When creating a comprehensive financial plan, it’s crucial to consider not just wealth accumulation, but also protection against unforeseen circumstances. While many focus on life insurance, another critical component of financial protection is Total and Permanent Disability (TPD) insurance.
TPD insurance provides a lump sum payment if you become totally and permanently disabled due to illness or injury, leaving you unable to work again. It’s a safety net that can help maintain your lifestyle and provide for your family when you’re no longer able to earn an income.
TPD insurance is often overlooked. Many people insure their cars, homes, and even their pets, but fail to protect their ability to earn an income – arguably their most valuable asset.
In this article, we will explore TPD insurance to help you understand what it is and how it works.
What is TPD Insurance?
TPD insurance provides a lump sum payment if you become totally and permanently disabled and are unable to work again in either your own occupation or any occupation for which you’re reasonably suited by education, training, or experience.
It’s different from Income Protection insurance, which provides ongoing payments if you’re temporarily unable to work. TPD insurance is designed for more severe, permanent disabilities that prevent you from ever returning to work.
The primary components of a TPD insurance policy are the sum insured, the definition of TPD, and how the policy is structured. Let’s examine each of these in detail.
Sum Insured
The sum insured is the amount that will be paid out if you become totally and permanently disabled. This is the core component of your TPD policy.
Your sum insured should be based on a Risk Needs Analysis. This calculation is individual to everyone’s specific circumstances and considers how much cover you would need in the event you were unable to ever work again.
It is common to get a default level of TPD Insurance provided when a superannuation fund is established. However, this may not be enough to cover your needs, and the premium may be above market rates. It is important you review the default cover and replace it with a tailored policy if needed. We discuss group vs retail insurance later.
Calculating your level of TPD Insurance
When considering your Risk Needs Analysis, you should take into account the following:
- Debts to be repaid;
- Income to be replaced;
- Expenses to be covered;
- Potential medical bills / rehabilitation costs; and
- Home modification costs.
You can offset the amount of cover you need by the existing assets you have. For instance, superannuation may be paid out in the event you meet the any occupation definition, and therefore you may decide to offset the amount of cover you need with your superannuation balance.
Also, there is potential overlap between Income Protection and TPD cover. Income Protection should also pay out in the event of a TPD claim and so you may decide to offset the amount of TPD you need with the Income Protection benefit.
Where the TPD policy is funded outside of superannuation, there is no tax payable on the benefit. Where the policy is funded inside superannuation, there may be tax payable upon accessing the benefit, dependent on your date of birth. Tax implications need to be factored into your Risk Needs Analysis.
Definition of TPD
The definition of TPD is crucial as it determines under what circumstances you can claim. There are generally two types of definitions:
- Any Occupation: You’re considered totally and permanently disabled if you’re unable to work in any occupation for which you’re reasonably suited given your education, training, and experience.
- Own Occupation: You’re considered totally and permanently disabled if you’re unable to work in your own occupation, regardless of whether you could work in another occupation.
The own occupation definition is generally more comprehensive but also more expensive. It’s particularly valuable for those in specialised professions. For instance, if a surgeon lost movement in her hand, it is unlikely she would be able to perform surgeries. However, her extensive knowledge and training would mean that there are many other suitable roles she could do such as mentoring and consulting.
There are other TPD definitions such as “home duties” or “activities of daily living”. These are typically more restrictive and should be avoided where possible. If you have a very high-risk occupation category (such as an underground miner), you may be limited to these restrictive definitions.
Structuring TPD Insurance
An any occupation TPD policy can be structured inside or outside of superannuation.
If you choose to structure your Life Insurance inside super, the premiums will be paid from your superannuation fund. If you structure it outside super, you’ll pay the premiums personally.
It is important to note that when structuring TPD insurance through superannuation, you are not limited to the default cover offered by your super fund. You can shop the cover around and have the premium funded via an enduring rollover.
Superannuation ownership helps reduce the impact of premiums on your cashflow. In addition, your super fund will be eligible to claim a tax deduction for paying the premium. By paying the premium via rollover, the tax deduction will be given upfront, and only the net cost of cover will be rolled over.
However, premiums deducted from your superannuation will have an eroding effect on your retirement savings and any additional super contributions will count towards your contributions cap. Also, there are the tax implications to consider which we discussed previously.
An own occupation definition can only be structured outside of superannuation. There are some policies that provide a split TPD definition with the any occupation component paid from super, and the additional cost to have an own occupation definition funded personally.
The right choice depends on your individual circumstances, including your cashflow, superannuation balance, and overall financial strategy.
How much does cover cost?
The cost of TPD insurance varies based on factors including age, gender, occupation, health status, smoking status, and the amount of cover.
For instance, a young, healthy non-smoker in a low-risk occupation will generally pay less than an older smoker in a high-risk job. This is because the insurer assesses the likelihood of a claim based on these factors.
Occupation is particularly important for TPD insurance. High-risk occupations like underground mining or construction will typically incur higher premiums than office-based roles.
All insurers price their policies slightly differently, so it’s important to compare options to find the best deal for your situation.
Stepped vs level premium
TPD Insurance premiums can be structured as either stepped or level premiums. Stepped premiums start lower but increase with age, reflecting the rising risk to the insurer. Level premiums start higher but remain relatively stable over time, increasing only with inflation or changes to the insurer’s rates.
The choice between stepped and level premiums depends on your personal circumstances and how long you expect to need coverage. Stepped premiums may be more cost-effective for short-term needs, while level premiums can be beneficial for long-term coverage.
Typically, we do not recommend level premiums as insurance is there to fill a short-term need. As your net asset position grows, you should require less cover. This strategy of reducing your cover as your wealth grows, goes against the reasoning behind locking in a level premium.
There are some TPD insurance policies where the premium remains the same, but the level of cover automatically reduces as you get older. This is common in the default insurance policies offered by industry super funds. Our preference is that the policy owner remains in-charge of the sum insured so it can remain appropriate for their needs.
Applying for cover
There are two main ways to obtain TPD Insurance: through group insurance (often via superannuation) or retail insurance. While group insurance can be convenient, retail insurance often offers more comprehensive and tailored coverage.
Retail TPD Insurance policies are medically underwritten at the time of application. This means you’ll need to provide detailed information about your health and lifestyle. While this process takes longer, it provides greater certainty at claim time because any pre-existing conditions have already been assessed.
To get a retail policy, consider speaking with a Financial Adviser. Advisers have access to a wide range of insurance products and can provide guidance on how much cover you need and how to structure it effectively. If you would like our assistance, please visit Personal Insurance where you can get the process started.
The underwriting process
The underwriting process involves answering questions about your medical history, usually either with your adviser or directly with the insurer via a telephone interview.
Depending on your medical history and the amount of cover you’re applying for, you may need to undergo medical tests or provide reports from your doctor. This helps the insurer accurately assess the risk of insuring you.
If you have pre-existing medical conditions, the insurer may apply a loading (increased premium) or exclusion (specific conditions that aren’t covered) to your policy. For example, if you have a history of back problems, the insurer might exclude claims related to back injuries.
It’s generally easier to obtain comprehensive cover when you’re younger and healthier, before developing any significant health issues. This is why we recommend considering TPD Insurance early in your career.
Linking TPD to Life Insurance
Where you have a Life Insurance policy in place, you may be able to link the TPD cover to Life Insurance, reducing the overall cost of your protection package.
Under a linked arrangement, the level of TPD cover cannot exceed that of Life cover. In addition, if you make a claim under TPD, the level of Life cover will be reduced by the amount of TPD claim. Retail policies have the option to include a Life cover buy back option, which will allow you to reinstate the level of Life cover in the event of a TPD claim.
The Guided Investor approach
TPD Insurance is a crucial part of a comprehensive financial plan. We include personal insurances in the ‘financial housekeeping’ of Phase 1 of Wealth Creation, when we are creating a solid financial foundation. It is an essential part of your overall protection package alongside Life, Trauma and Income Protection.
