Trauma Cover: Are we thinking things through or just doing what we have always done?

Being the first of the new insurance options, we stepped away from whole-of-life and endowment as the solution to all problems.

I've seen several approaches to provisioning trauma cover over the years, with varying degrees of success.

Some things we need to consider as constants.

•     The typical trauma claim is a value of $95-140k, depending on which insurer you talk to and what period they are taking their stats from.
•     The average age of a claim is around age 49
•     The average age of cancellation is around age 47

We hear in insurer updates that trauma cover needs to be sold. We need to sell more of it in various forms that provide a graduated response, because clients often lack sufficient cover when critical conditions arise.

Hmmm... I'm not buying the sales pitch here. The pitch doesn't align with the stats when you factor in human behaviour and experience.

Let's stop for a second and look at what trauma is being used for:

•     Replacement of income - valid in certain circumstances, but we have a product called income protection for this purpose.
•     Repaying debt - valid and has some reasonableness to it.
•     Covering unexpected costs, yup, probably the key reason for trauma cover.
•     Paying for education, ok, fair, but there are some alternative approaches we should be advising here.
•     Completing retirement savings. There is some justification for this; however, TPD is likely a better vehicle, which I'll expand on.
•     Holidays and other lifestyle provisions.

When I step back from all of this, I'm hit with a perspective that we may not be reading the tea leaves well.

When we consider budgets and behaviour, if people are cancelling cover at an average age of 47, it's not because the risk issues have been resolved or claims are being paid. It is budget pressure.

We know clients often have a knee-jerk reaction to premiums. When premiums get to a certain threshold, they call the insurer and cancel it.

When we consider that the average claim is $90,000 - $140,000, this does not mean they don't have enough coverage; it means they can't afford more coverage.

Which means we have a logical fallacy at play. In the early years, we advise repayment of mortgages; yet by the time the average claim is paid, it doesn't even touch the average mortgage.

This raises the question: why are clients spending so much on premium coverage that ultimately gets cancelled or removed?

Sales and commission. The sale is easy, and thus the commission earned is higher. I know that's a crass statement, but we need to consider motivation in this context.

If the average claim is in the 40s and 50s, and premiums are too expensive to hold coverage for mortgage debt, why do we continue to advise insuring mortgage debt?

I agree that high-interest debt, like credit cards and car finance, should be cleared here; high-interest debt out of control can be damn hard to manage. However, the quantum of value for this is distinctly different from lower-interest debt, such as mortgage debt.

In an ideal world, people would be able to afford coverage for mortgage debt; also, in a perfect world, they wouldn't need a mortgage either.

When we consider mortgage debt in conjunction with income protection coverage, the need for trauma cover for this purpose drops away. If the person can't work, their disability cover pays; if they can work, they can pay.

The real issue here is when it gets to the point of being total permanent disability, this is where telephone numbers for TPD should be used, as it's far more cost-effective to hold into your 50s and 60s.

In terms of expenses such as education, private education should be covered by disability insurance, as it is typically expected to be paid from present income without requiring a critical condition or disability. Provided you haven't got a very high earner, where replacement ratio limits have been hit. This is stratosphere earnings affecting about 0.66% of people in NZ, so a lesser issue than most think.

If it is for tertiary education, clients are better off using the student loan scheme and putting their money into an investment. When the student loan scheme only requires repayment when earning above the income threshold and is forgiven upon death, there is almost no requirement to repay it, and parents should use the money they set aside more effectively.

This risk should be addressed if parents are supporting their child once they qualify to repay their student loan and manage it accordingly.

•     A huge number don't repay it because they aren't working above the income threshold or it's forgiven.

If the kids disappear overseas, then there is interest charged, and at the same time, they are required to repay it. This is repaying it from inflation-adjusted earnings, meaning the value of the debt being repaid is less than the value of the debt when it was taken.

And to answer the usual "but it's responsible to repay it". Umm, sure, but we're typically talking higher earners who have already paid relatively significant levels of tax. This is one of those balancing-the-books things with the tax system.

A few things I have heard in more recent times, selling trauma cover over disability and medical covers: