Monday 24 August 2015
The real costs of underinsurance
Monday 24 August 2015
The impacts and associated costs of underinsurance and ways to close the gap
The phenomenon of underinsurance can have a devastating effect on any person who experiences a serious illness or injury. It also represents a serious financial drain on government and society at all levels.
What is underinsurance?
Underinsurance is inadequate insurance coverage. A policy holder is said to be underinsured if, when they make a claim, they experience financial loss due to the claim amount exceeding the maximum payout stipulated under the policy.
Some people deliberately underinsure as a strategy to lower their premiums. This is usually, however, a false economy.
You can calculate whether a person is underinsured simply by comparing the amount they would likely be paid, in the event of a claim, with their estimated long-term expenses.
If, for example, a family's sole income-earner has a $750,000 life insurance policy, this may appear to be adequate cover. But that may only be true if the person's annual income is $50,000 and if this figure satisfactorily supports the family's current living standards. In such a case, a full insurance claim payout could potentially support the family for 15 years or even more (if the lump sum is invested to generate an ongoing income stream).
On the other hand, if the family requires an annual income of $250,000 to maintain their standard of living, the person is significantly underinsured. In this case, an insurance claim payout might support the family for three years or less.
The costs to individuals
Rice Warner, an independent provider of research and advice to the superannuation and wealth management industries, released an underinsurance research report in November 2013. The report revealed that, for a family to maintain its standard of living in full, it requires life insurance cover of 15 years' income and 15 years' equivalent of total and permanent disability (TPD) cover. At the same time, however, "the median level of life insurance cover across the working age population is 64 percent of basic life insurance needs, but only 42 percent of the amount needed to fully maintain the standard of living of remaining family members."1
The median levels of TPD and income protection cover are much lower again, says Rice Warner, at 14 per cent and 16 per cent of needs respectively.
Another report, produced by Lifewise and Natsem in February 2010, revealed that:
- one in five families are impacted by the death of a parent, a serious accident or illness that renders a parent unable to work
- the typical Australian family loses half or more of their income following a serious illness, injury or the loss of one parent as a result of underinsurance
- 95 per cent of families do not have adequate levels of insurance.2
Underinsurance can have a serious personal impact on policy holders, with many underinsured people who have serious medical conditions going back to work before they're fit to do so, or continuing to work while unwell.
Underinsured people often underestimate the costs they may still face when an income ceases, either temporarily or permanently. These include housing costs, transport costs and the costs of raising children. The same people also tend to overestimate the potential contribution of governments in a time of need. Social security benefits are generally much lower than most people imagine.
While potentially devastating for individuals, underinsurance similarly places an increased burden on society and government resources.
Figures quoted in the Rice Warner report include the following:
- the total cost to government of life underinsurance across Australia is $47 million per annum
- the total cost to the government of Total & Permanent Disability (TPD) underinsurance is $1.26 billion per annum
- the total cost to government of income protection underinsurance is $247 million per annum.3
While you can't predict the future, ensuring you have the right level of insurance does bring peace of mind and will relieve you of a financial burden in the event of a serious illness or injury.