Trauma insurance is not a substitute for income protection insurance

Sonnie Bailey

18 June 2018

Every so often, I stumble upon an insurance adviser who waxes lyrical on trauma insurance, otherwise known as critical illness insurance.

They get really passionate about it. It seems to go beyond salesmanship – they believe in trauma insurance, at a deep and fundamental level. There’s something religious about it.

In person, it’s very compelling.

I’ll give my theory about why this is the case at the end of this article.

But first I want to point out: this is not characteristic of all insurance advisers. Most insurance advisers see trauma insurance in its proper context, as just another tool for managing a specific type of risk.

This article is meant to be antidote against those rare advisers who will go as far as recommending a really large trauma insurance policy, and not worry so much about having income protection insurance. Consider it a public service announcement.

Trauma insurance is not the most important insurance

A common refrain among the “converted” is that trauma insurance is the most important insurance to have.

But tell that to the grieving widow whose husband had a trauma policy but no life insurance.

Trauma insurance can be important. But different types of insurance manage different risks.

What determines the relative value of the different types of insurances? Your circumstances and objectives.

Reasons trauma insurance can’t substitute income protection insurance

Trauma insurance only comes into effect if you meet one of the conditions specifically defined in the policy.

If you’re unable to work because of a reason that’s not defined by the policy, and also isn’t covered by ACC, you’re effectively on your own.

Income protection insurance, on the other hand, is less focused on the reasons for being unable to be unable to work and more on the fact you can’t work.

In other words, if you’re relying on trauma insurance to protect you, you’re exposed to situations that might otherwise be captured by income protection insurance.

Unless you don’t have long to go in your working life, you would need an absurdly high level of trauma cover to support you over the long-term.

Let’s say you have $600,000 in trauma cover and you’re in your forties. If you’re unable to work for an extended period of time, but you’re not totally and permanently disabled and you’re not covered by ACC, is $600,000 going to be enough?

$600,000 will only cover a small portion of what would otherwise have been the rest of your working life. Remember, on top of this, that some of these funds are going to go towards the costs associated directly with the medical issue that resulted in you being able to make a claim.

From my perspective, being unable to work for an extended period of time is one of those catastrophic scenarios where you’ll most want/need good insurance cover.

Trauma insurance is expensive and gets relatively more expensive with time.

Unless you have “level” premiums (which I generally recommend against), trauma insurance gets more expensive, at a faster rate than income protection insurance.

Using trauma insurance to manage many different types of risks doesn’t offer much flexibility

Frankly, I’d like to see most of my clients get to a position where they can self-insure with respect to the specific risks of being diagnosed with an illness, making it unnecessary for them to have trauma insurance.

For most people, trauma insurance should be one of the first personal insurances they should be able to self-insure against.

Income protection insurance will generally be necessary for a longer period of time, but people can take steps such as extending the waiting period and perhaps even the level of cover, to reduce premiums as their financial position improves.

If you’re relying on trauma insurance to manage these same risks, you’re removing a whole lot of flexibility in relation to adjusting your insurance arrangements and making your premiums more affordable as your circumstances change.

Trauma insurance and the hero complex

Trauma insurance can be appealing to insurance advisers because it can be a nice feeling to help a client get a lump sum of, say, $200,000 of $600,000 after they’ve been diagnosed with a condition under the policy.

It can make them look like a hero. And for anyone, that experience can be formative.

In a lot of cases – for example, when the client meets the minimum definition of a standard item under the policy but their life isn’t hugely impacted and they return to work pretty quickly – the client might not strictly need the full amount, so they essentially end up with a large windfall.

This can be great if you’re a client. But ultimately: do you get insurance and pay premiums for windfall benefits (like a lottery) or do you get insurance to manage risks?

Don’t get me wrong: Trauma insurance is valuable!

Trauma is a valuable type of insurance, but my view is that it’s best for addressing the costs associated with the specific diagnosis. These may include medical costs that are not covered by the public system or your health insurance (if you have health insurance); travel for you and loved ones; and to perhaps provide a buffer to enable you or your partner to take additional time off work and focus on recovery rather than having to worry as much about money.

Income protection and trauma insurance can complement each other. For example, if you’re unable to work, income protection insurance covers your lost income. Trauma insurance provides cover in relation to the costs associated with the diagnosis.

A disclaimer

Of course, my comments are general in nature only and I urge you to seek advice when arranging insurance. There will always be situations where general statements break down. I have at least one client for whom income protection insurance wasn’t suitable, but it was appropriate for them to retain their trauma insurance. But for the vast majority of people, my above comments apply.

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