What happens to my family if I die or if I am ill or injured and cannot earn a living?
It’s a standard question in every financial planning meeting.
The answer differs depending on the GP’s stage in the life cycle and their other circumstances, but will usually involve a discussion of risk insurance, mainly life insurance and income protection insurances.A young unmarried GP without any financial dependants may not need any life insurance. No one suffers financially if they die. We often explain this by saying you should not be worried about the bus that hits you and kills you outright, but you should be worried about the bus that hits you and does not kill you outright, but leaves you unable to work as a GP.
The focus for these GPs should be on income continuance insurances and health trauma insurances, ie insurances for the living, rather than for the dead.
This changes when our client enters into a relationship with a potential spouse and there are prospects of one day having children. Someone will suffer financially if they die, ie the spouse or potential spouse and any children of the relationship. There is a real need for some serious sums insured. Each case is different but it is hard to see why the sum insured should ever be less than $1,000,000. It’s a psychologically nice amount: our client knows his or her spouse gets a tax free $1 million if they kick the bucket prematurely: usually this is more than enough to clear all debts and to allow a reasonable standard of living for the surviving family members.
The sum insured may of course need to be greater than $1,000,000 if the spouse or potential spouse does not have a high independent earning capacity, the children are younger or more numerous, and conversely the need for a large sum insured is reduced if the spouse or potential spouse has a high independent earning capacity, the children are older (and therefore closer to financial independence) or less numerous.
Our references to “potential spouse” may raise queries. Once a relationship goes beyond a mere casual acquaintance, life insurance should be in place. One of the first deaths we were involved in had a young electrician being electrocuted on the job. He never knew it, but he was well on the way to being a father: his girlfriend was pregnant, and gave birth to a beautiful bouncing baby boy eight months later. There was some life insurance but not nearly as much as there would have been had he known he was going to be a dad.
The cheapest form of life insurance is known as “renewable term life insurance”. More than 90% of life insurance contracts are set up this way. This is pure life insurance, without any bells and whistles and without any investment component. This is usually the best way to arrange a GP’s life insurance, particularly if the policy is owned by a super fund where all the premiums are tax deductible.
Under most renewable term life insurance policies the premium increases as the life insured gets older. This is largely because the risk of death is increasing too – unless you are male and in your 20s, in which case you become less likely to die each year.
There is often a case for reducing the sum insured as the GP gets older: hopefully the net wealth position is increasing, and the children are less dependant as each year passes by. In short, the economic consequences of death are less severe, so there is less need for insurance. The risk of a GP dying in an accident are actually quite low, and GPs are in a unique position to judge their own health and longevity prospects compared to the general population. Often the analysis leads to the conclusion that cutting back the life insurance makes a lot of sense. But it can depend on the GP’s own comfort zone and attitude to risk.
At each stage in the life journey the GP should objectively consider two issues: what is the statistical probability of premature death, and what are the economic consequences of premature death. These are two distinct issues. Once these issues are considered, an appropriate sum insured can be arranged. This probably means that the sum insured will rise and perhaps also fall as life circumstances change. The position should be reviewed on a regular basis, preferably once a year.
Are premiums tax-deductible?
If the GP owns the life insurance policy then usually there will be no tax relief for the cost of the premiums. But if the policy is owned by a super fund, including the GP’s own self managed super fund, the premium is tax deductible to the fund, and therefore in effect deductible to the GP. This means the after tax cost of the policy is almost halved.
It also means that any benefits paid are taxed in the super fund’s hands. However, as the premiums will certainly be paid and will be tax deductible at 48%, but the benefits will probably not be paid (ie the GP will probably not die prematurely), and even if they are will only be taxed at 15%, then it’s still a good idea to run the insurance through a super fund.
If the 15% tax on benefits is really a problem, then increase the sum insured by 17%. If you want your loved ones to receive $1 million and the benefit will be taxed, then insure for $1,170,000. 15% of $1,170,000 is $170,000, meaning that there will be $1 million left. The premium difference for the extra sum insured is not much, and it is of course deductible right now.
We routinely recommend life insurance be owned by super funds, to make the premium tax deductible, and that the sum insured be adjusted for any 15% tax charge.
Some GPs need life insurance (by which we mean insurance that pays someone if you die). Some do not. Each case is different and the need for insurance is a question of fact, driven by the GP’s individual circumstances.
- one GP, aged 28, may not need any life insurance, because he or she has no dependants and no one is financially prejudiced by his or her premature death;
- a second GP, aged 28, may need $300,000 of life insurance because her mother is an aged pensioner and there will be no one to look after her mum if the GP dies prematurely; and
- a third GP, aged 28, may need $1,000,000 of life insurance because he is married with a dependant wife, two young kids and a third on the way.
What is life insurance?
Wikipedia answers this question as well as anyone else, and it says:
Life insurance or life assurance is a contract between the policy owner and the insurer, where the insurer agrees to pay a designated beneficiary a sum of money upon the occurrence of the insured individual’s or individuals’ death or other event, such as terminal illness or critical illness. In return, the policy owner agrees to pay a stipulated amount called a premium at regular intervals or in lump sums. There may be designs in some countries where bills and death expenses plus catering for after funeral expenses should be included in Policy Premium.
As with most insurance policies, life insurance is a contract between the insurer and the policy owner whereby a benefit is paid to the designated beneficiaries if an insured event occurs which is covered by the policy.
Life policies are contracts and their terms describe the limitations of the insured events. Specific exclusions are often written into the contract to limit the liability of the insurer; for example claims relating to suicide, fraud, war, riot and civil commotion.
Life-based contracts tend to fall into two major categories:
- Protection policies – designed to provide a benefit in the event of specified event, typically a lump sum payment. A common form is term life cover, which applies for a specified term.
- Investment policies – where the main objective is to facilitate the growth of capital by regular or single premiums. These have become quite uncommon over recent years and are rarely taken up these days.
This is an American definition but it pretty much sums up the Australian situation too.
How much does life insurance cost?
The answer is it depends. The cheapest way to secure life insurance is through industry super funds such as Health Super and HESTA. These funds provide universal life cover to all members, without a medical examination and without medical disclosure.
For example, at age 28, a member automatically receives $166,200 of death cover and $166,200 of total and permanent disability cover for just $3.30 a week. The $3.30 is effectively tax deductible because it is paid out of your deductible contributions. This is remarkably cheap, and the simplest and easiest way to arrange life cover. The $166,200 will be sufficient for many GPs.
There are no commissions, which means we like industry fund life insurances.
But once you have kids $166,200 is nowhere near enough cover, if you love them.
Here you can consider:
- arranging extra life cover through your existing industry super fund, such as HESTA or First State Super. You can do this online and it is cheap and commission free;
- joining another industry fund. Most of the industry super funds provide similar cover. The covers are cumulative. Therefore, if a GP is a member of each of Health Super and HESTA, he or she will have twice this Some clients have as many as five industry fund memberships: a remarkably cheap and easy way to arrange a relatively large amount of life insurance without any medical examinations and without any medical non- disclosures; and/or
- arranging a separate life insurance policy directly with a life insurance company through a life insurance agent or
Once kids come into the equation we believe the total sum insured for a couple should be at least $1,000,000. And possibly a lot more, depending on your spouse’s occupation, your spouse’s insurance, the number of kids and your existing family financial profile including your parents’ financial profile.
Life insurance agents and brokers
Sometimes GPs cannot get an appropriate amount of life insurance through industry superannuation sources. Here the only alternative is a life insurance agent or broker.
The problem is commissions. Insurance agents and brokers are rewarded by commissions; initial commissions, bonus commissions, volume commissions and trailer commissions. This means the agent or broker will almost always try to sell you up. That is, increase the amount of life insurance above what you really need to maximise commission income.
To be forewarned is to be forearmed.
Be careful when dealing with insurance intermediaries: they are trying to maximise their commission income more than ensuring you have appropriate life insurance and are not over- insured.
Do not over-insure
Insurance is essentially a bet. You are betting you are going to die inside the agreed term, and the life office is betting that you will not. The life office will probably win the bet. Many GPs will need to make the bet: the consequences of losing are too high to ignore.
Do not bet too much. Make sure the sum insured is realistic and relevant to your dependants’ needs.
What is income protection insurance?
Income continuance or protection insurance involves the GP paying a premium to an insurer in return for the insurer agreeing to pay a set amount to the GP should they be unable to work for more than one month or some other agreed period.
The set amount is usually set as a monthly, fortnightly or weekly amount, and as a maximum tends to be about 70% of the GP’s usual income. Problems can be encountered proving the GP’s income, once super, related party salaries, negative gearing, service trusts and the rest of the tax planner’s armoury is taken into account. Usually communication between the GP’s accountant and the insurer, and an intelligent underwriter, will solve this problem: the larger income can be insured.
Assume a GP damages her back skiing and can’t walk for say three months. Once one month has passed she can claim a monthly amount of, say, $10,000 per month, or the equivalent of
$120,000 a year, under the contract, being 70% of her total reward from the practice. This is so even though her tax return only shows a taxable income of, say, $60,000.
Getting by for less than 3 months is not a big deal for most GPs. It’s getting by for 3 years, or even 3 decades that is our big worry. It’s that bus that does not kill you but causes mild brain damage that is the real concern here: your life expectancy is the same but your earnings fall to nothing. For this reason we usually recommend policies with a three month waiting period rather than a one month waiting period, as the premiums are significantly lower. A sound case can be made for running the risk that a GP is off for between one month and three months, but insuring the risk that the GP is off for more than three months. But it depends on the GP’s attitude to risk. The GP must be comfortable with the risk they run.
The number of financial dependants, whether they be children, parents or siblings, is relevant to the quantum of the sum insured, just as it is in the case of life insurance. But, unlike life cover, GP without any dependants will still need income protection insurance.
Why a 90 day waiting period?
More then one doctor has wanted to know a 90-day waiting period was recommended. They are usually 31 days into a disability and annoyed there is no cheque. Once it is explained that the longer waiting period means a greater benefit for the same premium, so although they lose in the first 90 days they make it up quickly after that, they tend to be quite accepting.
If you are really hit bad and off work for a year or two the 90-day waiting period is a much better option.
Sure, it means you are self-insured for the first 90 days. But that’s a risk most GPs can live with.
The policy documents need to be read carefully, and there is no substitute for an honest and competent adviser. For example, some policies are cancellable: each year the insurer can elect to cancel/not renew the policy if it wishes to. It can cancel the policy, for example, if the insured is in poor health! This is remarkable, if you think about it. Do not touch cancellable policies: only non-cancellable policies should be considered. And the payments must last to at least age 65: many of the cheaper policies stop all payments after two years. Not much good at all for a 35 year old GP with a dependant spouse, three young children with BCIBD, i.e. bus crash induced brain damage, or some other condition that means they can never work as a GP again.
Premiums are usually tax deductible, because they relate to the insured GP’s assessable income, which will include any benefits paid under the policy.
Trauma insurance was transplanted to Australia in the eighties and was originally limited to heart attack, cancer, strokes and by-pass surgery. It has grown to comprise a significant percentage of the total insurance market and the average contract extends to more than forty different health conditions, although some include as few as twenty. But nearly 70% of claims still involve heart attack, cancer, strokes or by-pass surgery.
Trauma insurance can be on a stand-alone basis or as part of a life insurance policy.
Read that fine print
We are half-hearted about trauma insurance. There is too much devil in the detail. Fourteen years ago, a client suffered a terrible stroke and after five days in hospital the machine was about to be turned off, along with our client. A last minute operation, against the odds, saved the day, and he is thankfully still with us, although there was a huge amount of rehabilitation and he is still under a specialist’s care. He never got his trauma benefits. The policy document was worded so that if he recovered sufficiently, no matter how long it took, the insurer could avoid the payment. It is hard to imagine a more traumatic health event. But it still was not traumatic enough for the insurer.
We have heard of similar problems elsewhere. Trauma is defined in unintelligible terms and different definitions are used in different contracts. GPs regularly tell us the contract definitions of various medical conditions are significantly narrower and more technical than those accepted by the medical profession. Hence our client had, according to his insurer, a non-traumatic near fatal stroke with permanent side effects, and no benefit payments.
Trauma insurance premiums are not tax deductible. This means they are relatively more expensive than income protection insurance premiums, which are normally tax deductible. Although there is a saving if a trauma occurs, as any benefits are tax-free. But with insurance premiums are certain, and benefits are not. So we prefer GPs to take out appropriate income protection insurance before they consider trauma cover.
Trauma insurance contracts can be held by self-managed super funds. But the preservation rules apply and it is highly likely that, unless the GP is 55 or older, most of the benefit will stay locked up in the fund. This is not the end of the world, but it is usually not what you would prefer.
On balance, we are not fans of trauma cover and usually counsel GPs against it, while thoroughly checking the life income protection boxes are ticked off.
Once again, if you do have trauma insurance you should make sure it’s commission free. Insurance commissions are huge: more than 25% of all premiums are paid back to the insurance salesman as a commission, unless you do something about it.
- identify the risk, ie what is the event you wish to insure against?
- ask what is the probability of that event occurring?
- ask what are the economic consequences of the insured event occurring?
- ask what is the proposed cost of insuring against that risk and those consequences? and
- decide if the cost is worth the benefit?
A cautious conservatism is required, particularly in the area of business insurances. We confess to thinking that many GPs are over-insured and that there are serious savings to be had by deleting unnecessary insurances wherever possible.
The insurance companies have come out with a whole range of insurances directed to the needs of the business sector. Many of these are actually applications or modifications of traditional insurance contracts rather than purpose specific insurance policies.
These insurances include key person insurance, split dollar insurance, business continuity insurance and similar contracts. We confess to not being too keen on these, for our GPs at least, and believe that most applications to GPs have been driven by the salesman’s thirsts for commission income rather than an objective assessment of risk. Thankfully these insurances have all but disappeared over the last ten years or so, and the abusive eighties and early nineties are just memories.
Our view is that most GPs’ needs will be more than satisfied by the traditional applications of personal risk insurances, particularly life insurance and income continuance insurance, and that separate so called business insurances just aren’t needed and are a waste of money.
Key person insurance
Key person insurance aims to indemnify a business (or more strictly its owners) against the loss of profit caused by the disablement or premature death of a key person. The normal examples of key persons provided in the text-books are the managing director with a wealth of knowledge and contacts in the relevant industry or the gun salesman who generates more than his fair share of all new sales.
Neither example is analogous to GPs, or at least commonly encountered GPs.
The big benefit claimed for key person insurance is that the premium is tax deductible. This is not relevant to GPs as their risk insurance premiums can be easily structured so that they are deductible. So even if a particular GP is a key person, the claimed benefit is superfluous.
GPs should not bother with key person insurance. The focus should instead be on whether there are adequate other risk insurances, ie life insurance and income continuance insurance.
Business expense insurance
This is a risk insurance contract aimed at covering the GP against the loss of profit connected to not being able to run his or her practice. So, if a GP was laid up with malaria for 6 months and had to continue to pay the costs of his or her practice whilst laid up, these costs would be recovered from the insurer.
This sounds great in theory but sadly turns out badly in practice.
This is because of the principle of loss mitigation. When a claim is made the insurers invoke this principal to basically require the GP to close his or her practice, i.e. shut the doors, put off the staff, cut off the electricity and, if possible, even terminate the lease, so that the insurers costs are mitigated, or better, eliminated. So that in the end the insurer only has to pay two or three months of costs. This is not big bikkies. And it is in sharp contrast to what the marketing documents said in the pre-sale stage, i.e. before the GP signed up.
Business expense insurance is not common amongst GPs, and we think this is a good thing. The risk it purports to address are much better covered by an income continuation policy with an appropriately large sum insured.
Each of the states and territories has compulsory basic third party cover insurance. This insurance is collected via the car registration processes. It protects the insured against claims by other persons for physical injury caused by the use of a car or other motor vehicle. The amount of the premium is set by the government and does not consider the individual driver’s circumstances or the value of his or her car. But obviously the population averages are considered when the actuaries do their thing and advise the government on what the premiums should be.
Occasionally we come across a driver who has not paid his or her car registration fees or is otherwise driving an unregistered car. Apart from being a breach of the law, this is also dangerous as the driver is not covered by compulsory third part motor vehicle insurance, nor any other insurances. If there is a serious accident the driver could be wiped out financially, not to think of the physical pain and suffering caused to the other driver and passengers. Happily the incidence of driving unregistered cars is not high amongst GPs. But it is a useful reminder of the importance of paying the registration fees on time.
After compulsory basic third party cover insurance there are a range of other car related insurances that can be considered. Cover differs from insurer to insurer and from contract to contract, so close attention to the fine print is always wise.
The major types of car insurance are:
- comprehensive insurance cover. This is the widest cover possible. It covers all damage to the car, usually based on market value but sometimes based on agreed values, and unlimited damage to third The amount of the premium depends on the driver’s circumstances and the value of the car;
- fire and theft This protects against the risk of financial loss due to, you guessed it, the car being burnt (rare) and the car being stolen (common) or both; and
- extended third party This protects against losses caused to third parties, ie other drivers and passengers, and does not cover losses to the driver, whether due to injury or due to fire or theft of the car.
GPs usually have higher dollar value cars, and hence there is a greater need for them to insure their cars than for most people. But the question of how much cover should be bought still needs to be thought through on a case by case, and car by car, basis.
For example a GP may decide that she has a lower than average risk of damage because she:
- only drives the car a short distance to the surgery each day and for local private travel, and does not otherwise use the car for long distance or frequent driving (example, from Melbourne to Surfers Paradise and back each school holidays) so that car use is well below the average of 15,000 kilometres per driver, and hence the basic risk faced by the GP is well below the average risk faced by a driver; and
- does not drive a car in the luxury car price bracket, for example, drives a second hand BMW costing $50,000, rather than a $150,000 Mercedes Benz;
a particular driver, whether it be the GP, a spouse or another family member, faces a below average qualitative risk, for example because he or she:
- does not speed and generally drives in a cautious and non-aggressive manner;
- does not drink and drive, even under the legal limits, and does not drive when extremely fatigued or otherwise drive when attention and response times are likely to be low;
- does not park the car in a suburb where there is a low risk of theft;
- uses a secure and lockable garage; and
- generally uses common sense to eliminate unnecessary risks connected to driving and owning a
The circumstances of both the car and the driver or more accurately, the drivers, should be considered before deciding on insurance for each car. It may be logical to have heavy insurance cover for the more expensive car that notches up the large kilometres, but only have low cover for the second car that only covers a few thousand kilometres a year around the local suburbs.
Car insurance costs are generally tax-deductible for a GP, to the extent that all car costs are deductible.