Insurance is a numbers game. Most insurers (or their underwriters) have a small army of actuaries that crunch the numbers on how risky an asset is, and then set a price to insure it accordingly.
Many insurances are necessary evils. Products like commercial insurance or life insurance make sense. These products cover those small risks that have outsized impacts. Risks that could financially ruin a business or household. Taking out these types of insurance provide a level of comfort and it’s worth the expense. It protects you against unforeseen, unexpected events.
So if much of the value of insurance is protection against unforeseen, potentially ruinous events, then why do people insure one of the few certainties in life – their funeral?
There’s over $300 million spent annually on funeral insurance premiums in Australia. Of all those policies, less than 20 per cent paid out. Think about that. Less than 20 per cent of people were paid out on an event that is certain to happen.
The scrutiny has come. A recent royal commission into Misconduct in the Banking, Superannuation and Financial Services Industry, made the recommendation that funeral insurance be reclassified as a financial service, bringing it under ASIC’s regulatory regime.
Regulation is an important and necessary step. The more critical component is educating people on what funeral insurance is, and the array of alternate options available.
Funeral insurance is a policy that will give your family or beneficiaries a lump sum payment to help pay for your funeral and associated expenses when you die. Insurers typically offer fortnightly, monthly or annual premium payments options for a fixed amount of cover. In Australia, the fixed amount generally ranges from $3,000 – $15,000, which is paid to your beneficiary when you die.
Across the industry, there’s minor nuances between providers. What is consistent across funeral insurance options is the following:
The final point I find really interesting. Let’s break it down.
The product is funeral insurance. You pay premiums to cover the cost of your funeral. Yet the pay out can be used for whatever the beneficiary wants. If that’s the case, the question begs why have it at all?
No it isn’t. Funeral insurance is not a savings plan. If you cancel it before you pass away or reach the early payout date, you won’t get anything back (with the exception of the 30 day cooling-off period). It’s quite the opposite of savings. It’s illiquid and the balance effectively resets to zero every period.
It’s understandable how people make the connection. They are paying into something that they will receive the benefit of in the future. The glaring difference though, is that if you stop paying one, your savings don’t go up that month. The other, you lose the nest egg altogether.
For many people, actual saving makes much more sense than paying the insurance premium. Let’s do a basic example, forgoing earning interest, or investing your money.
Geoff and Linda, both 70 years old and in good health have funeral insurance. Geoff pays $125/month, and Linda $95/month in premiums. If Geoff saved the same amount, he’d have $10,000 before he turns 77. For Linda, she’d have saved $10,000 by the time she’s 79.
The example above assumes that those monthly instalments amounts stay the same. In most funeral insurance products, your premiums increase over time.
Also remember, that in the first year or two, there is not coverage – so there is immediately at least $1,500 for Geoff and $1,140 for Linda paid into nothing. To put that into context, those initial premium payments would have already paid off more than 50 per cent of their funeral with a provider like Bare Cremation.
This is a valid point. For many people, knowing that in the event they pass away suddenly there will be funds available to pay for end-of-life arrangements, is comforting.
For those people who specifically want to cover their funeral costs, there are only rare circumstances where funeral insurance makes sense. For those that anticipate their passing is likely in the next couple of years and you currently have funeral insurance – it may be the most prudent option to keep it. Ultimately it will come down to personal circumstances.
To check what’s right for you, you can use the free calculator tool here.
Thousands of Australians currently have funeral insurance. I speak to multiple people with policies daily. The consistent concern is that they feel obligated to keep paying, as they have already paid in a lot, and are waiting for their payout.
In many instances, they are throwing good money after bad. I understand the emotional attachment to the money they have paid, but funeral insurance should calculated as the money you expect to pay in the future. Remember, every fortnight or month your premium is due, the balance is reset. You start on zero.
With other alternatives to funeral insurance now available, there are only a few certain circumstances (early payout or predictable time of passing) where it makes sense to continue paying your premiums. Generally, if you plan on living longer, the numbers make increasingly less sense.
Funeral insurance was originally sold to fill an important niche for people – to create certainty and comfort that when they pass away, there will be money available to cover the costs. There are now a range of alternatives that fill this need.
For those looking at end-of-life planning, I encourage you to look at alternative options like saving separately, using superannuation, paying in instalments for a prepaid funeral or investing in a funeral bond. I’ll dig into these alternatives in coming articles.
Please note – this is not financial advice. But it is common sense.