What Is Life Insurance And How Does It Work?

Leaving our loved ones in a financially precarious situation is a daunting prospect. However, life insurance, otherwise known as death cover, or term life insurance, can be a financial safety net. It will pay out once you die, to keep your family afloat. You’ll need to pay either fortnightly, monthly or annual premiums for a policy in order for your elected beneficiaries to receive a lump sum payout. You may receive a discount for paying annually.

Certain policies will also pay out when you’re living, if you’re diagnosed as terminally ill, or develop a chronic or critical condition. They may also pay out if a permanent disability leaves you unable to work, as long as you’ve paid for this particular benefit. Additionally, there may be other forms of protection included. All benefits and exclusions or limitations on cover will be outlined in the product disclosure statement.

You can read more in our pick of the best life insurance providers in Australia.

If you’re the breadwinner for your family, or if you have dependents, you may worry how they will survive once you’re not around.

Life insurance is designed to provide them with crucial funds for costs they may otherwise struggle to cover themselves, freeing them of potential financial worry, at what will already be a very difficult time.

There are four main types of life insurance to consider:

• Term life insurance or ‘death cover’: pays a lump sum to your beneficiaries if you die, and depending on the policy, if you are diagnosed with a terminal illness
• Total and permanent disability cover: Available to take out alongside your life insurance policy or as a standalone product. It pays out should you suffer serious illness or a severe injury that leads to permanent disablement. Many Australians already have access to some form of TPD cover via their super fund.
• Critical illness cover: Pays a lump sum in the event you are diagnosed with a serious medical condition such as cancer or heart disease.
• Income protection: Should an injury or illness prevent you from working, it pays out up to 90% of your pre-tax income in the first six months and up to 70% for a specified time after this period.

Depending on the insurer’s offering, and how you choose to tailor your policy, your cover could also include the following benefits:

Advanced Payment

When you die, your loved ones will have to make a claim to receive a payout, and this will need to be assessed by the insurer. As assessments can take up to two months, an advanced payment benefit can help tide your family over by providing a certain amount to them up front. This could be as high as $20,000 to $25,000 but will depend on your provider.

Inflation or Indexation

This benefit increases the sum insured in line with CPI annually, as a way to protect the policyholder against the cost of living.

Financial Planning

This benefit will cover the costs of a financial advisor, for the person insured on the policy, or their loved ones. It usually covers a maximum amount per year, or per consultation.

Grief Counselling

If you or your family need grief counselling after a terminal diagnosis or your death, the policy will reimburse the cost, up to a maximum stated number of sessions.

Future Insurability

With this benefit in place you will be able to increase your cover, should you require, without needing to provide proof of health or insurability.

Repatriation

This benefit pays out should you die while travelling abroad, covering the costs to bring you back home. Comprehensive travel insurance policies can also include this benefit, should you choose not to add it to your life insurance.

Premium Pause

You can pause your policy for a stated amount of time, typically for up to 12 months. During this period you won’t need to pay policy premiums.

Usually policyholders can only take a premium pause a set amount of time after taking out the policy, and will not be able to claim for any event that occurs during the pause period or potentially for some time after it has come to an end.

Child’s Critical Illness

If you have chosen this benefit, your policy will pay out if your children suffer a critical illness.

Remember to check with the insurer what it classifies as a critical illness, the maximum benefit paid, and the age limit on this form of cover.

You may choose to take out life insurance for any number of the following reasons:

For your beneficiaries to cover:

• the mortgage
• day-to-day costs
• funeral costs.

Ultimately, the goal may be for your loved ones to be able to continue paying the bills, or the mortgage, and stay living in the family home. There may be other wants and needs of theirs that you would also want your policy to cover.

Life insurer NobleOak conducted a survey of 1,000 Australians in 2022. It asked them their main reason for taking out life insurance or income protection, and found some 58% of respondents wanted to provide financial security for their family and 13% wanted to protect their home or pay off the mortgage. A slightly smaller percentage said they either wanted to maintain their lifestyle or provide a future income stream (both 12%). Meanwhile, 4% of respondents wanted to ensure their children’s education.

Some Superannuation funds include default life insurance. Before taking out a policy, you may want to check exactly what your superannuation fund offers to avoid paying twice for similar protection. Some funds also provide income protection and TPD cover.

Premiums through your superannuation fund are often lower than if you were to opt for specialist cover, but are paid out of your super balance which will eat into your retirement savings.

Furthermore, life insurance through super is often more basic than the cover provided by specialist insurers, and typically only lasts until the policyholder turns 70. If cover is insufficient you could take out extra insurance. Specialist cover generally continues as long as the insured person pays the premiums.

It is important to refer to each policy’s fine print for exclusions as these can differ greatly between them.

Generally, it’s common for life insurance to refuse claims resulting from the policyholder dying from suicide, for a period of typically 13 months from the policy start date.

There will also be specific exclusions relating to the specific benefits you have opted for on your policy, for instance, if you have Total and Permanent Disability (TPD) insurance or trauma benefits.

Also remember that insurers usually apply an upper age limit to their policies, in terms of who they can cover on new policies, and until when they can cover their existing policyholders.

Your beneficiaries will receive lump sum payouts from life insurance policies, trauma insurance and TPD cover. Income protection usually provides a monthly payment.

Taking all the above into account, there’s no denying that choosing the right life insurance policy that suits you and your family’s needs can be tricky.

The Australian Securities & Investments Commission’s Moneysmart site recommends considering the following before signing up for a policy:

• the cover included and any limitations or exclusions
• the information you’ll need to give the insurer, including medical details
• the cost of the cover and how this may change over time
• waiting periods applied before you make a claim
• how to make a claim
• how to complain about the claims process or the outcome of a decision

You may also want to look through our best picks for life insurance.

The cost of your policy will depend on the type of cover you need and any optional extras you choose.

Other factors that contribute to how a policy is priced are:

• Age: The younger you are the less you’ll pay for a policy. This is because there’s less risk of a younger person dying soon, and their beneficiaries needing to claim.
• Sex: Men typically have to pay more than women for cover as they usually have a shorter life expectancy. According to the Australian Bureau of Statistics (ABS) men usually have a life expectancy of around 81 years compared to just over 85 years for women.
• Health: Your insurer will take into account any past and current medical conditions to work out your life expectancy. Those who are likely to live longer often pay less.
• Lifestyle: Hobbies such as scuba diving, dangerous occupations, a history of reckless driving and a criminal record can all drive up life insurance rates.

We look at what life insurance could cost in our dedicated guide. You can also use the life insurance calculator on the Moneysmart website to gauge what you likely would have to pay.

In order to estimate the amount of cover you need try:

1. Adding up all the expenses you have to cover, or the funds you need. You may need to cover mortgage repayments and children’s college fees or need income to replace your work salary.
2. Once you have the total, subtract any amounts your loved ones can cover themselves, due to savings or existing life insurance. Exclude retirement savings if your partner will need these later on.

The amount you’re left with is what you’ll need in life insurance. If you’ve accounted for income replacement over a span of years, it’s likely to be high, but try not to let this put you off running quotes for cover. Doing so is free, and you may be surprised by what’s on offer once you’ve had a good look around.

If you can’t find any affordable deals, you can purchase cover that falls within your budget and add to it at a later date. However, it’s worth noting that premiums will potentially rise down the line, to reflect you being older and any health conditions you may have developed.

You can run quotes for life insurance for free online. The first step will involve answering questions about your age, health (including whether you smoke), your family health history, any dangerous occupations or hobbies and your driving record.

Once you’ve found a suitable quote, you can apply formally for cover. This will involve answering more questions in more depth. You will also need to specify details such as the type of policy you want and the amount of cover you need. Some insurers may also require you take a life insurance medical exam, but not all.

A life insurance beneficiary is someone you nominate to receive the death benefit after you pass away, and any other benefits your policy offers. If you don’t have beneficiaries in place, your estate will decide what happens to the money.
You can choose multiple beneficiaries, who will each receive a percentage of the payout when you die. You can also add contingent beneficiaries; they will receive the death benefit should your primary beneficiaries die before you.

Alternatively, some name trusts as their life insurance beneficiaries. This will ensure the money is used as you wish, such as specifically to take care of children.

It’s important to work with an attorney and a financial planner when structuring the trust, so it’s done correctly and as part of your larger financial plan.

You’ll want to review your beneficiary selections regularly, and update them, if need be. Events such as having children, or getting married or divorced may be a reason to change them. You can update your beneficiaries by contacting your life insurer and submitting a change of beneficiary form.

Your beneficiaries can take these steps to claim on your life insurance:

• Submit a copy of a death certificate: They’ll need to provide the insurer with a certified copy of the death certificate. Note that the insurer will keep this, so they may want to request multiple certified copies to keep for anything else.
• Contact the insurer straight away: This will probably be the last thing your beneficiaries want to think about. However, it will be important if they’re depending on the payout and need it as soon as possible.
• Verify meeting all requirements: They will need to attach all supporting documentation, such as a death certificate, to the claim paperwork.

Calling the insurer is key, as it is unlikely to know when a policyholder has died.

There are no restrictions on how beneficiaries use life insurance payouts. They may want to use the sum to:

• pay for the funeral and other related expenses
• cover everyday household expenses
• pay off a mortgage or other debts
• fund the children’s education
• maintain a family business.