Insurance has become expensive over the last few years – prohibitively expensive for some. This article gives tips to lower the cost of insurance so that, hopefully, it becomes more affordable and doesn’t eat into your retirement funding.
Quick Links
Get only as much as you need
Increase your waiting period
Pay your premium annually
Consider whether to insure under the same policy
Replacing part of your IP with TPD
Consider moving from level to stepped premiums
Avoid adviser commissions
1. Get only as much as you need
Get as much insurance as is suitable and no more. This is because while insurance is based on pooling funds to make payouts to those who claim, there are additional costs that don’t go to the payouts, which are the insurance company’s administration costs and profits to shareholders.
As a result, for every dollar put in, less than a dollar goes towards payouts. So overall, insurance is a financial loss-making position.
But for anything you are unable to bear the risk of and unable to self-insure, insurance is an absolute necessity.
The lesson is:
- Don’t underinsure. Insurance is there to cover a need that you cannot cover yourself.
- Don’t overinsure. You could put in some leeway if you put down a range of what you might need and use the upper end of the range, but beyond that, be aware there is a cost to over-insuring or insuring things that you can easily afford to self-insure.
For instance, trauma insurance is quite expensive, and you may not need to be insured for large amounts in the $300-600,000 range that some advisers recommend since most illnesses covered by trauma insurance aren’t anywhere near that amount. This would mean a much lower premium than insuring for larger amounts without a good reason.
Another example is that as you age and have more wealth and less ‘human capital’ (earning capacity), there’s less to insure in terms of missed future earnings/savings capacity regarding term life & TPD insurance. So you may want to have part of your insurance as a level premium (that is, one that starts higher but does not rise with age to ensure long-term cost-effectiveness) and part as a ‘stepped’ premium (which starts cheaper but rises quickly from about middle age) which you will just cease as your total amount to insure reduces over time.
This last point also ties into whether you want your life insurance to be inflation-linked or not (i.e., if it goes up each based on inflation). If the benefit is increasing each year, so is the premium. Think carefully whether that is appropriate for your term life and TPD insurance, since often that’s the opposite of what you want. If you get ongoing financial advice, they should be adjusting this each year (but for an ongoing fee, usually hidden in commissions), but if you don’t feel the need to pay for new advice every year, consider whether having your life insurance inflation-adjusted is really suitable for you.
Another example is that a 23-year-old single person with no financial dependents or debts may have no use for term life insurance. In this case, it may be sensible to turn that off in your super if you have it. However, be aware that TPD insurance would still be essential to fund missed income and savings from what would have been the rest of your working life if not for the disability.
2. Increase your waiting period
The next tip is to have more funds that can be easily liquidated (for example, an emergency fund), which allows you to increase the waiting period on your income protection insurance before your benefit kicks in. This will lower your premium considerably. Besides your emergency fund, don’t forget to factor in sick leave, annual leave, and long service. Most income protection policies will offset a claim against any built-up sick leave, so it is important to match your waiting period to your situation.
You could potentially even have a year or two worth of expenses in the offset (either saved up or extracted via an equity release) that you don’t intend to spend, and extending your waiting period this long would lower your premiums significantly while maintaining cover for your more catastrophic risk of not being able to work for many more years.
Another option besides the offset is if you have investments you can liquidate, ideally with defensive assets, such as cash or bonds held separately from growth assets, so you can draw from your defensive assets and avoid selling growth assets during a market decline. But since you may not need to draw on it for years or decades, you may also consider your shares for such an occasion.
As you may not need to tap these funds for years or decades (or ever), the opportunity cost of not investing them a bit more aggressively might be worse than being willing to tap into those growth assets in case they are down at the time you need them. Another option is an overfunded emergency fund.
* Be aware that benefits for income protection are often paid at the end of the month in arrears, so a 3-month waiting period would get the first payment at the end of the 4th month.
3. Pay your premium annually instead of monthly
Many providers will offer you the equivalent of 1 month free if you pay annually rather than monthly (which is effectively an 8.3% tax-free discount).
If you assume your investment returns will be around 8% on average, then amortising your returns over a year of investing the difference you paid monthly would result in a loss of return of 4%. So 8.3% is way ahead. And the fact it is tax-free, unlike investment returns, makes it even better.
So call up your insurers – and this is not just for life insurances – and ask if paying annually is cheaper.
If you take this money from your investments to make the early payment, make sure you are putting more away into your investments each month above your regular savings to replace it.
4. Consider whether to insure under the same policy
You have the option to get TPD and Trauma insurance attached to your term life insurance in a combined policy. In this case, cover may be cheaper, but a claim may reduce the benefit amount on the other insurances.
Note that unlike term life, TPD and trauma insurance, income protection often will have its cover reduced when other income protection benefits are paid to ensure you are not incentivised to delay going back to work.
5. Replacing part of your IP with TPD insurance
There have been significant changes in income protection over recent years as the regulator (APRA) found that insurance companies have been bleeding money through claim payments. Insurers were also found to be subsidising income protection claims from premiums paid for other life insurances, such as term life insurance, which is paid out less frequently.
To avoid the risk that the Australian insurance industry failed and could not meet claim payments, the regulator (APRA) stepped in and laid out new requirements for insurers, which resulted in significant price increases to ensure the insurance industry was operating in a sustainable way.
These industry-wide hikes have left a lot of people disillusioned with the idea of insurance, especially those who purchased level premiums to avoid having their insurance costs increase with age but did not envision that it would still be able to rise so much.
Income protection costs were hit particularly hard, and to keep costs manageable, many advisers now put forward to their clients the option of income protection insurance with a benefit of only 2 or 5 years (rather than to 65), based on the idea that most of the time, if an income protection claim lasts longer than five years, you will fall into the definition of being totally and permanently disabled, and so they use more TPD insurance instead which is significantly cheaper.
This isn’t a perfect solution because there are some situations that don’t fall under the definition of being totally and permanently disabled but last longer than five years, but for those where the cost of insurance is too high as a result of the changes, this offers a compromise.
Make sure you understand what you are giving up by doing this, and consider speaking to an adviser. It may well be the case that increasing your waiting period (provided you have enough sick leave and liquid assets to support you through this period) could reduce your premiums enough so that you can continue to have income protection to age 65, which, in turn, would avoid having to increase TPD cover.
6. Consider moving from level to stepped premiums
We explained level vs stepped premiums previously, so have read of that if you haven’t already.
In summary, stepped premiums start off cheaper when you are younger due to the likelihood of a payout being low and then increase more once you hit about middle age as your risk of an event requiring a payout increases, and level premiums are higher at the start to guarantee they won’t increase based on your age.
However, as mentioned in the above link, if you look at projections of premiums, it can take a very long time for the cumulative higher initial cost of level premiums to become cheaper overall than using stepped premiums – often over 20 years. This also pigeonholes you to the insurer, who may not have the cheapest coverage after the time you took the premium out.
Also, while level premiums don’t increase based on age, level premiums can still increase when the insurer changes premium rates for all their level premium policies. For instance, they might need to increase premiums if they are paying more claims than they expected or if economic conditions change. This occurred significantly in 2021, 2022, and 2023, and has caused most people (policyholders and advisers) to question level premiums for the long term.
Also, the higher cost in the early years with level premiums means that advisers can also get higher commissions, so if you are using a commission-based adviser, it’s going to be impossible to know if their recommendations are really based on your best interests.
This is not to say that you should immediately jump over from level to stepped premiums, and you should consider what you may be giving up by doing so, but at the same time, you should consider whether level premiums are the most suitable solution considering the often significantly lower cost of stepped premiums for so many years.
7. Avoid adviser commissions
When you go to an adviser for insurance advice, you need to pay for the advice as well as the insurance premium. What often happens is that the adviser says you don’t need to pay any money to them, and there’s a little party in your head (and theirs!). The reason is commissions.
Here is an example of the difference with and without commissions:
Scenario 1: You pay $3,000 per year to the insurance company. $1,000 goes to your adviser, $2,000 to your insurance premium.
Scenario 2: You pay $2,000 one-time to your adviser and $2,000 a year to your insurance premium.
After 10 years:
Scenario 1: You paid $30,000 total. $20,000 towards insurance premiums and $10,000 to your adviser.
Scenario 2: You paid $22,000 total. $20,000 towards insurance premiums and $2,000 to your adviser.
The longer you have that insurance, the worse it is for you (and the better it is for them).
You can see why your adviser has a little party in their head.
The commission-based adviser also gets paid more if you spend more on insurance, which is a conflict of interest. Insurance is often oversold by commission-based advisers because it is in their interests – not yours.
Following on from this, the commission-based adviser is less likely to promote ways to reduce premiums, such as those mentioned above (paying annually, increasing your waiting period, avoiding unnecessary extras) because that reduces their own remuneration.
Commission-based advisers are financially incentivised to work in the interest of the product provider at your detriment, so you can never be sure if their advice can be trusted to be in your best interest.
What you can do
You can tell your adviser you want to make it a fee-for-service payment with no ongoing commissions. It is the adviser who selects how much commissions are added to or subtracted from your premium. In fact, some advisers state right on their website that if you want insurance advice, they do the insurance advice fee upfront and remove the commission from the insurance product. They are obviously rare.
By law, their advice must spell out how much they are paid, or they risk losing their license and livelihood. So double check it in your advice statement under the page on their fees.
Unless you are going to be insured for a short period (typically under about 4 years), it is more cost-effective to pay more upfront and explicitly tell them to remove the ongoing commissions.
If you have an existing commission-based policy and the commissions paid so far are sufficient to have paid for their advice, you would think that you could instruct the insurer to remove the adviser and your premium would fall by the amount of the commissions, but this does not seem to be the case. The closest thing to a solution to this is if you move to another adviser and they are willing to rebate the commissions directly to you, but this would likely mean becoming their client and paying ongoing advice fees to a new adviser. I haven’t found a solution to this problem.
One thing to note – when you go with the commission-based model, advisers may provide assistance during a claim for free. Well, not for free – you already paid large amounts of money! But when you go with the upfront-fee no-ongoing-commission model, be aware that you will likely have to pay for their time if you need assistance lodging a claim. This is only fair – you wouldn’t like your boss to ask you to occasionally work for free.
Is there a case where commissions may be suitable?
The commission-based model may be a way to get accessible insurance advice for those without the cash flow to afford the upfront fee for advice. One way to do this without having to pay ongoing inflated premiums is to ask them to refund ongoing commissions once an agreed-upon one-off amount has been paid to them (and check that it says that in the statement of advice they provide, along with the figures, and put a note in your calendar to alert you to contact them again when the period is up to remind them).
However, if you can’t afford insurance advice without commissions, there is an argument that you can not afford insurance advice, and it may be better to get insurance through your industry super fund – at least until you have a handle on your personal cashflow management.
Something to watch out for with advisers who rebate insurance commissions – there is an adviser/podcaster who says that he rebates commissions above a certain amount but fails to mention that he rebates commissions above a certain annual amount. So he is still collecting ongoing commissions for the life of the insurance policy. The point where he rebates commissions is also above the premiums of his target client age. So nothing would be rebated for most clients.
There is also still the downside of having commissions rebated after a fixed one-off fee because the adviser favours policies with commissions as it helps with paying their fee, but it is better than ongoing commissions.
Why this is so important
Many advisers will argue until they’re blue in the face over why the commission-based model should continue. They will say anything from, their business couldn’t survive without it (a good thing if you ask me) to commissions being a “social service like remuneration to mortgage brokers” (yes, more than one adviser has actually said this) to the fact that many people would rather not pay a large out of pocket expense for insurance advice.
The problem is that clients who choose the commission-based model either haven’t got their cash flow sorted out to be able to afford what is important (and insurance is very important), or they simply didn’t understand the consequences of their actions (the same way that they don’t understand the consequences of having a credit card that never gets paid off).
Fixed ongoing expenses in your budget must be met each and every month (or quarter or year). They are different from discretionary expenses, which you can just decide not to purchase, like a meal out. Examples of fixed ongoing expenses are rent, mortgage, phone, internet, electricity, water, insurance, gym membership, subscriptions, and car rego. These ongoing fixed expenses cost you large amounts of money over the course of your life when you consider the compounding had that gone to investing for your future. If you can reduce or eliminate these, you will have more money every month. Debt is an example where once you pay it down, you have more money every month.
And insurance commissions are no different to debt. They are fixed ongoing expenses that eat away at your income indefinitely, and you can avoid this by paying upfront, which will allow you to direct your money towards more important goals such as paying off your house sooner, having enough money to switch to part-time work and spending more time with your family, starting a side hustle, travel, or anything else that is important to you.
Commissions – just like debt and all your other fixed expenses – reduces your capacity to allocate your resources in a more efficient way to achieve your most fulfilling life.
The solution for people without the cash flow to pay for insurance is to start budgeting.
It is ironic that the same people who you are paying to advise you on making the best use of your limited income are so often doing so in a way that is to your detriment so that they can get as much money as possible from you. It’s no wonder only 10% of Australians use advisers even though a competent and ethical adviser who has your best interest can help in such a profound way.
Final thoughts on tips to lower the cost of insurance
Insurance has become very expensive, largely due to the changes in the insurance industry in recent years as a result of the regulator (APRA) finding that insurance companies have been bleeding money through claim payments and laying out new requirements for insurers, which resulted in significant price increases to ensure the insurance industry was operating in a sustainable way. Hopefully these tips to lower the cost of insurance can help to keep the cost of insurance manageable.