Advising on need not Premium

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Advising on need not Premium

Determining Insurance Adequacy Levels

Brendan Bowen

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“I keep tweaking and crafting until I get the perfect sound.”

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This presentation has been prepared by BT Financial Group Limited (ABN 63 002 916 458) ‘BT’ and is for general information only. Every effort has been made to ensure that it is accurate, however it is not intended to be a complete description of the matters described. The presentation has been prepared without taking into account any personal objectives, financial situation or needs. It does not contain and is not to be taken as containing any securities advice or securities recommendation. Furthermore, it is not intended that it be relied on by recipients for the purpose of making investment decisions and is not a replacement of the requirement for individual

research or professional tax advice. BT does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this presentation. Except insofar as liability under any statute cannot be

excluded, BT and its directors, employees and consultants do not accept any liability for any error or omission in this presentation or for any resulting loss or damage suffered by the recipient or any other person. Unless

otherwise noted, BT is the source of all charts; and all performance figures are calculated using exit to exit prices and assume reinvestment of income, take into account all fees and charges but exclude the entry fee. It is

important to note that past performance is not a reliable indicator of future performance.

This document was accompanied by an oral presentation, and is not a complete record of the discussion held. No part of this presentation should be used elsewhere without prior consent from the author.

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Determining adequacy levels

“Every artist is different, but it’s my job to make them all sound amazing.”

A life lesson from a music producer

3. TPD and Living

2. Determining life insurance need

1. Factors in calculating insurance need

4. Insurance need after an event

5. Industry fund considerations

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Determining adequacy levels

3. TPD and Living

2. Determining life insurance need

1. Factors in calculating insurance need

4. Insurance need after an event

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Life insurance need changes with life stage

• Singles

– TPD & Trauma

• DINKs

– Mortgage risk

• Couples with children

– Bring up children

– Education expenses

– Mortgage

• Empty Nesters

– Protection for income in retirement

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Three main variables in determining adequacy

• Loss of future income

– Effect of other policies such as income protection

– Younger clients may experience higher growth in income

• Debt

– Home & investment loan

– Personal loans and credit cards

• Fixed expenses

– Medical costs

– Home modifications

– Mobility aids (e.g. Scooters)

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Need is different for different types of insurance

Life (death)

Insurance TPD Living Protection Income

Future income

need dependants Maybe, if Yes Yes Yes

Adjust for income

protection No Yes Yes N/A

Payout loans Yes Yes Yes No

Medical Expenses No Yes Yes Yes

Modifications to

family home No Yes Yes Maybe

Funeral expenses Yes No No No

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Determining adequacy levels

3. TPD and Living

2. Determining life insurance need

1. Factors in calculating insurance need

4. Insurance need after an event

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Determining need for Stuart and Bronwyn

• Stuart and Bronwyn both aged 30, with 2 children

– Hamish (age 5)

– Samuel (age 3)

• Employment details

– Stuart earns $100,000 + 9% super, employed in an office role

– Bronwyn is a stay at home mum

• Superannuation

– Stuart - $50,000 in HESTA

– Default cover ($100,000 death & TPD)

• Home valued at $500,000

– Mortgage of $300,000

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Stuart’s future income capacity increases over time

$0 $50,000 $100,000 $150,000 $200,000 $250,000 $300,000 $350,000 30 35 40 45 50 55 60 A n n u a l I n c o m e Age

Income and Super contributions

Tax Payable Super

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Future income component calculation

• Adjusted future income

– All future income amounts

– Super contributions

• Plus

– Estimated future income increases

• Less

– Tax on taxable income

– Discount for future earnings on investment of lump sum

Assumptions for Stuart

• Inflation rate 3%

• Income growth rate 3%

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Breakdown of components reinforces need

• Stuart’s total life insurance need is calculated as $2,442,805

• Future income

– Adjusted for inflation

– Future income increases

– Reduced by monthly payments by paying off mortgage

• Fixed costs added

– Funeral costs

– Pay off mortgage

– Children’s expenses

– Private school/university fees?

Estate Planning $30,000 Children's costs $340,000 Future income $1,772,805 Mortgage $300,000

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Adjusted future income need decreases with age

$0 $500,000 $1,000,000 $1,500,000 $2,000,000 $2,500,000 $3,000,000 30 35 40 45 50 55 60 65

Future income need as age increases

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Workshop exercise

• Bronwyn is currently not earning any income

–

Calculators recommended need largely on future income

–

Bronwyn’s future income calculation is zero

• Questions

–

What additional costs would Stuart incur if Bronwyn was to

pass away?

–

Would calculations change if she intended to go back to work

when children turned age 10 ?

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Workshop exercise – Suggested solutions

• Childcare

–

Day care

–

School holidays

• Housekeeping

• Reduction in income - Stuart

–

Part time

–

Change jobs

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Bronwyn’s need doesn’t factor in a return to work

$0 $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 $700,000 $800,000 30 35 40 45 50 55 60 65

Bronwyn's insurance need

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Could include estimate of Bronwyn’s future income

$0 $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 $700,000 $800,000 $900,000 30 35 40 45 50 55 60 65

Bronwyn's need with estimated future income of $30,000pa

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A note on single parents

Step 1 – Calculate taxable (taxed)

–

Benefit amount x

Service days

Service days + DTR

–

Less tax free amount

Step 2 – Calculate taxable (untaxed)

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Calculating untaxed - Example

• Leah was born on 18/4/1966

• Eligible start date - 1/4/1997

• Life policy of $500,000 held within her super fund

• Super benefits:

– Taxable (taxed) $500,000

– Tax free $ 20,000

– Total $520,000

• Leah passes away on 18/9/2012 and her superannuation death benefit is paid to her son Jeremy (age 22)

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Calculation of untaxed component

• Insurance policy taints the taxable (taxed) component

• Taxable (taxed) reduced from $500,000 to $443,375 with insurance added

• Segmenting insurance can provide better results

Component Amount Tax payable Net benefit

Taxable (taxed) @15% $443,375 $66,506 $376,869 Taxable (untaxed) @30% $556,625 $166,987 $389,638 Tax free $20,000 $Nil $20,000 Total $1,020,000 $248,494 $786,507

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Superannuation benefit

Insurance only super (with same ESP)

Taxable (taxed) @15% $500,000 $75,000 $425,000

Taxable (untaxed) @30% Nil Nil Nil

Tax free $20,000 Nil $20,000

Total $520,000 $75,000 $445,000

Taxable (taxed) @15% $227,145 $34,072 $193,073

Taxable (untaxed) @30% $272,855 $81,856 $190,999

Tax free Nil Nil Nil

Total $500,000 $115,928 $384,072

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Considerations for Life Insurance

• Higher income growth rate for younger clients

• Consider costs each party would incur on death of the other party

– Loss of income to look after kids

– Relocation costs

– Housekeepers

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Determining adequacy levels

3. TPD and Living

2. Determining life insurance need

1. Factors in calculating insurance need

4. Insurance need after an event

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TPD and Living are offset by income protection

$0 $200,000 $400,000 $600,000 $800,000 $1,000,000 $1,200,000 $1,400,000 $1,600,000 $1,800,000 $2,000,000 30 35 40 45 50 55 60 F u tu re I n c o m e Age

TPD future income need

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TPD need includes medical and other fixed costs

$0 $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 $700,000 $800,000 $900,000 $1,000,000 30 35 40 45 50 55 60 65 TPD + Fixed Costs

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Considerations for TPD and Living

• Income protection covers part of TPD need

– Deductibility

– Ease of claim

• Consider costs each party would incur on TPD of the other party

– Loss of income to look after kids

– Relocation costs

– Housekeepers

• Direct costs of disability

– Mobility aids

– Medical expenses

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Case Study - Tax effect on TPD proceeds

• Rohan (36), born on 14/2/76 has the following benefits in super with service

date of 10/7/97:

Tax free

$100,000

Taxable

$300,000

Total

$400,000

• Home valued at $800,000 with mortgage of $500,000

• He takes out $500,000 TPD (any occ) in super to cover mortgage

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• Increase in tax free = Benefit x Days to retirement

Service days + Days to retirement

• Rohan’s benefit increases to:

–

Tax free

$729,650

–

Taxable

$170,350

–

Total

$900,000

• Withdrawal to pay off mortgage:

Components Tax Net Withdrawal

Taxable $94,639 $20,347 $74,292

Tax Free $405,361 $Nil $405,361

Lump sum withdrawal $500,000 $20,347 $479,653

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$- $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 35 40 45 50 55 60 65 Age

TPD Super compared to mortgage

Insured amount Net insurance benefit Mortgage

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Determining adequacy levels

3. TPD and Living

2. Determining life insurance need

1. Factors in calculating insurance need

4. Insurance need after an event

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Still need for life insurance after TPD or living paid

• Income protection portion not covered in original benefit

– Future income need shortfall

• Estate planning expenses not covered in TPD or living

– Funeral costs

– Estate equalisation

• TPD and living often linked to death benefit

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Death $900K (Premium free portion) TPD $900K (double TPD) Death $1.5M

Double and buy-back can reinstate death benefit

• Double benefits

– TPD & Living

– Insured survives 14 days

– No further premiums payable on reinstated amount to age 99

• Buy backs

– TPD buy back

– Living buy back

– Living reinstatement TPD $900K Example - Double TPD Stuart Death $2.4m

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Double features provide bucket list protection

• Ensures death benefit payable

– Doubles reinstate death benefit

– No premiums on reinstated portion to age 99

• Gap of total need

– Life insurance reduced by fixed costs specific to TPD

– Estate planning costs

• Bucket list protection...

– Overseas trips

– New car or boat

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Determining adequacy levels

3. TPD and Living

2. Determining life insurance need

1. Factors in calculating insurance need

4. Insurance need after an event

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Default insurance in industry funds vary greatly

• Insurance options vary considerably

• Cover can either:

– Decrease as member gets older (premium smoothing)

– Remain fixed based on age when joined plan

• Personal plans don’t tend to get allocated to default plan

• Some funds require members to have at least 1 unit of cover

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Industry fund default life cover varies greatly

$- $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 $700,000 16 21 26 31 36 41 46 51 56 61 66 S um I ns ur e d Age

Default Life Insurance Cover - Industry Funds

Cbus Life Insurance (manual) Australian Super Life Insurance Hesta Life Insurance

Hostplus Life Insurance* Caresuper Life Insurance

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Caresuper TPD follows future income trend

$- $50,000 $100,000 $150,000 $200,000 $250,000 $300,000 $350,000 $400,000 $450,000 16 21 26 31 36 41 46 51 56 61 66 S um I ns ur e d Age

Default TPD Cover Industry Funds

Cbus TPD (manual) Hesta TPD

Hostplus TPD Caresuper TPD Australian Super TPD

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Salary continuance is not default on all funds

Industry Super Fund Income Protection

CBus Not default - Optional

Australian Super

60 day wait

2 year benefit period

Default capped at $3,000 per month (age 21-49) Hesta

90 day wait Benefit to age 60

Default capped at $850 per month

Host Plus Not default – Optional

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Stronger super requires opt-out of insurance

• APRA funds

– Required to offer life and TPD on an opt out basis

– Discretion for IP as an opt in, opt out, or at all

• My super

– Standard default level of life and TPD

– Members will be able to adjust their cover

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Negotiate on need not premium

• Tailor insurance portfolio to life stage

– Anticipate future events

• Negotiate based on adequacy

– Assumptions

– Inclusions

• Consider growth rate when projecting future income increases

– Younger clients & Professionals

• Industry funds

– Insurance tends to decrease with age

• Protect against bucket list risk

– Double benefits – Buy backs Estate Planning $30,000 Children's costs $340,000 Future income $1,772,805 Mortgage $300,000

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The Insurer of BT Protection Plans is Westpac Life Insurance Services Limited ABN 31 003 149 157. All BT Protection Plans, except for Term Life as Superannuation and policies paid via SuperWrap, are issued by the Insurer. For Term Life as Superannuation, which is part of the Superannuation Division of Westpac MasterTrust ABN 81 236 903 448 SFN 281412 SPIN WFS0112AU RSE R1003970, the issuer and trustee is Westpac Securities Administration Limited ABN 77 000 049 472 RSE L0001083 (WSAL). For policies paid via SuperWrap, which is part of Retirement Wrap ABN 39 827 542 991 RSE R1001327, the issuer and trustee is The Trust Company (Superannuation) Limited ABN 49 006 421 638 RSE L0000635 (SuperWrap Trustee). The administrator of all policies paid via SuperWrap and Wrap and the arranger of policies paid via Wrap is BT Portfolio Services Ltd ABN 73 095 055 208 (BTPS). BT

Protection Plans are distributed by the Westpac Banking Corporation ABN 33 007 457 141 (the Bank). The Insurer, WSAL and BTPS are wholly owned subsidiaries of the Bank. Neither of an investment in, or acquired using, SuperWrap or Wrap nor BT Protection Plans are an investment in, deposit with or other liability of the Bank. Neither the Bank nor any member of the Westpac Group (other than the Insurer and WSAL) guarantees the benefits payable in relation to BT Protection Plans. Investments in, or acquired using, Wrap and SuperWrap are subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of

income and principal invested. None of the Bank or any other company in the Westpac Group stands behind or otherwise guarantees the capital value or investment performance of any investments in, or acquired through Wrap or SuperWrap. This information has been prepared without taking into consideration any persons personal objectives, financial situation or needs (personal

circumstances). Because of this, before acting on this information, any person receiving this information should consider its

appropriateness, having regard to their personal circumstances. Conditions, limits and exclusions on cover apply and are explained in the BT Protection Plans Product Disclosure Statement and Policy Document and BT Protection Plans (SuperWrap and SuperWrap Essentials) Insurance Booklet (each a PDS). Before any person makes a decision in relation BT Protection Plans, they should consider the relevant PDS available from advisers. This communication may contain financial product advice and has been prepared for use by advisers only. It must not be made available to any retail client and any information it is must not be communicated to any retail client or attributed to the Insurer, WSAL, the SuperWrap Trustee, BTPS, the Bank or any other member of the Westpac Group. This information has been prepared by the Insurer.

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