The one insurance you can’t afford to skip (and one you definitely can)

With the increased private health insurance premiums kicking in this week at an average of 4.41 per cent, many households are probably wondering if it’s really an expense that can be justified right now.

In Australia, we spend an average of between $1500 to $2000 per person, and collectively about $120 billion every year on insurance. And yet, we’re still one of the most under-insured countries in the world.

Perhaps that’s why one in five Australians say they’ve bought insurance they don’t fully understand, and half of us aren’t confident that insurers will actually pay up when we need them.

Like most things relating to personal finances, there is no one-size-fits-all solution to insurance, and not all insurances are created equal. So before you make any decisions, here are some useful things to consider, as well as some of the best and worst options to spend your money on.

Let’s start with what I, personally, think is the most important band of insurance: personal insurance. There are generally four types of cover that fall under this umbrella – life insurance, income protection, total and permanent disability (TPD) insurance, and trauma or critical illness insurance.

In a nutshell, these insurances exist to financially protect you from worst-case scenarios and guarantee that if something bad does happen, you’ll be able to maintain your current standard of living.

If I could only ever have one kind of insurance for the rest of my working life, it would be income protection.

The good news is that many superannuation policies include some level of income protection and life insurance. But the level of coverage and access requirements varies, so it’s worth looking into and knowing what you’re entitled to because you might want greater coverage depending on your situation.

The stage you’re at in life is also important here. If you’re young, healthy, have no dependents and no debt, you likely won’t need or want the same level of coverage as someone working full-time, with two kids and a mortgage.

Similarly, someone with a great family health history might not feel the need to take out trauma insurance, but for someone with a family history of cancer or heart conditions it might make sense.

Trauma and TPD insurance come into play if you are diagnosed with a serious condition (or if you are permanently disabled) by providing a one-off tax-free lump sum to cover medical expenses and general living costs. If you’ve got a mortgage, have young children, hold other debts or don’t have substantial savings, having this while you focus on your recovery can take a huge weight off.

Income protection operates similarly to trauma insurance, but with a few key differences. Namely, policies tend to pay between 70-90 per cent of your income, and it’s delivered in instalments rather than a lump sum. The coverage also tends to be broader and include things like mental health.

If I could only ever have one kind of insurance for the rest of my working life, it would be income protection. That’s because my income is what makes everything else possible.

If I hurt myself, I can see a doctor because there’s money in my account thanks to my income. If my car breaks down, I can visit a mechanic and pay for it to be fixed thanks to my income. If my roof leaks, I can phone a builder and, you guessed it, cover the bill with my income.

Yes, having health, car and home insurance will ease the financial pain a lot, but without an income coming in, I can’t pay for those protections in the first place – let alone any out of pocket gaps that those insurances don’t cover.

Then there’s the one that few people like to talk about or think about: life insurance. Many people wrongly assume this is only something wealthy people need, but that’s not true. Life insurance at its most basic means that if you die with debts, your loved ones won’t be lumped with the burden of those and will have a good level of financial support to keep them on their feet in their darkest days.

Now we get to the second band of insurance, which is the most common: private health insurance, pet insurance, car insurance, and home and contents insurance.

If you have the means to pay for these insurances, and it makes sense to have them, these are great to have. Most banks insist mortgage holders have home and contents insurance as a condition of the loan, so that’s a non-negotiable if you own a property. The same goes for cars that have loans attached to them or are through a lease agreement.

When it comes to private health insurance, don’t get me wrong, I think it’s great and have written about this previously. But again, if we’re working to a tight budget and can only have one, the reality is that a one-off expensive dental bill is going to hurt much less than six months of no salary.

If you are in a position to afford it, the most important thing is to look at if you have the right level of coverage for your needs and that you aren’t under or over insured. It’s also important to remember that unlike other insurances, this will only cover a portion of your medical bills if you get sick – it doesn’t provide the breathing space that TPD, trauma or income protection will.

Then we get to the third band, which are the insurances I, personally, would never pay for. This includes things like phone insurance and funeral insurance.

For extended warranties and phone insurance, it’s straightforward. When you work out what you will pay on insurance over the coverage period versus what it would cost to replace the item if it broke or was stolen, the out-of-pocket expense is relatively minor. That means the insurance is not money well spent.

Funeral insurance is similar in that the average payout in Australia is about $8500, but the premiums paid are generally between $20,000 and $30,000. Instead, you’re much better off putting a lump sum or small amount aside each paycheque into a high-interest savings account.

At the end of the day, insurance is about finding a balance between how likely something is to happen to you, what the cost of that would be if it happened, and protecting something you can’t afford to lose.

Most of us take out insurance with the hope that we will never have to use them. I understand that this can make them seem like a waste of money – especially when the cost of living is already stretching and straining so many of us.

But I’ve seen the impact that unexpected life events can have enough times to know that even when people do make it out the other side, the process takes its toll. So knowing nothing has to change monetarily when many things are out of your control is arguably one of the best investments you can make.

Victoria Devine is an award-winning retired financial adviser, a bestselling author and host of Australia’s No.1 finance podcast, She’s on the Money. She is also founder and director of Zella Money.

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their personal circumstances before making any financial decisions.

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