What should you consider when determining how much insurance cover do you need?

1 July 2015

(When I talk about insurance cover in the context of this article, I’m thinking primarily of life insurance, total and permanent disability insurance, and trauma protection insurance cover.)

Calculating the level of insurance cover you need is both simpler and more complicated than it seems. Making sure you have an adequate level of insurance is one of many reasons it’s worth going to a financial adviser. 

Unfortunately, it’s an area that many advisers don’t do as well as they could. And if you were to go to three different advisers, chances are that you’ll get three different sets of recommendations regarding level of cover.

On a personal note, I recently engaged a very experienced (and otherwise excellent) adviser to provide my wife and I with advice for updating our insurance advice.

We didn’t need advice on the level of cover that was necessary. We had already done the calculations. If he had asked us whether we wanted advice on this point, then it would have saved him a lot of time. But that’s a topic for another time.

The figures he came back with were far below what I thought we needed. He was recommending that my wife reduce our levels of life, total and permanent disability, and (in my wife’s case) income protection insurance. I’m incredulous about this. 

It comes down to what the client wants and some inherent uncertainties

The amount of cover a client (or clients) need will depend on their circumstances and how they want to provide for their loved ones in the event of something unfortunate happening to them.

Because of this, two clients who are otherwise identical in objective terms (eg, same age, same relationship status and number of dependents, same income, same net asset position), might have two different amounts they want to insure for.

A specific example of why this might be the case is because one client wants to provide more to support the education for their children than the other. 

Another example is that the two clients might simply have a different view on the cost/benefit calculus associated with insurance cover; the likelihood that they will pass away; and the level of peace of mind having insurance will give them. 

There are also uncertainties relating to what might happen in the future. For example, if they suffer a traumatic health event you want to ensure that there is sufficient cover to help them with the costs associated with recovering from that event. But if you don’t know what that event will be, you are making a wild guess about what might be a suitable level of cover. 

There is an interaction between level of cover with different types of insurance

There is an interaction between the types of insurance. The level of cover for a TPD policy will generally differ from a life policy. Why? Because in the case of TPD, a client will generally have income protection and trauma insurance. If a client is eligible for TPD payments, they will almost certainly qualify for receiving income protection payments, and may very well qualify under their trauma policy as well. 

A big component for life and TPD is often how much income you want to leave for your loved ones in the event of something happening. If they are already receiving income protection payments this part of the equation will not generally be so high for TPD. 

This is another area that can get me worked up. I’ve spoken to a number of advisers who recommend clients significant levels of trauma cover, without considering what the client is likely to receive from the other types of policies they are recommending (eg income protection and TPD). (Trauma is very expensive relative to these other types of insurance.) 

The process of determining level of cover is not one of dictating to the client but eliciting from the client

The process for calculating an appropriate level of cover is a process of elicitation, and asking questions. 

Ultimately, my view is that an adviser could successfully guide a client through a series of questions and scenarios and not even advise on a figure. All they need to do is ask a client the right questions, and the client will give the adviser an answer. 

Not all people need insurance. Self insuring is a good goal to have. 

Do Bill Gates or Warren Buffet require life insurance? Of course not! If they were to pass away today, their loved ones would be fine. Likewise, if something was to happen to them, they’d have enough resources to see them through.

You don’t need their level of wealth to be able to self insure. If, after going through the exercise of working out what you’d want to leave behind or have available if something were to happen, and you look at your asset position and realised you already have that, then chances are good that you might be in a position to self insure.

At the moment I have a significant amount of personal insurance. I’m worth more dead than alive. But one of my financial goals, as boring as it might seem, is to require less insurance over time and get to a position where I can self insure.


About the author 

Sonnie Bailey

In his spare time, Sonnie likes telling people that he’s a former Olympic power walker, a lion tamer, or that he is an orthodontist. He is none of those things. In reality, Sonnie is a financial planner based in Christchurch. Through his business, Fairhaven Wealth (www.fairhavenwealth.co.nz), he provides independent, advice-only, fixed-fee financial planning services. Sonnie is a “recovering lawyer”: he has specialised in trusts and personal client work. He has also worked as a financial services lawyer for many years.

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