In this episode, we look at the best ways for you to protect yourself. Insurance is a necessary evil of a holistic financial plan. Some investors avoid enroling or reviewing their insurances.as it's a tedious task that provides no immediate benefit. It however, provides peace of mind and protection at some of the most vulnerable times of your life. It's important to optimise your insurance to make sure you are adequately covered, but also that you are minimising the costs. We go through the best ways to protect yourself.

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Mark LaMonica: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances, or needs. We'll do one quick reminder, comments, YouTube, Spotify, email them to me if you have questions. We will answer them on here very briefly. All right. What are we talking about today, Shani?

Shani Jayamanne: Okay. So we're going to talk about something that you don't really like talking about, and apparently I like talking about a lot.

LaMonica: My feelings, like what are we doing?

Jayamanne: Well, being financially secure requires you to take a step back and not just focus on wealth creation, and investing.

LaMonica: Well, there we go. We've done a lot of these episodes, mostly ones that you came up with. We did estate planning to make sure there's, of course, a plan for your assets when you die. We did some episodes on what happens if your health declines, and you need assistance with managing your day-to-day life and assets.

Jayamanne: So now we're going to come to a topic that makes a lot of people, including Mark, groan, but it is a necessary part of your financial plan and peace of mind in case the unexpected happens.

LaMonica: And we're going to talk about insurance.

Jayamanne: Woohoo. So Mark has this running joke that I love insurance because I talk about it so often, but I think a lot of people just avoid talking about it because it's boring and it's scary, and it makes a lot of people feel like they're wasting money on something that they're never going to claim.

LaMonica: So basically, a conversation with you is boring and scary.

Jayamanne: Yeah.

LaMonica: Okay. So I, of course, do joke with you a lot about that, Shani, but there's a reason why you think insurance is important, and it was because you used to process insurance claims.

Jayamanne: In the past. I've had a lot of past lives.

LaMonica: I know. You worked at Grill'd. You worked at the optometrist.

Jayamanne: I forgot to mention this. I went to Tassie recently in December, and I met someone that listens to Investing Compass, Tim, who was really, really nice.

LaMonica: You forgot to mention this to who I knew that. I wrote him a note.

Jayamanne: I said I would mention it on the podcast because it was very embarrassing for me because I told him to meet me at a specific coffee shop, and I went to the wrong one and he had to come and find me.

LaMonica: All right. It's too bad he didn't have insurance on the time that you wasted. While, he was sitting there.

Jayamanne: Well, he brought up, he was like, did you actually get fired at Grill'd? And I was like, no, Mark's just making up stories. But when I was working at the superannuation fund, I wore multiple hats, and I used to process claims that could be approved by the superannuation trustee. And one of the biggest lessons that I saw was that there was a variety of claimants, and most of the people putting claims through actually are those that had no preexisting conditions, no inkling that they were going to be in this situation, and otherwise physically and financially healthy. And it was just people who had experienced extremely bad luck or unfortunate circumstances that had changed the course of their lives. And they luckily had a contingency plan to soften the blow and take the financial worry out of an already stressful situation.

LaMonica: So now we have to talk about it.

Jayamanne: I hope so.

LaMonica: After your...

Jayamanne: Otherwise we don't have an episode.

LaMonica: We can just talk about how you actually did get fired at Grill'd. So one of the main questions that investors come across when they start looking at how to insure themselves, that is what vehicle should they hold their insurance in? So basically what we're saying should it be inside super, should it be outside super? And if it's outside super, that's referred to as retail coverage.

Jayamanne: All right. So let's get started. We discussed that there's two main ways to insure yourself, but what we're forgetting is self-insurance. And we're not going to focus on that because self-insurance is difficult and it's not really achievable for many of us.

LaMonica: Yeah. So basically you just need a lot of money. And then you're self-insured. So the concept of course is that if there's an event that requires insurance, you have the funds to address whatever the issue is without becoming destitute or impacting your life adversely. So for example, if you die, which I would say impacts your life. So if you die and leave your partner with a large mortgage and they're unable to pay for it. That situation of course could be fixed if you also left them a lot of money that they could then pay the mortgage.

Jayamanne: Yes. And there are some circumstances that you're able to do this. So if you have a partner that has their own sufficient retirement funds and you also have yours, it may be a suitable replacement for life insurance and covering any debts owed or obligations. But in general circumstances, self-insurance is very hard and not for most people. So we're going to focus on super and retail as we mentioned.

LaMonica: Okay. So we're going to go through all the different types of insurance. So this will take approximately three hours and then we'll get into some tips afterwards. So there's life insurance, as Shani mentioned, in her lovely death scenario. So life insurance is paid at death or earlier if you have a terminal illness. There's total and permanent disability or TPD insurance and TPD is insurance that covers somebody if they've experienced an event that has left them totally or permanently, totally and permanently disabled and they're unable to work. And there are of course differing opinions on what constitutes unable to work and we'll talk a little bit about that.

Jayamanne: And then there's income protection insurance. This insurance looks to help cover you for unexpected accidents or illness that will prevent you from working. And this is another case where there are different levels of cover depending on whether you take out insurance inside or outside of super.

LaMonica: Yeah. And every time Shani almost gets hit by a car, which actually happens more frequently than you would think.

Jayamanne: I'm very clumsy.

LaMonica: She makes this little joke about what words -- you use the same words.

Jayamanne: I just say compo.

LaMonica: Yeah. So that's another pleasant conversation you can have with Shani when she isn't talking about insurance. There's trauma cover. So trauma cover protects individuals who may suffer a critical illness or injury and it's a lump sum payment. It's prevalent with workers and physical jobs that are reliant on their physical health to work.

Jayamanne: So first it's worth noting that not all insurances are available in and out of super. Life insurance is available through both. TPD and income protection are available through both. But super has some restrictions, which again we'll go through. And trauma cover isn't available through super. You'll only be able to get that through retail cover. So let's move over to costs and costs are obviously a large consideration for insurance.

LaMonica: That is true, Shani. So you're protecting yourself from something that may potentially happen. And of course that you hope does not happen. So it is the cost that you're paying for peace of mind. Generally retail policies are more expensive, but they can be tailored to the individual. So the main differences in consideration of the cost can be found. Price, tax effectiveness and cash flow. Those are the three considerations.

Jayamanne: So let's start with price. In super, premiums are often lower because it's a group insurance rate. Retail is often higher because the policy is tailored to the individual and their circumstances.

LaMonica: Okay. Tax effectiveness. Premiums are paid from your superannuation balance, which means you pay a lower effective tax rate on the premium. And that's in most cases where the marginal tax rate that you're paying outside of super is above 15%. For retail cover, premiums are paid from post-tax income, which is less effective, but income protection is the exception. These premiums are usually tax deductible if taken out as a retail policy.

Jayamanne: And the last consideration is cash flow. Having the funds taken from super can help an individual manage their cash flow, but it also reduces their retirement savings. While the retail policy, you've got to manage the premiums with your wages.

William Ton: I'm Will, producer of Investing Compass and here are this week's essential reads on Morningstar.com.au. Mark's Unconventional Wisdom focuses on AI this week. He explores why he's not intentionally investing in AI and why it might not live up to the expectations that investors have. When it comes to buying individual shares, investors should seek to avoid big losers every bit as much as chasing potential winners. Joseph explores Pat Dorsey's 10-minute test for cutting lower quality companies from consideration quickly. Does the familiar ASX name he puts under the microscope get pass marks? Find out in Joseph's Bookworm column.

An Investing Compass listener has asked a question about why Shani invests in managed funds. Shani shows how she's based her investing strategy and therefore her investing products around what suits her goals and behavior the best. Find out what Shani likes about managed funds in her Future Focus column. Ongoing cost of living pressures continue to weigh down on young Aussies trying to fulfil the Australian dream. This raises an important question about the financial viability of raising the next generation. While the crippling price of home ownership is no secret, the cost of having a child is perhaps a lesser discussed issue. With birth rates declining, Sim explores whether the average millennial can afford to have children in the current economic climate. These articles are available in the episode notes. Now it's back to Mark and Shani.

LaMonica: Okay, so we're going to go in-depth that Shani likes to do on insurance. So we'll go into each vehicle. So let's start with super. There are some nuances that come with taking out group insurance compared to individual retail policies. The first is the group insurance policies do not usually require medical underwriting. Financial advice professionals often advocate for exploring whether retail policy will cover an individual before cancelling their insurance within super. So this is particularly true for those with pre-existing conditions. So go to the doctor.

Jayamanne: Mark?

LaMonica: I know I should go to the doctor.

Jayamanne: This is not unconditional. There may be certain exclusions in the group policy that includes certain health conditions or high-risk occupations. Group insurance policy.

LaMonica: Like podcasting?

Jayamanne: Yeah, exactly. I mean, I do normally try and get hit by a car. I don't try. I do.

LaMonica: To be clear, Shani is not trying to off herself.

Jayamanne: No, for compo. But group insurance policies often do not exactly meet the needs of the individual. So for example, with TPD insurance, most group insurance policies will only cover any occupation while retail policies can cover own occupation.

LaMonica: And this can make a major difference to someone who needs a claim. Any occupation means that the claimant is not able to perform any role. A specialized surgeon who has spent over a decade studying and specializing would not be eligible for the cover if he lost his hand in an accident. What kind of scenario is that, Shani?

Jayamanne: This is the example that we were trained to give people when we'd explain the insurance to them.

LaMonica: If you lose your hand...

Jayamanne: As a surgeon, and you can't operate anymore. But you can still do another job.

LaMonica: I mean, if you're a really good surgeon, you could do it with one hand.

Jayamanne: Would you want to be operated on by a one-armed surgeon or a one-handed surgeon?

LaMonica: Depends what the operation was for. But anyway, let's get back into it. So the surgeon, of course, would be able, Shani said, to work other roles such as a consultant, where apparently you do not need hands. Although you have to create a lot of PowerPoints, which can be hard. So this, of course, could be a significant step down from the qualifications of this surgeon. Retail policies are able to cover own occupation. So if you're unable to perform your usual duties and your role, you will be eligible to claim on the TPD policy.

Jayamanne: As I mentioned, I used to work at that superfund and assisted in submitting claims. And I can tell you firsthand, these claims take an extended period to get processed and paid out.

LaMonica: Just the ones handled by you or all of the claims?

Jayamanne: Just the ones by me.

LaMonica: Okay, there we go.

Jayamanne: So you may not have a problem. This is due to several layers of approval that come with holding funds within super, where trustee must also approve the claim before funds are dispersed. It's one of the disadvantages of group insurance policies and worth keeping in mind if you or the beneficiaries of the policy, if that's not you, do not have a long runway of emergency funds in case of death, illness or injury.

LaMonica: I mean, you're making a lot of assumptions that the insurance companies outside of super are just handing out money as fast as possible.

Jayamanne: No, but in general, faster.

LaMonica: Okay, so two tips. Outside of super is faster if you're in super.

Jayamanne: Don't go with an insurance company that Shani works on.

LaMonica: Yeah, transfer to a different agent if Shani picks up the phone. Okay, so let's take a look at the other side of this at retail. So retail policies, you can customize, as we said, and they offer specific cover for the individual, which of course is you. The cover can be tailored to ensure that you are covered adequately and increase the chance of successful claims if the circumstances arise. So this flexibility also offers better and broader coverage. For example, with income protection, many group insurance policies are limited to two years. Retail policies can offer protection up to 65 years of age. If you're in a situation where you're unable to work due to a critical injury, it is likely that you will continue to suffer complications past that two-year period. Retail policies allow the peace of mind to protect yourself for the rest of your working life. So as mentioned, TPD policies can be taken out as any occupation with retail policies as well.

Jayamanne: And retail policies also have extra features, including inclusions for rehab support or wider inclusions for health conditions. And as there's no superannuation trustee claimants will usually experience a faster approval process, and payments of the funds are paid directly to the individual.

LaMonica: All right, you're ready for some more tax implications, Shani?

Jayamanne: Yeah.

LaMonica: Because you love insurance, but you also love tax.

Jayamanne: I know. The two most interesting parts of a financial plan. That was sarcasm.

LaMonica: I get it. I thought originally you were going to say the two most interesting parts of me. Like not me. You were going to say yourself because you're the one interested in it.

Jayamanne: Group insurance policies within super may be taxable depending on your circumstances. So this is mainly dependent on whether the beneficiaries of your policy are classified as tax dependent under super law. And I've written an article before on the differences and what qualifies. So we'll link that within the article that's in the episode notes, but you'll also just find it on the ATO website.

LaMonica: So in the case of TPD and death insurance, normally people call it life insurance, Shani, but Shani is calling it death insurance. The benefits are also split into taxable and tax-free components. Generally life insurance and TPD policies are not taxable for retail policies. Any income stream from income protection payments will be taxed as regular income in both group and retail policies.

Jayamanne: And look, the main point of this is like with many aspects of your personal finances, you do not have to pick a side. For some Aussies, the best solution may be to have a mix of super and retail policies. For others, it may be one or the other depending on cash flow and ability to afford premiums with post-tax wages, whether the coverage within super is adequate and the tax efficiency of both options. And as mentioned, insurance and super might also suit individuals that have pre-existing conditions that may not get approved retail cover.

LaMonica: And obviously, I think Shani mentioned this before, but particularly if you're younger, think about the impact that these premiums, these insurance premiums that you're paying, have on your superannuation balance over the long term. Taking premiums out of your super when you are young often results in a large opportunity cost for compounded earnings and growth. So we go through a detailed example of the impact in why you should take super seriously before a 35 episode. And if insurance within superannuation makes sense for an individual, it is worth considering replacing the insurance premium amounts through concessional or non-concessional contributions, of course, in that order, is concessional better. And one thing to add to this, somebody read your article, one of our colleagues, and she came up to you and she was like, I should cancel my insurance because I have insurance outside of super.

Jayamanne: Yes. Don't cancel your insurance unless you have a reason to do it, but yes.

LaMonica: There we go. So thank you guys very much for suffering through Shani's insurance discussion.

Jayamanne: Yeah, it wasn't great.

LaMonica: No, but it is something that obviously is important and can make a big difference. So we hope that helped. And once again, any comments, questions you have, Spotify, YouTube, or email to me.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)