Total and permanent disability, or TPD, is a great product but seems under-utilised with the clients I generally see.
“What is it and why should I care?” – I hear you ask.
Many of the clients that I see already have some personal insurance. Most people understand the concept of life insurance – it isn’t about life at all, it is about death – you die and your spouse/family/estate gets a lump of money to do what they will (presumably as you’ve wished it in your will – you do have a will, yes?).
The main challenge is, that statistically, people are far more likely to have some other health concern happen to them long before death occurs. The chance of death prior to 70 is lower than having some health complication that stops the person from going to work for an extended or permanent period. This is a key financial risk, loss of income to the household.
There has been a big drive in the industry to promote trauma covers (or critical care-type covers). These are also great products, but serve a very specific need. You need to have one of the 40-70 listed conditions occur for you to get a pay out from the insurer. To discuss these products will take another article and too long to do them justice here.
Looking at risk from the ‘income replacement’ perspective can take on a myriad of forms. “Hold up” [I hear you say]- “what do you mean ‘income replacement’ – ?”
As in the above example, the main income earner for the house has a car crash/stroke/heart attack and cannot work for the 9/12/24 months while they recover. They don’t have enough sick leave and holiday pay, with little savings in the bank. The income that the household was getting is now next to nothing (and don’t believe that ACC or WINZ will fill the gap). This is a massive risk, with 55,000 households every year losing their main income earner.
Every situation is different with different products helping to create the correct strategy. If you are unsure, speak with your adviser. That caveat in place, replacing income in a cost effective manner, that takes into account under-writing terms and successful claims, can be a minefield.
Enter stage-left TPD. Any vs Own …?
As the name suggests, TPD is when you are completely munted (a technical insurance term that I find gets the point across) and are unlikely to ever work again. You are totally and permanently disabled.
As with most things insurance – there is still yet another consideration; Own Occupation versus Any Occupation, which basically comes down to just how munted you really are.
I heard a story the other week which helps to highlight this. A barrister had a minor car accident. At first there didn’t seem to be a problem until this gentleman realised that his short-term memory was shot to pieces. He would walk to court, with the legal casefile under his arm, and forget which case he was supposed to be defending. He couldn’t remember enough of the details.
A medical professional certified that he was unfit to do his own occupation. In that instance, under that condition, he was paid out his lump-sum amount for TPD.
Now let’s consider if this barrister had taken TPD but with Any occupation as the option instead. Yes, he would be unfit to do his role as a lawyer. However, potentially, this gentleman would have been able to do low-skilled manual work. Therefore, in that scenario, he would not get his TPD benefit paid out.
How much do I insure for then with TPD?
Good question. I’ve heard different amounts and different types of theories. There is not a one-sized fits all method. This is where you need to check with your adviser again. However, let’s look at a couple.
I read an industry article today that said that people should have 4 times their household income in TPD insurance. I’ve read elsewhere that you should have 10 times your gross income. Neither is right or wrong (see the above caveat about taking good advice).
The lower amount will be more affordable, which automatically makes it more accessible to everyday people to have some cover. This lower amount may be viewed to allow the household some breathing space while they sell the family home, or make other arrangements (maybe the other people in the home start working more, so there is time for them to re-enter the workforce). It may be used to reduce the debt (typically the mortgage) therefore reducing the repayments, which frees up the household cash on a weekly basis. However, this is still a temporary solution. If you can never work again, what happens when that money runs out?
The larger amount, the 10x gross salary option, is typically designed to do something else entirely. It is meant to provide an ongoing cashflow, due to the lump sum being invested to give an annuity (ongoing) return. Most insurance firms have built-in to their products, financial advice benefits so that claimants can get good advice about the lump sum of cash they recieve. Let’s look at an example that I did recently for a 27 year male. We’ll call him Luke.
Luke is living in a city apartment, on his own so he does not have dependants, neither does he have a mortgage. His main concern is about his ability to earn an income. If he has an accident or some other health condition, he wants to still have money coming in to help him live through to retirement. Luke’s gross salary is $70,000. Any income that Luke gets from investments will still be taxed (although the rates may differ from his employee tax rate). The New Zealand and global stock markets have historically returned around 8-12% since 1970. Using an ultra conservative rate of return of just 7% would give us the following: $70,000 /7% = $1,000,000
Therefore, for Luke, we may agree that insuring himself for $1,000,000 TPD on his one occupation ,would allow him to live with the same financial conditions that he currently has, should he have a claimable event. If Luke is never able to work again in his role as an IT data warehouse technician, at least he will still have money (an income) until he dies. His $1,000,000 is invested at a 7% return giving him $70,000 a year, every year.
TPD isn’t contagious, in some ways I wish it were. New Zealand faces a massive problem with people being under-insured, which places the burden back on society, family and the community to help when things go wrong.
If you don’t have a financial adviser, or if you want to discuss some of these points further, please let me know. I’d be happy to help or in the least, have a chat.