Watch out for insurance traps

OPINION: Many New Zealanders are underinsured when it comes to protecting their biggest assets – their future income and their lives.

Death, illness, redundancy and accidents can destroy wealth and jeopardise your standard of living. The purpose of insurance is to pass on the risk of financial loss to someone else; the insurance company.

It is neither affordable, nor practical, to insure against all risks.

Getting the right insurance cover is a balancing act. It is a matter of identifying financial risks, then estimating the probability of each risk and the potential financial loss. The next step is to decide how much risk to accept, and how much to pass on to the insurance company. This will depend on the cost of the insurance (the annual premium) and how secure you want your future to be.

It should be a simple process but it’s not.

While the theory is easy, putting it into practice is challenging. To be really accurate, you could develop a complicated spreadsheet to work out the risks, the probabilities and the potential financial losses. That’s difficult and time-consuming, so the default position for many is to simply pretend that risk doesn’t exist and do nothing about it.

Somewhere in between is the happy medium where risks are thought about, estimates made, and action taken.

The complexities of working out how much insurance cover is needed are part of the reason why many New Zealanders are underinsured. There are no standard rules of thumb that can be applied. Everybody’s situation is different. Age, health, marital status, occupation and a host of other factors have an impact on risk and the cost of premiums.

While you can buy insurance online, most people are reliant on the advice of an insurance broker to recommend the amount and type of insurance cover they need. Finding a broker you can trust is critical.

Bad broker behaviour can include:

Overselling. Brokers earn a commission so from the outset they are incentivised to sell you as much insurance as possible. Selling more might also earn them bonuses (additional commission) or other benefits such as free overseas trips and tickets to sporting events. A good broker will put your interests first and only sell you what you really need and can afford.

Underinsuring. Your circumstances and therefore your insurance needs can change over time. What is sold to you at a point in time may not be sufficient later on. Work with a broker who takes your future lifestyle into account and regularly reviews your insurance.

Churning. This practice was once rife but is fortunately becoming less common. Churning is when a broker replaces your existing insurance policy for one with a different company for the main purpose of earning commission, particularly upfront commission. This behaviour is highly unethical and in some cases can cause loss of benefits to the person being insured.

A review of replacement insurance business undertaken by the Financial Markets Authority in 2016 showed that policies with a high upfront commission and low trail commission were more likely to be replaced, especially if there was an overseas trip offered as a sales incentive.

Negligence. Errors, omissions and incompetence on the part of your broker can result in lack of insurance cover. A broker may fail to disclose terms of an insurance policy, or how a replacement policy differs from an existing policy. In some cases the purchase of the insurance cover may not be completed or the insurance cover put in place may be inadequate.

Fortunately, the majority of insurance brokers are competent and have your best interests at heart. You can protect yourself from bad behaviour by taking a close look at the disclosure document your broker must give you and ensuring you know how the broker is being remunerated and by whom.

If you are offered a replacement policy, make sure you get a good explanation as to why your existing policy no longer meets your needs. Have regular reviews with your broker to ensure you have adequate cover and that you are neither overinsured nor underinsured.

❚ Liz Koh is an authorised financial adviser and author of Your Money Personality: Unlock the Secret to a Rich and Happy Life, Awa Press. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free of charge by calling 0800 273 847.