Insurance glossary. Contents

Transcription

1 Contents Overview of life insurance, terminology and benefits... 2 Overview of the five risk products... 2 Traditional insurance policies... 4 Common life insurance terminology... 5 Common policy benefits... 9 Common policy options... 9 The five risk insurance products Term life Total and permanent disablement Insurance Non-occupational TPD definitions Trauma Income protection Definitions Business Insurance Buy-sell insurance Business Expense cover or BOC Overview of retirement incomes Types of income streams Term certain income streams (from 20 September 2007) Advantages Disadvantages Lifetime income streams Advantages Disadvantages Term allocated pensions (TAPs) Advantages Disadvantages Account-based pensions (allocated pensions) Advantages Disadvantages Commonly used annuity terminology Insurance bonds Advantages Disadvantages Page 1

2 Overview of life insurance, terminology and benefits Overview of the five risk products There are five main risk insurance products: term life, total and permanent disablement (TPD), trauma, income protection and business expenses. Term life insurance Term life insurance pays a lump sum to the policy owner (or their beneficiaries) on the death of the life insured. Term life can be owned as an ordinary policy or through superannuation, premiums are offered on a stepped or level basis and there are future insurability provisions. Most policies provide a terminal illness benefit. The two chief exclusions are for any preexisting conditions not disclosed at time of application and suicide in the initial 13 months after policy commencement. Total and permanent disablement insurance TPD insurance pays a lump sum to the life insured if they suffer a total and permanent disablement and are unable to work again. There are two key occupation definitions of TPD, own or any, and the definition chosen will have impact at claim time. TPD is commonly attached as a rider to a term life policy, meaning it is bundled together with that policy and the claim amounts are linked to each other. Alternatively, TPD can be issued as a stand-alone policy, which means any TPD claim will not impact on the term life benefit. Trauma (also known as critical illness and dread disease) Trauma insurance pays a lump sum to be life insured if they suffer an illness or traumatic event as defined by the policy. Common traumatic events covered are heart attack, coronary artery bypass surgery, stroke and cancer. More complex (and expensive) policies cover far more than the basic events. Similar to TPD, trauma can be issued as a rider to a term life policy or issued on a stand-alone basis. One of the options available is child trauma cover, where children aged from two to eighteen can be covered on an adult insured s policy for events such as cancer, leukaemia, organ transplants and paralysis. Income protection insurance Income protection insurance pays an income stream benefit if the insured, upon suffering a disabling event, is unable to continue generating personal exertion income. There are two definitions of disability, total and partial. Total disability means that the insured is unable to perform one (or more) of the duties of their occupation and a full benefit is payable. Partial disability means the insured can commence work with fewer hours or at a reduced level, and the benefits received are adjusted accordingly. Page 2

3 Benefits are paid up to 75% of pre disability income and benefit periods vary from two years to age 65. Waiting periods (the time between the disablement and benefits commencing) are also variable and range from 14 days to 2 years. The shorter the waiting period (say 14 days) and the longer the benefit period (say to age 65), then the more expensive the premium. Business expenses insurance Business expense insurance pays a benefit to business owners who suffer a disabling event. It covers expenses incurred by the business to ensure it can operate while the insured is unable to work. Benefit period range from 12 to 18 months or until a benefit pool is exhausted. Waiting periods also apply from 14 days to 90 days. Common expenses that may be insured includes wages for non-income generating staff, business insurance, subscriptions and professional fees, advertising, leases and principal and/ or interest (only) on loans. Page 3

4 Traditional insurance policies The two main traditional insurance policies are whole of life and endowment and they contain both an insurance and investment/savings element. Unique features of permanent insurance not found in current product offers include: Surrender (cash) value Policy loan Non-forfeiture Paid up policy convertibility These policies are no longer issued in Australia. Endowment insurance policies that have a fixed term maturity date such as 10,15 or 20 years or set to mature at a specific age such as 18 or 21, as was commonly the case with child endowment policies Whole of life insurance policies that have a premium ceasing date greater than age 65 and commonly to 85 years with cover generally continuing to a later point, such as age 95. Page 4

5 Common life insurance terminology A B F G Age limits All policies have entry limits based on the minimum and maximum ages that a person may apply for the policy. There are also expiration ages, where at a set age certain (or all) benefits expire under the policy. Benefit indexation Most insurance companies will offer indexation of the sum insured to Consumer Price Index (CPI) on an annual basis at the time of the policy anniversary. The policy owner holds the right to refuse this indexation. A minimum rate of indexation may also be provided, whereby the greater of the CPI or that stated minimum (generally between 3 and 5 per cent) will be offered. Future insurability Most term life and TPD policies provide for future increases in cover, with limited application requirements, so that future increases are made relatively simple. This benefit allows an easy way to increase cover at times when it is needed as only proof of a listed event (such as birth of a child) is required, saving the need for full assessment of the health insured. Changes in the policyholder s health are also not assessed, making it possible to increase cover even if their health has deteriorated since initially taking out the policy. These are generally available for personal and business purposes. Guaranteed renewable Guaranteed renewable means the policy is automatically renewed on each policy anniversary (on an annual basis) up until the age limit specified on the policy, provided that premiums are paid when due. Page 5

6 I Indemnity versus agreed value Income protection policies may be issued as agreed value, guaranteed agreed value or indemnity. An agreed value policy means that the insured monthly benefit, plus any indexation increases, will be payable at the time of claim regardless of any reduction in the insured s income since commencing the policy. Guaranteed (or financial endorsed) agreed value contracts are those where sufficient financial information has been provided prior to the commencement of the policy to allow a claim for total disablement to be paid without further financial justification. Where this financial endorsement or guarantee does not apply, financial justification for the insured benefit may be sought at the time of claim. In all cases, financial information may be sought in the event of a partial disablement claim. In simple terms, providing full financial information at the commencement of a policy makes it less likely that financial evidence will be sought at the time of claim, particularly for claims where the insured is totally disabled and not working. Indemnity policies provide a limit on the benefit payable, such that at the time of claim, the maximum benefit payable is a factor of the income the insured has earned (generally) in the 12 months leading up to claim. This means that if the insured has suffered a drop in income since taking out the policy, that the benefit payable may be less than the insured monthly benefits. Indemnity policies usually cost less than agreed value policies, and may be a discount option on a standard policy. Insurance policy The contract to which both parties policy owner and insured have agreed. The policy lists the terms and conditions and provides the details on when the insured is entitled to claim under the policy. Interim cover Most policies offer interim cover while an application for insurance is being assessed. The cover offered can have a number of limitations, including: In most cases cover is only provided for accidents The sum insured may be capped to an amount which is less than that applied for Certain pursuits and pastimes may be excluded Cover is generally limited to a certain number of days, which may expire while the application is still being assessed Page 6

7 L P Life insured The person whose death or disablement gives rise to a claim. Policy owner The person/s, company or trust that has legal ownership over the policy. In most cases the life insured is also the policy owner, but this may vary in circumstances where ownership via a superannuation trust is desired or in some business insurance scenarios. Policy schedule A summary of the benefits covered under the insurance policy. While the policy details the policy conditions, the schedule provides the specific details relevant to the individual policy owner. These include the name and particulars of the life insured and the policy owner, the benefits, the sums insured and premiums for the insured benefits. Where special conditions apply, for example, any limitations or exclusion, these would also be details in the policy schedule. Premium The amount to pay for the benefit/sum insured, which is due on a yearly or more regular basis (eg. monthly) to ensure the policy stays in force. Q R Qualifying period This generally refers to the period that must expire before certain benefits become payable. Rider versus stand-alone Linked refers to benefits that interact in the event of claim, for example, a TPD benefit may be linked to term life cover, which means that upon a TPD claim, the life cover amount will be reduced by the TPD claim amount. Stand-alone benefits refer to benefits that do not interact in the event of claim for example, a trauma benefit may be on the same policy as a life cover amount, but as a stand-alone benefit. In this case, a trauma claim will not have the effect of reducing the life cover amount. Stand-alone benefit generally cost more than comparable linked benefits. Page 7

8 S Sum insured The benefit amount paid upon a claim. For income protection policies it is commonly referred to as a monthly benefit. Stepped versus level premiums Life insurance premium levels are calculated according to mortality risk. Mortality risk is the likely risk of death for a person at a particular age. As the insured ages, so does their mortality risk, meaning the premium must increase to reflect the increased risk. The premium increase is in steps over the term of the policy, giving risk to the concept of a stepped premium. There is an alternative to stepped; level. This is where the premium rates that are paid are set at the same rate for when the insured commenced the policy. While this means the policy holder will pay a higher initial premium, it does ensure that the premium rate will stay level over the period (usually until age 65, where the premiums revert to a stepped structure). A key advantage of level premiums is that of client retention ie. the insurance is more likely to stay in place and continue to be renewed by policy holders, rather than steeply climbing stepped premium that can become unaffordable after a period of time. W Waiting period This term generally refers to the period of time the insured must be disabled before being eligible for benefit payments under income protection or business expense policies. Page 8

9 Common policy benefits Guaranteed renewable Guaranteed renewable means the policy is automatically renewed on each policy anniversary (on an annual basis) up until the age limit specified on the policy, provided that premiums are paid when due. Interim cover Most policies offer interim cover while an application for insurance is being assessed. The cover offered can have a number of limitations, including: In most cases cover is only provided for accidents The sum insured may be capped to an amount which is less than that applied for Certain pursuits and pastimes may be excluded Cover is generally limited to a certain number of days, which may expire while the application is still being assessed Common policy options Stepped versus level premiums Life insurance premium levels are calculated according to mortality risk. Mortality risk is the likely risk of death for a person at a particular age. As the insured ages, so does their mortality risk, meaning the premium must increase to reflect the increased risk. The premium increase is in steps over the term of the policy, giving risk to the concept of a stepped premium. There is an alternative to stepped; level. This is where the premium rates that are paid are set at the same rate for when the insured commenced the policy. While this means the policy holder will pay a higher initial premium, it does ensure that the premium rate will stay level over the period (usually until age 65, where the premiums revert to a stepped structure). A key advantage of level premiums is that of client retention ie. the insurance is more likely to stay in place and continue to be renewed by policy holders, rather than steeply climbing stepped premium that can become unaffordable after a period of time. Rider versus stand-alone Linked refers to benefits that interact in the event of claim, for example, a TPD benefit may be linked to term life cover, which means that upon a TPD claim, the life cover amount will be reduced by the TPD claim amount. Stand-alone benefits refer to benefits that do not interact in the event of claim for example, a trauma benefit may be on the same policy as a life cover Page 9

10 amount, but as a stand-alone benefit. In this case, a trauma claim will not have the effect of reducing the life cover amount. Stand-alone benefit generally cost more than comparable linked benefits. Future insurability Most term life and TPD policies provide for future increases in cover, with limited application requirements, so that future increases are made relatively simple. This benefit allows an easy way to increase cover at times when it is needed as only proof of a listed event (such as birth of a child) is required, saving the need for full assessment of the health insured. Changes in the policyholder s health are also not assessed, making it possible to increase cover even if their health has deteriorated since initially taking out the policy. These are generally available for personal and business purposes. Indemnity versus agreed value Income protection policies may be issued as agreed value, guaranteed agreed value or indemnity. An agreed value policy means that the insured monthly benefit, plus any indexation increases, will be payable at the time of claim regardless of any reduction in the insured s income since commencing the policy. Guaranteed (or financial endorsed) agreed value contracts are those where sufficient financial information has been provided prior to the commencement of the policy to allow a claim for total disablement to be paid without further financial justification. Where this financial endorsement or guarantee does not apply, financial justification for the insured benefit may be sought at the time of claim. In all cases, financial information may be sought in the event of a partial disablement claim. In simple terms, providing full financial information at the commencement of a policy makes it less likely that financial evidence will be sought at the time of claim, particularly for claims where the insured is totally disabled and not working. Page 10

11 Indemnity policies provide a limit on the benefit payable, such that at the time of claim, the maximum benefit payable is a factor of the income the insured has earned (generally) in the 12 months leading up to claim. This means that if the insured has suffered a drop in income since taking out the policy, that the benefit payable may be less than the insured monthly benefits. Indemnity policies usually cost less than agreed value policies, and may be a discount option on a standard policy. Benefit indexation Most insurance companies will offer indexation of the sum insured to Consumer Price Index (CPI) on an annual basis at the time of the policy anniversary. The policy owner holds the right to refuse this indexation. A minimum rate of indexation may also be provided, whereby the greater of the CPI or that stated minimum (generally between 3 and 5 per cent) will be offered. Page 11

12 The five risk insurance products Term life The function of term life insurance is to pay a lump sum in the event of the death of the life insured. Policies will also offer a terminal illness benefit, which provides an advancement of the death benefit in the event that the life insured is unlikely to live (longer than 12 months). Term life insurance is offered on a guaranteed renewable basis, meaning that, once issued, the insurer can t cancel or alter the contract without the policy owner s consent. Term life insurance: Is usually annual renewable with no cash or surrender value Typically provides payment of lump sum benefits May be offered as an ordinary policy or via superannuation Offer optional benefits (linked or stand-alone) that can be added to protect against the financial consequences of TPD or trauma Premiums are offered on a stepped or level basis, with insurers generally happy to offer cover after age 65 on a stepped basis only (up to age 99). Most inforce policies are on a stepped basis Cover is provided worldwide Policy benefits and conditions Most term life policies include a number of standard conditions and standard or optional benefits including: Terminal illness benefit Riders Age limits Policy exclusions Limitation on the sum insured Future insurability Terminal illness benefit Terminal illness cover is an advancement of the death benefits (that is, it reduces the life cover by any amount of benefit paid) when the insured is diagnosed with a condition that is incurable and likely to result in death within a defined period of time (usually 12 months) Page 12

13 Riders TPD and trauma covers can be attached to term life policies as a linked benefit or a rider. Where the policy is owned by a superannuation fund, generally only TPD benefits may be added (as trauma cover is not normally available through superannuation). Insurers may offer additional options which can be added to the term life policy. Age limits The insured must usually be between 16 and 70 at the commencement of the policy. A child aged between 10 and 15 can take out term life cover, but must have parent or guardian authorisation. Policy exclusions There are a few standard policy exclusions, and they vary across insurance companies. Suicide and pre-existing conditions are two standard exclusions: Suicide cover is not provided where the insured commits suicide within 13 months of policy commencement. Pre-existing conditions cover is not provided for pre-existing conditions not disclosed at the time of application. Sum insured There is no current industry maximum limit amount for term life cover, although large sums insured over $10 million may involve significant further financial and medical underwriting. At all sum insured levels it is important to demonstrate that the policy owner (or their beneficiaries) would suffer a loss commensurate with the sum that was insured for the life insured. Future insurability Most term life and TPD policies provide for future increases in cover, with limited application requirements, so that future increases are made relatively simple. This benefit allows an easy way to increase cover at times when it is needed as only proof of a listed event (such as birth of a child) is required, saving the need for full assessment of the health insured. Changes in the policyholder s health are also not assessed, making it possible to increase cover even if their health has deteriorated since initially taking out the policy. These are generally available for personal and business purposes. Page 13

14 Additional policy extensions There are some additional policy extensions that can be offered some at no extra cost or others may be an additional charge. Indexation benefit Guarantee of upgrade Funeral expense advancement Accidental death Business future insurability Child trauma cover Premium waiver Financial Planning Benefit Cash Back option Page 14

15 Total and permanent disablement Insurance Total and permanent disablement (TPD) cover is a lump sum benefit payable on the total and permanent disablement of an insured person. A TPD can often mean that the life insured is unable to ever work again due to sickness or injury. There are a number of TPD definitions: Any occupation requires the insured person to be unlikely (or unable) to ever be able to be gainfully employed in any occupation for which they are reasonably suited based on their education, training or experience. Own occupation requires the insured person to be unlikely (or unable) to ever be gainfully employed in their own occupation. The definition is relevant for those insured persons with occupation that are particularly specialised, such as materials engineers or professional musicians. Home duties these definitions are in place to cater for those working in the home and/or caring for children and family. Home duties definitions commonly require the insured to be unlikely (or unable) to perform any domestic duties or be engaged in any occupation for which they are reasonably suited by their education, training or experience. Home duties may be further defined as: Inability to perform household duties Being confined to home A loss of physical ability, whole body impairment or cognitive impairment. There are usually limits in terms of level of cover for home duties. Page 15

16 Non-occupational TPD definitions These are definitions that usually form a second tier under TPD policies. There is generally no waiting period for this definition (as opposed to the three or six month qualification under occupational definitions). Loss of limbs or sight the insured suffers a permanent loss of o Two limbs (hands or feet) o The sight in both eyes o One limb and the sight in one eye Unable to perform the activities of daily living the insured is permanently unable to perform two of the following without assistance from someone else: o Moving from place to place or getting in and out of a chair or bed o Using a toilet to maintain personal hygiene o Eating or drinking o Dressing and undressing o Bathing and/ or showering Cognitive impairment means the insured suffers cognitive impairment, requiring permanent ongoing supervision. Policy benefits and conditions There are a number of standard policy conditions, included policy benefits and extra cost options in a standard TPD policy. Future insurability Most term life and TPD policies provide for future increases in cover, with limited application requirements, so that future increases are made relatively simple. This benefit allows an easy way to increase cover at times when it is needed as only proof of a listed event (such as birth of a child) is required, saving the need for full assessment of the health insured. Changes in the policyholder s health are also not assessed, making it possible to increase cover even if their health has deteriorated since initially taking out the policy. These are generally available for personal and business purposes. Policy exclusions Common policy exclusions are war or war like activities and self inflicted injury Qualifying period Upon the insured becoming disabled, there is usually a three or six month period to qualify for a benefit, during which the insured must be continuously unable to work. Page 16

17 Sum insured The current industry maximum for TPD is $3 million for own and any occupation definitions. When the TPD policy is an extension to term life, then in most cases the benefit amount can only be less than or equal to the life sum insured. Life cover buy back This optional benefit allows for the reinstatement of term life which has been reduced as a result of a TPD claim. Insurers generally accept policies for those aged between 16 and 60. The policy can normally be renewed up to age 65, with some insurers allowing the policy to continue on only a non-occupational basis. This means that the benefits for own or any occupation cease, but any benefit for loss of limbs or sight, or cognitive impairment for example, may continue. Waiver of premium This option waives premium payments during the period of total and temporary disablement of the insured after a qualifying period of between three and six months. A refund on premiums paid during the qualifying period may also apply. Additional Policy Extensions There are some additional policy extensions that can be offered some at no extra cost or others may be an additional charge. Indexation benefit Guarantee of upgrade Business and personal future insurability Premium waiver Financial Planning Benefit Page 17

18 Trauma Trauma insurance pays a benefit if the insured suffers an illness or traumatic event as specified by the policy (e.g. heart attack, cancer and stroke). Importantly, a benefit will only be paid if the event or illness meets the definition. A traumatic event does not have to be life threatening or cause a total disablement, it simply needs to meet the policy definition. Most trauma policies will only pay a claim if the insured lives for a specific amount of time, commonly 14 days, after the defined traumatic event. If the insured dies before this time, a trauma benefit will not be paid. For most policies a nominal amount of death cover is payable. Policy benefits and conditions Most trauma policy conditions are described with reference to: Medical diagnostic and treatment procedures (various measures or tests are normally considered) Severity criteria (some conditions require a level of impact or physical impairment before a claim is satisfied.) Trauma cover is usually offered on two levels; basic cover and comprehensive cover or Plus cover. Sum insured The current industry maximum combined trauma benefit (total of stand-alone and linked cover) is $2 million. Waiting periods Waiting periods vary between basic policies. There will always be a waiting period for the following events: Heart attack Coronary artery bypass surgery Stroke Cancer Multiple sclerosis The standard waiting period is 90 days. Policy exclusions The most common policy exclusion is for self inflicted injury. There may also be an exclusion which applies where any condition is suffered as a result of alcohol or drug abuse. Page 18

19 Age limits Cover is normally provided up to age 65, although some policies provide cover to 70 or 75 and then limited cover (for loss of limbs and inability to perform the activities of daily living). Optional benefits A buy-back benefit, where there is an automatic reinstatement of any linked term life cover lost as a result of a trauma claim. Child cover - trauma Some insurers provide trauma cover for children aged between two and 18 years (the ages may vary slightly depending on the insurer). The benefit amount ranges between $50,000 and $200,000 and most policies also include a nominal death benefit, such as $5,000/ In most cases, an adult benefit must be applied for, with the child benefit then added as an optional extra. As with adult trauma, there is a 90 day waiting period for a number of these trauma events. If the condition occurs initially in the 90 day waiting period and then occurs again, the benefit can never be paid. Riders Trauma cover is available as a rider benefit to term life and TPD. Alternatively, trauma and/or TPD may be added as a stand-alone cover, so that a TPD or trauma claim will not impact upon the other. Partial trauma benefits Partial trauma benefits are a partial advancement of the sum insured, generally in the range of 10% to 25% of the total sum, for certain conditions. Following a partial payment, the remaining trauma sum insured will reduce. Additional Policy Extensions There are some additional policy extensions that can be offered some at no extra cost or others may be an additional charge. Indexation benefit Guarantee of upgrade Business and personal future insurability Child Trauma cover Premium waiver Financial Planning Benefit Page 19

20 Income protection Income protection protects the insured if, upon suffering a disabling event, they are unable to continue to generate their personal exertion income. Income protection is important for those who rely on their ongoing income, rather than investment or passive income, to cover living expenses and service debt. Once issued, income protection policies are generally guaranteed renewable. Definitions There are a number of industry income protection definitions : Total disability To be deemed totally disabled, the insured person must usually satisfy three strict elements of the definition. The life insured must be: Under the care of a medical practitioner Not working in their own or another occupation Unable to perform one of the important duties of their occupation The other difference in wording is that the policy may include the term income producing in front of duties of their occupation, which raises a new set of possible exclusions. Hours based definition Hour-based definitions generally refer to the inability to perform an important duty for a set number of hours per week (such as 10 hours) to qualify for a benefit. Income-based definition An income-based definition requires the insured to be unable to generate a certain level of income, (such as 80% of pre-disability income) to qualify for a benefit. Partial disability A partial disability benefit is payable when the insured is able to work to a limited extent, or is employed in a lower paying job due to their disability. To qualify, the insured must generally have been totally disabled for at least 14 days (sometimes seven) of the waiting period, and the payment only begins at the end of the waiting period. In some cases, a period of total disability is not required to satisfy eligibility for partial disability payments. This is often referred to as day-one partial benefit, meaning they are paid after the waiting period but without a total disability period. Page 20

21 After a period of total disablement, if the insured person returns to work at less than their full capacity they may qualify for partial disablement benefits upon satisfying of the following requirements: They are under the care of and following the advice of a medical practitioner, and They are earning less than their pre-disability income, or They are working in another occupation but earning less than their pre-disability income as a result of their illness or injury The amount paid is calculated on a benefit formula as follows: (A-B) x C A Where: A. = pre-disability earnings (the highest twelve months income prior to claim usually over past three years) B. = post-disability earnings (current earnings while on claim) C. = monthly benefit (the amount insured) Additional Policy Extensions There are some additional policy extensions that can be offered some at no extra cost or others may be an additional charge. Indexation benefit Guarantee of upgrade Death benefit Guaranteed insurability option Premium waiver Financial Planning Benefit Cash Back option Rehabilitation expense benefit Accommodation benefit Family Support benefit Home care benefit Bed confinement benefit Overseas assist benefit Specific injuries benefit Crisis benefit Death benefit Page 21

22 Business Insurance Business insurance can help business owners minimise risk caused by death or disability.there are four core business insurance concepts: Buy-sell insurance Key person capital insurance Key person revenue insurance Business expense cover Buy-sell insurance This form of protection provides the outgoing owner or their nominee with sufficient cash for the transfer of equity to the continuing owners, if a business owner dies or becomes disabled. Buy-sell insurance is managed via a buy-sell agreement. This involves the business owners entering into a written agreement to plan what they are to do with their respective interests in the business should one of the owners die, become disabled, suffer a traumatic or terminal illness, resign or retire. Essentially, the agreement should provide a mechanism whereby the terminating business owner (or his or her estate) can sell his or her interest in the business to the continuing owners, and the continuing owners can purchase the terminating owner s interest in the business. The agreement generally also recognises the means of funding the buy-sell obligations of the respective owners. What insurance products can be used? The choice of insurance solution depends on which trigger events are being provided for: Death and TPD can usually be readily insured against, by way of life and TPD insurance in the buy-sell agreement. Trauma can also be used but some complex issues must be considered. Resignation and retirement - cannot specifically be insured against and therefore cannot be funded with insurance proceeds. However, a sinking fund can help by providing a cash amount that can be used as a deposit against any buy-out obligation at the time of retirement or resignation. Key person capital To provide the business with sufficient cash to preserve its asset base i.e. to repay or reduce debts, free up cash flow and maintain its credit standing, if a business owner dies or becomes disabled. Page 22

23 Key person insurance proceeds can be applied to maintain the capital value and stabilise the business. The capital value of a business following the loss of a key person could be reduced in the following ways: Credit standing Goodwill Business debts Loan accounts and Guarantor protection. The capital value of the business is often determined by profitability and may include a goodwill component. If profitability or goodwill would be reduced by a certain percentage, this would be one measure of the potential capital loss to the business. Financiers most commonly secure business loans by having guarantees signed by principals and most will insist on the joint and several liabilities of business owners in relation to the loans or overdraft facilities. Capital purpose insurance premiums are not tax deductible to the business and the death benefit proceeds are not taxable if received by the beneficial owner. The proceeds of TPD and trauma insurance are subject to capital gains tax (CGT) if received by a company or trust and are not taxable if received by the life insured, a spouse (including de facto and same-sex) or a defined relative. 1 What insurance products can be used? The choice of insurance solution depends on which trigger events are being provided for: Death and TPD can usually be readily insured against, by way of life and TPD insurance in the buy-sell agreement. Trauma can also be used but some complex issues must be considered. Key person revenue This insurance provides the business with sufficient cash to compensate for the loss of revenue and replacement costs, if a business owner or key employee dies or becomes disabled. The loss of a key person can cause revenue to decrease, and business costs to increase. Key person insurance proceeds can be used to: replace the revenue the key person would have generated; and fund the extra costs the business would have in finding a suitable replacement. It is unlikely that a business has excess profits or has non-income producing assets that could be readily liquidated or even if a financial institution would provide credit to fund loss 1 Defined relative section ITAA 1997 Page 23

24 of profits and key person replacement costs. Therefore, the most logical and cost-effective solution is life insurance in the form of life, TPD and trauma cover as the funding vehicle. The principal tax rulings provide for the deductibility of premiums if effected for a revenue purpose and meets the six key requirements under Income Tax Assessment Act (ITAA) However, any insurance proceeds for revenue purpose will be assessable as income to the business. Since it is the business that is being protected against the loss of a key person, to obtain a tax deduction, the entity (company, partnership, trust or individual) should own the policy and pay the premium. What insurance products can be used? The choice of insurance solution depends on which trigger events are being provided for: Death and TPD can usually be readily insured against, by way of life and TPD insurance in the buy-sell agreement. Trauma can also be used but some complex issues must be considered. Business Expense cover or BOC Business expense cover (BOC) provides for 100% of fixed business expenses, if the business owner becomes totally disabled due to sickness or injury. Business expense cover is specifically designed for self-employed individuals or members of a small business who need to cover their fixed business expenses if they cannot work due to sickness or injury. It is vital for sole proprietors, who are generally responsible for the 100% of the fixed expenses of the business. It is equally important for small partnerships to ensure that each partner is covered for his or her share of business expenses These are the regular fixed operating expenses of running a business, including (but not limited to): rent, property rates, land tax, accounting & audit fees, equipment and vehicle leasing, business loan repayments (principal & interest), business insurance premiums, gas, electricity, telephone, water, bank fees & charges, professional fees & subscriptions, contracted repairs & maintenance, computer servicing expenses, cleaning & laundry, remuneration of non-income generating employees (salaries, super, FBT), contracted advertising, workers compensation costs, postage, printing, stationery, locum hire (if applicable) and courier costs. 2 Revenue purpose premium deductibility section 8-1 ITAA 1997 Page 24

25 The business expense benefit will be offset by: The insured s portion of income from the business derived from trading during the period of disability The income generated by any employee(s) hired after the insured became totally disabled to perform the work normally performed by the insured Any amount received, during the period of total disability, from any other insurance policy to reimburse the insured s business expenses. Page 25

26 Overview of retirement incomes Types of income streams Term certain income streams are contracts payable for a fixed term in return for an initial invested lump sum. Complying term certain income streams may receive social security assets test exemption if purchased before 20 September Lifetime income streams provide a regular income for life and can continue for a lifetime of a reversionary beneficiary. Complying lifetime income streams may receive a social security asset test exemption if purchased before 20 September A lifetime income stream has the advantage of simplifying investments and provides security through guaranteed income. Lifetime income streams also eliminate longevity risk for the client, as the life insurance company guarantees to pay an income for the rest of their life. Term allocated pensions (TAPS) are account-based with a term based on life expectancy or up to age 100. Income is paid each year as a percentage of account balance, with ability to choose a variation of +/-10%. Term allocated pensions are complying for social security purchases if purchased before 20 September TAPS were introduced on 20 September 2004 as a new category of complying income stream. Legislation refers to them as market linked income streams. They were essentially introduced to gain access to the pension RBL and asset test exemptions, with a market based return. However, with the changes in both areas they are generally not available for new purchases from 20 September Account-based pensions (also known as allocated pensions provide the most flexibility. A minimum income payment must be received each year and lump sum withdrawals can be made. Income payments continue until the account balance is exhausted. Account-based pension s offer the greatest flexibility for clients however, the client bears the risk of investment volatility and outliving their retirement money. An account-based pension can commence at any age provided a condition of release has been met (including transition to retirement rules) This type of income stream can only be purchased with a superannuation lump sum. Ordinary money would first need to be contributed to super (if eligible) and then rolled over to purchase the account-based pension. Once an account-based pension has commenced, further money cannot be added to the account. Transition to retirement income streams are non-commutable income streams started with preserved superannuation money under the specific rules of this release conditions. Generally they will be non-commutable account-based pensions with a maximum income payment equal to 10% of the account balance. Page 26

27 Death benefits The remaining balance of an account-based income stream is paid as a death benefit. Nonaccount based income streams may have a death benefit depending upon contract details. Death benefits can be paid as a lump sum to any Superannuation Industry Supervision Act 1993 (SIS Act 1993) dependent or the estate but income streams can only be paid to a death benefits dependent as defined under tax law. A pension paid to a child under age 18 must be commuted by their 25 th birthday unless the child meets disability requirements. Page 27

28 Term certain income streams (from 20 September 2007) Advantages Provides regular guaranteed income for a fixed number of years. Can be purchased with ordinary or superannuation money. Client does not carry the market risk from the underlying investment performance. Payments can be indexed to maintain real value. A death value is payable to the estate calculated as the net present value of the remaining income payments, commuted to a lump sum. Disadvantages Return on investment depends on interest rates at the time of purchasing the contract. Once commenced, changes cannot generally be made to options. No ability to vary income outside contractual arrangements (i.e. limited to agreed indexation rate). Client is taking some longevity risk as they may live longer than the selected term. Break costs to withdraw a lump sum can be high. Page 28

29 Lifetime income streams Advantages Provide regular income guaranteed for life, so the client takes no longevity risk Can be purchased with ordinary or superannuation money Client does not carry the market risk from underlying investment performance Can be eligible for an assets test exemption if a complying income stream was purchased before 20 September 2007 Income can be indexed to maintain real value (fixed % or CPI) Disadvantages Return on investment depends on interest rates at the time of purchasing the contract Once commenced, changes generally cannot be made to options No ability to vary income outside contractual arrangements (i.e. limited to agreed indexation rate) Death value may only be payable within guarantee period therefore, early death can result in a large capital loss Generally cannot be commuted Access to cash as lump sum withdrawals is not allowed (if non-commutable) Page 29

30 Term allocated pensions (TAPs) Advantages Provides income for a set number of years. Met criteria to be complying for social security purposes if purchased before 20 September Upon death, remaining account balance is paid to dependents or estate. Potential to earn higher income than other complying income streams due to market rates of return. Disadvantages Limited ability to vary income each year. No access to cash as lump sum withdrawals. Client is taking some longevity risk as they may live longer than the selected term. Client carries the market risk from underlying investment performance and this will result in a variable income stream each year. Cannot be purchased with ordinary money (unless able to contribute to super). Page 30

31 Account-based pensions (allocated pensions) Advantages Ability to vary income each year (must take at least minimum). Access to lump sum withdrawals is allowed. Upon death, the remaining account balance is paid to dependants or estate. Potential to earn higher income than other income streams due to market rates of return. Disadvantages No asset test exemption for social security. Client takes longevity risk as income payments stop when the account balance runs out. Client takes the market risk and poor performance can shorten the life span of the income stream. Cannot be purchased with ordinary money (unless able to contribute to super). Page 31

32 Commonly used annuity terminology A Annuitant the owner of the annuity Assets and income tests these tests are used by the Government agencies such as Centrelink to determine the level of government support a person is entitled to ie. age pension. The Income Test measure the level of income a person receives. The Asset Test measures the amount of assets a person has. C Commutation another term for withdrawal Complying annuity no longer available since 20 September 2007 due to legislation changes. Allowed the annuitant to have certain asset test exemptions. D E G J Deductible amount the amount of gross income that is tax free. Calculated by taking the amount invested, minus any withdrawals, minus any RCV, then divided by the fixed term or your life expectancy in years (for ordinary monies policies only). Effective date the effective date of the annuity contract will be date that the annuity is put in force. The annuity can only be put in force when all outstanding requirements have been received and are correct. As a general rule, no contracts will be backdated. Guaranteed period - applicable only for Lifetime annuities, this is the minimum period selected in which regular payment will be made. A period between zero and the annuitants life (expectancy rounded up to the nearest whole year) can be chosen. If the annuitant dies during the guaranteed period, regular payments can continue until the end of the guaranteed period or the withdrawal value may be paid out to the annuitants estate or beneficiaries. Joint owner where the annuity has two owners and the regular payment is split between them. Not available for superannuation annuity or where the investor is a company, trust or fund. On death of the one owner, payments will automatically revert to the remaining owner. Page 32

33 L N O P R S Life insured the person who s life the annuity is based on. Non commutable where a lump sum cannot be withdrawn or the contract cannot be terminated other than in very limited circumstances stipulated by legislation. Ordinary annuity annuity purchased with ordinary or personal monies. Preservation age the age at which a client may access their superannuation monies. Based on the date of birth as follows: Date of birth Age Before 1 July July 1960 to 30 June July 1961 to 30 June July 1962 to 30 June July 1963 to 30 June After 30 June Residual capital value (RCV) the amount the annuitant chooses to have returned at the end of the term of the annuity. Amount can be between 0 100% of the original investment. For superannuation annuities, the amount of the RCV may be restricted due to the minimum annual payment requirements. Reversionary beneficiary a person nominated by the annuitant to continue to receive the regular payment in the event of their death. A reversionary can only be nominated at the inception of the annuity. A nomination cannot be added or changed once the annuity is in force. Not required if joint owners. For superannuation annuities, the reversionary must be a dependant at the time of the annuitants death. Superannuation annuity annuity purchased with a superannuation rollover. Monies must be unrestricted, non preserved, unless it is a transitional to retirement (TTR) annuity. Page 33

34 Insurance bonds Insurance bonds are life insurance products with a savings component. They operate similarly to a managed fund (unit trust), but with different taxation implications as the taxation is payable at the life company (issuer) level. Advantages Investment choices to suit time horizon and risk profile. Growth potential (depending on investment option). Earnings taxed within fund at 30% with no impact on client s tax return unless withdrawals are made in first 10 years. Amounts can be withdrawn tax-free after 10 years. Readily accessible (liquidity restrictions may apply in some situations). Can invest additional amounts within 125% rule (periodically or regular payments). Provider makes the buy/sell decisions on underlying assets. Tax offsets may apply if money is withdrawn in the first 10 years. Disadvantages Entry fees and ongoing management costs. Subject to market risk and volatility. Need longer timeframe to ride out period of volatility. Minimum investment requirements for initial investment and additional amounts. Tax payable on earnings portion if withdrawn within first 10 years. Additional amounts are limited to 125% of the previous year s deposit to avoid recommencing the 10 year tax deferral period. Page 34

35 Insurance bond terminology Bond owner owner of a Bond it can anyone aged 16 years and older, multiple joint owners, a company, trust or other legal entity (such as deceased estates). Child Advancement Policy subject to the dealings of the Bond owner, ownership of the policy will transfer to the child when they reach a nominated age also known as vesting age. If the owner of the Child Advancement Policy dies before the child has reached vesting age then ownership will transfer to the Bond owner s estate. Death benefit guarantee a guarantee that payment of the greater of the cash value of the Bond, or the total value of the deposits less any withdrawals, upon the death of the last surviving life insured, or the 99 th birthday of the youngest surviving insured person, whichever is the earliest. (Investment Growth Bond only) Nominated beneficiary - person or estate nominated to receive the proceeds of the Bond upon confirmation of death of the last surviving Bond owner. Tax rate for insurance bonds the current life company tax rate applicable for insurance bonds is 30% less any imputation credits the life company may receive. Page 35