How does life insurance work?

Are you unclear about exactly how life insurance works? You're not alone.

Did you know life insurance refers to a category of insurance as well as a specific product? No wonder some Australians find the topic of life insurance confusing! Sorting out life insurance can seem tricky, but it doesn't have to be. We’re here to help demystify life insurance so you can gain a deeper understanding and make protection choices that are right for you and your loved ones.

What is the purpose of life insurance?

In a nutshell, life insurance allows you to proactively protect yourself and your family against the financial impacts of your death, serious illness, injury or other loss of earning capacity.

If there are people in your life who depend on your income – including you, your partner, your children and any other dependents such as aged parents or other relatives – life insurance can mean the difference between their continued financial security and sudden financial hardship.

What does life insurance cover?

There are actually different types of life insurance, each of which protects you and/or your family in different ways.

The type properly known as life insurance (also known as term life insurance or death insurance) provides a lump-sum payment to your dependents in the event of your death or, in some cases, on diagnosis of a terminal illness.
Critical-illness insurance (also known as trauma insurance) covers the financial impacts of certain serious medical conditions – which are defined and covered differently by different policies.
Income protection insurance (also known as salary-continuance insurance) replaces a proportion of your regular income if you become temporarily unable to work due to an injury or illness. Insured events, waiting periods, amounts paid and maximum coverage periods (also known as the benefit period), all vary between policies.
Total and permanent disability (TPD) insurance supports you if you become permanently unable to work due to an injury or illness.
Funeral insurance covers the often significant costs relating to your funeral, and can also be used to cover any unpaid debts or bills you leave behind.

Who needs life insurance?

If you have financial dependents, a mortgage to pay off or debts to clear, holding a life insurance policy can be a worthwhile part of your financial protection plans. You may think you're too young for life insurance or that life insurance costs too much, but when you think about the real cost of not having it, you may find it's something you don't want to do without.

How much does life insurance cost?

The cost of life insurance in Australia is determined by your health, whether you're a smoker, age, occupation, and the amount of cover you want. Usually life cover costs more for men. One way you can reduce your premiums is to quit smoking. Also, if you no longer have children as dependants, you may not need the amount of life cover you initially took out. If you feel you are paying too much, you should consider shopping around to see if you can get a better deal.

For income protection, the insurer calculates your premium based on a number of factors such as your age, gender, whether you’re a smoker, and your occupation. If your job is a physical one, your premium is likely to be higher as your insurer will view you as being more at risk of injury. Women also tend to pay more for income protection insurance.

You can reduce your premium by choosing a longer waiting period, which is the amount of time you’re prepared to wait before you become eligible for payment.

Also premiums paid directly by you, rather Income Protection cover provided through your super fund, can be tax deductible.

Can I get life insurance as a couple?

Yes, some insurers do allow you to have a joint or 'multi-life' policy. It's usually taken out by spouses or partners, and allows for different amounts of cover for each partner. Generally, insurers will require you to nominate your partner or spouse as the beneficiary.

How does life insurance pay out?

Depending on your type of policy, your family might receive a lump-sum payment once they've submitted a valid claim on your policy. Refer to the Product Disclosure Statement (PDS) for details.

Some policies will pay out a small amount immediately to cover your funeral and other urgent costs, before paying the balance once the claim has been fully processed.

Which type and amount of life insurance is right for me?

This will depend on your circumstances, but in general the aim of life insurance is to ensure your family could maintain their current lifestyle if your income were to stop coming in or you were no longer there.

To determine what type and amount of cover you might need, consider the following questions.

What is your current income?
Who currently relies on that income?
What potential events do you want to protect them from?
What debts do you have, including mortgages, other loans and credit cards?
What ongoing living expenses do you have, including school fees and other regular bills?
What savings do you have that could be used to cover some of these expenses?
What assets do you have that could be sold to cover some of these expenses?
What other insurance policies do you already have (including through super) that would cover some of these expenses?