, is particularly useful for self-employed people but it is more
               expensive. For those who have a reliable, regular income, an indemnity policy may
               suffice.



HOLDING IP COVER INSIDE OR OUTSIDE OF SUPERANNUATION

               Some superannuation funds offer IP as default cover and automatically accept
               applications without medical checks - and offer a choice for those who would otherwise
               not be covered. While this is good for some, often these ‘group’ policy definitions are
               not as robust as the definitions contained in personal insurance policies. When we use
               the word ‘robust’, we are referring to the scope of what is covered as an insurable
               event, and what is not. A more ‘robust’ policy definition would be easier to satisfy and
               hence receive a benefit pay under the contract. Personal insurance policies (in contrast
               to group policies often offered by super funds) can afford to cover more insurable
               events because they individually underwrite each ‘insured person’ one by one. This
               means they understand the risk intimately and therefore can price the premium and
               offer a broader definition in the insurance contract. It is important to distinguish




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               between personal insurance policies that can be held within superannuation, and
               ‘group’ superannuation insurance policies, they are two different things. A person may
               choose to hold a personal IP policy with robust definitions etc through superannuation,
               and get the premiums paid from the superannuation fund. The reason why a person
               may want to get the premiums paid from superannuation rather than from their
               personally bank account, is generally due to cash flow constraints which are a common
               problem for many people.



TAX ON IP POLICIES

               It is important to be aware IP policies if held personally, are tax deductible at the
               insured’s marginal tax rate. Similarly, the benefit payment is assessable much like
               income in the hands of the insured. If held via superannuation, the premiums are tax
               deductible to the superannuation fund (not the individual) but the benefit payments are
               assessable at the insured’s marginal tax rate. For people that are on the top marginal tax
               bracket, it may be more advantageous to hold an IP personally to claim a tax deduction
               at the 46.5% rate than holding it through superannuation and effectively receiving a tax
               deduction at only 15% which is the tax rate applied to superannuation earnings.



WHAT IS THE COST OF INCOME PROTECTION INSURANCE?

               Premiums are set depending on:

               • Age (premiums may increase or cover decrease as you get older)

               • Gender

               • Health and pre-existing conditions

               • Whether or not you smoke

               • Occupation (for example, a manual labourer pays different premiums to an office
                   worker)

               • The time you choose to wait before receiving payment.




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STEPPED OR LEVEL PREMIUMS?

               You can pay for IP in stepped or level premiums.

               A stepped premium starts out cheaper, but increases over time.

               Level premiums stay constant but will vary depending on age at entry. They start out
               more expensive, but after 10 to 12 years of cover become the cheaper option. If an
               applicant plans on sticking with the same provider, a level premium is better in the long
               term, but if they like to switch providers from time to time, a stepped premium might be
               preferable.

               Things to look for in the policy

               • When taking out a policy, consider what exactly is covered; what is not covered; how
                   much will be paid after a claim; and what will the insurance premiums cost now and
                   later

               • Consider selecting a policy with index-linked premiums and cover so the cover keeps
                   up with inflation.

               • Consider a non-cancellable policy; otherwise companies may reassess your health or
                   other factors on each renewal, possibly raising your premiums or refusing to
                   continue cover.

               • Look for a policy with Guaranteed Future Insurability, a benefit that allows you to
                   increase your level of cover without further underwriting. This is important if
                   circumstances change due to such things as buying a home or having a child.

               • Offset clauses allow most insurers to reduce payouts if you have other income (for
                   example, sick pay from your employer or Centrelink benefits). Check the relevant
                   section of the policy for details.

               • With group insurance provided through super: the agreement is between the fund
                   trustee and insurer. Make sure both know who the applicant’s nominated
                   beneficiaries are.

               • Check the waiting period (how long before a payment is received, often 30 or 90
                   days) and the benefit period (for how long payments will be made — typically two
                   years or sometimes until expected retirement age).




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               • Some policies pay out if you’re unable to perform your normal occupation; others
                   only pay if you can’t perform any occupation for which you’re suited by education,
                   training or experience. Look out for policies that pay on if you're unable to perform
                   your own occupation.




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9.0            TRAUMA INSURANCE

         Trauma insurance, sometimes called crisis, critical illness or living insurance was first
         introduced into Australia in 1986. Trauma insurance pays a lump sum benefit to the policy
         owner if they are diagnosed with a serious medical condition such as heart attack, stroke,
         cancer or kidney failure. Depending on an insurer’s policy, a claim can generally be made
         after 14 days of surviving a traumatic event; however this time frame varies from company
         to company. After these conditions are met, the policy owner is paid either a lump sum or
         partial payment depending on the terms and conditions of the product disclosure statement
         (PDS), and which traumatic event has been suffered. Trauma insurance is designed to
         provide a benefit to help cover medical and rehabilitation costs, and to help with lifestyle
         and employment changes. A critical illness can be just as damaging to family finances as a
         death and more so if medical bills result from a long lasting illness. With a trauma policy, a
         person is quite likely to recover from the medical condition and get on with their life again.
         The proceeds payable under the policy may be used to pay for various recuperation costs or
         for any other purpose the policy owner may decide upon.

         Trauma insurance policies include a detailed list of medical conditions on which they will
         make payment. Thus, it is important to carefully read the exclusions and other conditions for
         the traumas covered in a policy being considered. Pre-existing conditions must be declared.
         Conditions caused by intentional self inflicted injury are usually excluded.



HOW TRAUMA INSURANCE BENEFITS YOU

         The lump sum proceeds from a Trauma insurance policy can help pay for a number of things,
         including:

                  modifications to the home, for example in the event of disability where ramps or lifts
                   may need to be built for ease of access
                  specialist medical attention, whether within Australia or overseas
                  repayment of debts, such as a mortgage, personal loans, credit card bills and living
                   expenses
                  provision of a buffer for you and your family should you require your partner to take
                   some time off to care for you and/or children while you are recovering from the
                   medical condition.




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WHO SHOULD CONSIDER TRAUMA INSURANCE?

               Trauma insurance is suitable for all people and all ages not just married couples with
               children. Trauma cover is most important for people who are in a high risk age category
               or have a debt that needs to be serviced. Some of these people include:

               • single individuals who are unable to rely on anyone else for financial help

               • homemakers that perform a housekeeping role and/or look after the children & have
                   no protection against the implications of a traumatic event happening to them

               • older individuals who are more likely to suffer from a traumatic event

               • self-employed or business owners who do not have a cash reserve should they need
                   to take extended time off to recover from a critical illness

               • those who have families or financial dependents



THE STATISTICS ARE SCARY!

               Cancer in Australia

               • An estimated 114,000 new cases of cancer were diagnosed in Australia in 2010.

               • 1 in 2 Australians will be diagnosed with cancer by the age of 85.

               • Cancer is a leading cause of death in Australia – more than 43,000 people are
                   estimated to have died from cancer in 2010.

               • Nearly 15,000 more people die each year from cancer than 30 years ago, this is due
                   mainly to population growth and aging. However, the death rate (number of deaths
                   per 100,000 people ) has fallen by 16%.

               • More than 60% of cancer patients will survive more than five years after diagnosis.

               • The survival rate for many common cancers has increased by 30 per cent in the past
                   two decades.

               • The most common cancers in Australia (excluding non-melanoma skin cancer) are
                   prostate, colorectal (bowel), breast, melanoma and lung cancer

               • 1 in 3 men and 1 in 4 women will suffer from cancer in their lifetime. Half of those
                   will live more than 5 years after diagnosis.




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               • Each day about 32 men learn the news that they have prostate cancer – tragically
                   one man every three hours will lose his battle against this insidious disease.

               • Both men and women are at risk of developing bowel cancer. In Australia, the
                   lifetime risk of developing bowel cancer before the age of 75 years is around 1 in 19
                   for men and 1 in 28 for women. This is one of the highest rates of bowel cancer in the
                   world.

               Source: Cancer Council Australia


               Cardiovascular disease (Heart attack, stroke, blood vessel disease)

               • kills one Australian nearly every 11 minutes

               • affects more than 3.4 million Australians

               • prevents 1.4 million people from living a full life because of disability caused by the
                   disease

               • affects one in five Australians, and affects two out of three families

               • claimed the lives of almost 48,500 Australians (34% of all deaths) in 2008 - deaths
                   that are largely preventable.

               • Cardiovascular disease (CVD) is one of Australia's largest health problems. Despite
                   improvements over the last few decades, the health and economic burden of CVD
                   exceeds that of any other disease.

               Where do Trauma claims come from?

               In 2008, there was over $334 million dollars paid out it Trauma Insurance claims.




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Source: Securitor



TRAUMA INSURANCE AND ‘BUY-BACK OPTIONS’

               When taking out trauma cover, you may want to combine this benefit with a life
               insurance benefit. This type of life insurance policy is called a bundled or rider policy. It
               offers a cheaper premium however it only pays out for either the life insurance or
               trauma insurance event, basically whichever occurs first. The buy-back option on a
               trauma insurance policy may be beneficial, particularly for those people who need the
               extra level of cover. The buy-back option allows you to re-purchase the death cover
               component once there has been a full trauma insurance payout. So a buy-back option
               can offer additional protection should you have to make a claim in the future and you
               know you will still need a level of life insurance should you then pass away.



WAITING PERIODS APPLY

               In most cases "accidental" types of traumas are covered immediately, although many
               insurers impose a waiting period (commonly 90 days after the policy is accepted) for
               certain illnesses eg cancer, stroke, heart attack. This is particularly important when
               changing or replacing policies as you may not be covered during the waiting period on
               the new policy for certain conditions.



INSURABLE INTEREST

               Many people are puzzled to find out that they can own a life insurance policy or other
               personal insurance policy (TPD, trauma etc) not only in relation to themselves, but also
               on someone else. That means they are able to receive a payout directly from someone
               else’s death, disablement or traumatic event for example. Some find this a little
               disconcerting for obvious reasons. However, it is not as simple as that. It is true that you
               can own a personal insurance policy on another person, but firstly, you must be able to
               establish something called ‘insurable interest’ in that person.

               A basic principle of insurance law is that the insurance policy does not cover any
               property or ‘people’ in which the insured has no insurable interest. An interest can be
               established where it can be shown a sufficient connection exists between the policy




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               owner, and the insured person or property in question. The policy owner must be able
               to demonstrate a financial loss as a result of an insured event occurring in relation to the
               insured person or property.

               This prevents policy owners gambling on the risks of loss by others and turning
               insurance underwriting into a casino for gamblers. Without an insurable interest, the
               underwriter also has no assurance that the policy holder or insured will use any efforts
               to protect and preserve the insured property or a person’s health.



KEY PERSON INSURANCE

               A common situation where an insurable interest is easily established is key person
               insurance. Key Person Insurance (also called Key Man Insurance) is a life insurance on a
               key employee, partner or owner on whom the continued successful operation of a
               business depends. For personal life insurance, usually a family member is the
               beneficiary, but in the case of Key Person Insurance, the business is the beneficiary
               under the policy.

               Key person insurance is simply life insurance, TPD insurance or trauma insurance on a
               key person in a business. It may include:

               • For large companies an executive, principal shareholder, a senior scientist, or a
                   particularly effective salesperson.

               • In a small business, an owner, the founders/partners or perhaps one or more key
                   employee/s.

               How key person insurance works

               A company purchases a life insurance policy on its key employee(s), pays the premiums
               and is the beneficiary of the policy. If that person unexpectedly dies, the company
               receives the insurance payout. The reason this coverage is important is because the
               death of a key person in a small company can cause the immediate death of that
               company. The purpose of key person insurance is to help the company survive the
               financial cost of losing the person who makes the business work or is imperative to the
               business’s ongoing success.

               The company can use the insurance proceeds:

               • for expenses until it can find a replacement person,




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               • in smaller companies partners can use the money to purchase the shares in the
                   business from the family of the deceased,

               • pay off debts, distribute money to investors, pay severance to employees and close
                   the business down in an orderly manner.

               In a tragic situation, key person insurance gives the company some options other than
               immediate bankruptcy.

               Insurable interest between spouses and children

               Remember a much more common situation where an insurable interest can be
               established is between spouses or between parent and child. In such situations, it is
               quite obvious that a financial impact would be felt if a spouse (or child) died, was unable
               to work or suffered a traumatic event. In this instance, the policy holder may be one
               spouse and the insured may be the other spouse (or child). There may be a variety of
               reasons why it makes sense to structure policies in such a way. Whilst we discuss estate
               planning in detail in a subsequent module in the Advanced Diploma of Financial
               Planning, it is important to cover estate planning issues very briefly here.

               It is important to know that life insurance payouts fall outside of a will. This means that
               sometimes, as part of an overall estate plan, and particularly where blended families are
               involved, people may provide life insurance ownership to a child or new spouse as an
               interim measure before readdressing their own will in a much more comprehensive
               way. This ensures that whilst the will may not provide for a new partner, spouse (or
               child of a new partner or spouse), insurance can be put in place to ensure surviving
               partners or spouses (or their children) can be looked after financially.




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10.0           HEALTH INSURANCE

               The government Medicare system provides universal basic public hospital and medical
               cover to:

               • all Australian residents

               • non-residents who have legitimate reasons for being in Australia for more than six
                   months

               • visitors who are citizens of countries with which Australia has a reciprocal health
                   agreement.

               Medicare is funded by taxpayers through a special levy and via the general tax system.
               All taxpayers, except those on low incomes, pay a levy of 1.5% on their taxable income.
               Singles who earn more than $84,000 (in the 2012-2013 financial year) and couples and
               families with a combined taxable income of more than $168,000, pay an additional
               surcharge of between 1% and 1.5% depending on their income level if they do not have
               private health cover. Private health insurance is not tax deductible.

               In an attempt to encourage more people to take out private health insurance cover, the
               government introduced a number of initiatives, including the Federal Government's
               introduction, on 1 January 1999, of a 30% rebate on private health insurance regardless
               of the insured's income level. That rebate for 2012/2013 is now income tested and
               depends on a person’s age and income level.

               The Federal Government has also introduced Lifetime Health Cover which started on 1
               July 2000. Specifically, Lifetime Health Cover is designed to encourage people to join a
               private health fund at a younger age and to reward people who maintain continuous
               hospital insurance cover throughout their lives. Under Lifetime Health Cover, different
               premiums will be charged based on the age of the people taking out hospital over. From
               1 July 2000, people who joined a health fund before they are 30, and who keep their
               membership, will pay lower premiums than people who delay joining until they are
               older. People over the age of 30 years pay a 2% loading on top of the base rate
               premium for each year they delay joining a private health fund.




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11.0           APPLICATION OF LIFE INSURANCE

               No one expects sudden death, accident or illness despite the statistics. Maybe it is part
               of our survival mechanism to be positive and assume that we will not be afflicted with
               illness or worse death at an early age. However if we look at the diagram below, it is
               clear that a large proportion of the population are afflicted.




               Source MLC

               In the case of death, accident or illness, insurance can help protect the financial security
               of families. Insurance can protect income, repay debts, and provide for dependants.

               In this section we will consider several scenarios where insurance can make a huge
               difference to both the financial as well as the emotional well-being of family members.



ELIMINATING DEBT ON DEATH OR DISABILITY

Case study

               Karen and Peter have three children. Karen is a homemaker and Peter earns $80,000
               p.a. Their home is valued at $620,000, they currently have debts totalling $240,000 and
               the repayments are $2,152 per month.



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               In the event of Peter’s death or permanent disability, Karen would need to fund monthly
               repayments. Her options to meet these repayments include:

                        Return to full time employment

                        Rely on Government assistance

                        Sell the family home to repay loan

               If Karen and Peter had taken out insurance, Karen could clear the outstanding loans and
               ideally she would receive a provision for on-going living expenses.

               Insurance providing a lump sum upon death, total and permanent disability, or for
               critical illness can be used to eliminate debts so the full value of assets can be passed on
               to dependants. After eliminating any debts, the balance could be invested to provide
               an income stream.

               How does this work?

               Karen & Peter have the following financial commitments:




         Commitments                          Amount          Frequency      Annual amount

         Groceries                            $1,000          Monthly        $12,000

         Household expenses                   $4,250          Quarterly      $17,000

         Medical/Dental                       $1,200          Annual         $1,200

         Other living expenses
                                              $150            Weekly         $7,800
         (clothing & entertainment)

         Total                                                               $38,000



               Peter expects to work for the next 25 years and to continue to support his family for at
               least 18 years. Peter decides to take out life and TPD insurance with a cover of
               $400,000.

               (This is in addition to insurance taken out for $240,000 to cover existing debts).




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               Should Peter die or become permanently disabled an insurance claim of $400,000 would
               be available to his family to be reinvested. This would provide an income stream of
               $38,000 p.a. over 18 years.

              Pro Tips
                  When determining a lump sum requirement, it is important to accurately calculate
                   financial commitments
                  Provisions should be considered for expenses that may be incurred at the time of
                   death or disability
                  All those whose death or disability would have a serious financial impact on the
                   family need to be insured
                  Insurance that allows you to automatically increase your cover in line with inflation
                   (CPI) should be considered
                  Insurance cover can be reduced over time as circumstances change
                  Make sure you protect the homemaker
                  It is important to take out insurance for the homemaker in case of death or disability
                  An insurance payment should cover the cost of home help and child-care services
                   and / or lost wages if the breadwinner reduces their working hours
                  Insurance can also cover medical expenses and/or funeral costs.




Case study

               Neil has two children, Mandy and Ben, under the age of five. Jill, his wife, was the
               homemaker. She was diagnosed with breast cancer and died within 6 months. Neil is
               faced with extra expenses to raise his children and run the household.



         Commitments            Amount p.a.                  No of years                  Total amount

         Full time child        $17,500                      1 (includes time when Jill   $17,500
         care for Mandy         ($70 per day for 50 weeks)   receives treatment)


         Full time child        $17,500                      3 (includes time when Jill   $52,500
         care for Ben           ($70 per day for 50 weeks)   receives treatment)




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         Commitments            Amount p.a.                    No of years                Total amount

         Home help (part        $7,500                         11 years                   $82,500
         –time cooking          ($150 per week for 50 weeks)

         and cleaning)

         After school care      $6,000                         10                         $60,000
         for children           ($150 per week for 40 weeks)


         School holiday         $6,400                         9 (10 years for Mandy, 8   $57,600
         care                   (8 weeks at $400 per child)    years for Ben)


         Total                                                                            $270,100




                A combination of life and critical illness insurances could have provided Jill’s family with
                a lump sum to be invested to pay for the additional expenses over the years.

                Pro Tips

                  Insurances for a non-working spouse may have tax advantages if taken through a
                   super fund
                  A homemaker’s insurance can be owned by a working partner, thus ensuring
                   complete control over the benefits received
                  It may be possible to insure a couple under one policy




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