How Life Insurance Works: A Step-by-Step Guide to Key Decisions
What “life insurance” means
“Life insurance” is a general term used for a range of insurance covers that look after you if something unexpected happens to your body or mind. These covers are designed to protect your quality of life and the future you’ve planned for your loved ones. Because the category includes different types of insurance that protect you in different ways, understanding what each cover is intended to do is a useful starting point.
Step 1: Identify which types of cover you may need
Each insurance protects your life in a different way. The first decision is to consider which types of insurance you need to help you live the life you’ve planned. This decision is personal: everyone’s life and budget is different, and the mix of cover that suits one person may not suit another.
As you think this through, focus on the purpose of cover: protecting the people you love and supporting your quality of life if you experience serious health impacts. The goal is to understand what you want the insurance to do for you, rather than simply selecting a product name.
Step 2: Decide how much you want to be insured for
Once you have a sense of the types of cover you may need, the next step is to consider how much you want to be insured for. Because budgets differ, this is an important part of the decision-making process. The amount of cover you choose influences how much protection is available if you need to claim, and it also affects the premiums you pay.
Step 3: Understand how benefits are paid
Different covers can pay benefits in different ways. Some benefits are paid as lump sums, while others are paid over time.
Lump-sum benefits: Life Insurance cover, and Critical Illness or Trauma Insurance are paid as lump sums.
TPD (Total and Permanent Disability): TPD is usually paid as a single lump sum, but partial payments can apply under the TPD Support Option (TSO).
Income Protection Insurance: Income protection involves a waiting period before benefits start accruing and a benefit period that sets the maximum time payments may be received.
How TPD payments may work under the TPD Support Option (TSO)
TPD is usually paid as a single lump sum, but the TPD Support Option (TSO) can change how claims are assessed and paid when TPD is contributed to or caused by a TPD Support Condition (such as a mental condition or disorder, fatigue or functional disorder, or other specific syndromes or disorders).
Under TSO, claims are assessed using definitions of Total and Permanent Disability applicable to TSO. This uses a definition that is similar to an “Any Occupation” definition. If TSO applies, the definition you selected for your TPD policy (Own or Any Occupation) will not apply.
Where TPD is contributed to or caused by any TPD Support Condition, partial payments (20% of the TPD Benefit Amount) are made at 12-month intervals. These partial payments are subject to meeting the TSO Total and Permanent Disability requirements for each partial payment, and continue until the Benefit Amount is paid in full.
Claims for TPD that are not contributed to or caused by any TPD Support Condition are assessed once using the definition you selected (for example, Any or Own Occupation). If eligible, the benefit is paid as a single lump sum.
Step 4: Learn how waiting periods and benefit periods affect income protection
If you are considering Income Protection Insurance, two key features are the waiting period and the benefit period.
Waiting Period: The waiting period is the length of time you have to wait after an injury or illness that stops you from working before you start accruing Income Protection Insurance benefits. It could be 4, 6, 13, or 26 weeks. Shorter waiting periods generally cost more in premiums.
Benefit Period: The benefit period is the maximum length of time you could receive your Income Protection Insurance payments. The longer your benefit period, the higher your premium.
These two settings are central to how income protection is structured. They shape both the timing and duration of payments, and they can have a direct impact on premium cost.
Step 5: Consider how to structure your policy
To get an insurance plan that is right for you, it can also help to consider how best to structure the policy. Two common premium approaches are variable age-stepped premiums and variable premiums.
Variable Age-Stepped Premiums: These are calculated based on your age at each policy anniversary and the length of time you have had your policy. This means your premium will generally increase at each policy anniversary. There are a range of reasons why variable age-stepped premiums may increase.
Variable Premiums: These are based on your age at the plan start date.
Understanding how premiums are calculated can make it easier to plan for changes over time and to choose an approach that aligns with your budget preferences.
Step 6: Review ownership options
There are different ownership options available depending on the plan you choose. The type of ownership can determine how premiums are funded and may have different tax implications in respect of the premiums and benefits paid. Because ownership can affect how a policy operates in practice, it is another important part of structuring cover.
Bringing it together: the key question to guide your decision
After working through types of cover, benefit styles, waiting and benefit periods, and policy structure, it can help to return to the most important question: how will life insurance help you protect those you love or assist your return to wellness, so you can continue to make the most of your life?
Keeping that question in focus can help you choose cover that matches your needs, your priorities, and your budget, while also clarifying what you expect the insurance to do if you ever need to claim.