Trauma insurance – how versus how much

Col Fullagar explores the advantages of advisers applying a logical basis when deciding on a trauma insurance benefit amount for clients.

Crucial to the provision of risk insurance advice is the presence of an underlying logic supporting the recommended benefit amount.

It is this logic that assists the adviser to explain to the client the reason for the suggested level of cover such that if the recommendation is accepted, the client can apply for the cover needed.

No more, no less.

When it comes to making a benefit amount recommendation, appropriate advice is arguably as much about "how" as "how much", and nowhere is this more evident than in regards to trauma insurance.

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The challenge, however, since this insurance was first introduced to Australia in the 1980s has been the underlying logic.

Many and varied benefit formulae have been and continue to be used. For example:

• Twice or sometimes thrice times gross income;
• Once times salary plus total debts; or
• What the client can afford.

While each of these may ultimately possess merit as to quantum, they do not have an obvious logic that links the benefit amount to the need.

The fall-back recommendation of "as much as possible" may only make matters worse.

If the client puts trauma insurance in place in excess of that which they reasonably require, and in so doing there is underinsurance elsewhere, any subsequent claim "elsewhere" may result in disgruntlement and risk exposure to the adviser and the licensee.

Generic logic

The need for any type of insurance, not just risk insurance, is a factor of likelihood and impact.

Thus, to identify a generic need, two questions might be asked:

(i) Is the event being insured against likely to occur?

(ii) If the event occurred, would it have a material, adverse financial impact on the client and/or the client's family?

Any number of statistics demonstrates that the answer to (i) is "yes", and while the answer to (ii) comes out of the adviser's analysis process, for the sake of the exercise, "yes" will again be the assumed answer.

When the answer to both questions is "yes", logically a financial exposure exists, warranting mitigation by the implementation of an insurance solution, and taking this one step further, the greater the likelihood and/or the greater the financial impact, the greater the insurance imperative.

The likelihood

Another challenge with trauma insurance is the presence of so many (sometimes 60 or more) insured events, each of which has a unique statistical likelihood.

To consider the likelihood of them all would be impractical but there is a reasonable alternative — consider "the most likely."

Of all the insured events, heart attack, cancer and stroke are far and away the most likely to occur and thus, when giving generic advice, the focus could be on these three insured events.

The financial impact

The financial impact on the client and their family of suffering a major medical trauma can be measured in various ways, but again, for the sake of the exercise, it is helpful to consider the financial impact as the sum of:

(i) Fixed costs: Costs that will be incurred simply by virtue of suffering the trauma event. Examples are ambulance costs, diagnostic costs, the cost of occupying a hospital bed, certain medical costs, etc.; and

(ii) Variable costs: Costs that will be incurred to a greater or lesser extent depending on the severity of the insured events. Examples are specialist medical care, rehabilitation, etc.

Because neither the trauma event nor the severity is known in advance, it is necessary to consider averages; i.e. the "average" cost of suffering the insured event of "average" severity.

Within the medical and statistical fraternity the term used to describe this is the "individual lifetime cost".

Sometimes the individual lifetime costs will include the loss of earnings to the individual; however, this should not be included in the context of a trauma insurance recommendation as loss of earnings is covered by income protection insurance.

In summary, when giving general advice, the individual lifetime costs associated with the "most likely to occur" trauma events (heart attack, cancer and stroke) will provide a reasonable basis for the medical and rehabilitation component of the trauma insurance recommendation.

Heart attack

Finding recent lifetime costs for a heart attack proved difficult; however, the following was identified:

"The average treatment cost of an acute myocardial infarction episode in 1993-94 was approximately $5000..."

"In 1998-99 the average total expenditure per admission for acute myocardial infarction was $5898." (Source: Australian Institute of Health and Welfare publication Health System Costs of Cardiovascular Disease in Australia 1993-94).

If these amounts are increased in line with inflation through to 2015, the individual lifetime cost would be around $20,000.

Cancer

"There are more than 200 different types of cancer. You can develop cancer in any body organ. There are over 60 different body organs in the body." (Source: Cancer Help UK, January 2011).

Due to the number of different types of cancer, it is impractical to research the lifetime costs of them all. Therefore, again, the focus is on those cancers which are the most likely to occur i.e. prostate, breast, colorectal, melanoma, lung, lymphoma and leukaemia.

(Source: Cancer Incidence Projections, Australia 2002 to 2011, Australian Institute of Health and Welfare, August 2005).

The estimated lifetime costs of these ranges from under $10,000 (melanoma) to around $120,000 (leukaemia).

(Sources — adjusted for inflation:

(i) Australian Institute of Health & Welfare, Health System Expenditures on Cancer in Australia 2000 — 2001, Published May 2005.

(ii) Optimising Cancer Care in Australia, National Cancer Control Initiative February 2003.

(iii) Access Economics — Cost of Cancer in NSW, April 2007).

Stroke

Initial diagnostic and treatment costs for stroke total around $120,000; however, in addition there are costs of ongoing care of around $30,000. Thus the lifetime costs for stroke are in the order of $150,000.

(Source: Lifetime costs of stroke subtypes in Australia, Melbourne, June 2003, adjusted for inflation).

The advantage of implementing a logical basis is that if the advice is questioned during or after it is provided, an explanation can be given such that the client can make the all-important informed decision.

Thus, the individual lifetime costs of the most-likely-to-occur trauma insurance insured events are:

• Heart attack — $20,000
• Cancer — $120,000
• Stroke — $150,000.

In making a recommendation, the adviser might reasonably choose the largest amount i.e. $150,000 on the basis that:

"It is more appropriate to have the most expensive appropriately insured even if it results in others being potentially over-insured."

It may be, however, that in questioning a particular client, the adviser identifies a need for specific rather than general advice.

Paraplegia

A younger client, who is physically active, for example, participating in rock climbing or mountain bike riding, may be concerned about the risk of paraplegia or quadriplegia.

The current cost of providing basic support for a person who has sustained a spinal cord injury at age 20 and who has a life expectancy to age 70 is:

• For a person with paraplegia, $1,500,000;
• For a person with quadriplegia, $10,000,000.

(Source: Spinal Injuries Association website, Facts & Statistics).

If the client was able and willing to pay the premium for these higher levels of cover (up to the insurable limit for trauma insurance), an appropriate recommendation along these lines may be warranted.

As the client grows older, premiums may increase to the point of being prohibitive; however, it is also possible that as and when this occurs, the client will be reducing the extent of their physically active lifestyle such that a reduction in the trauma insurance benefit amount could appropriately be recommended.

Dementia

An older client may have a parent or know someone who is suffering from a form of dementia and they may wish to ensure they have financial protection in place to cover this contingency.

If this client wants "the best" for themselves or their family, considerable funds will be required, with costs being incurred in areas such as:

• Loss of home carer's earnings in the early (average five) years;
• Nursing care in the later (average five) years;
• Medical, pharmaceutical and associated expenses, ongoing; and
• A one-off, upfront bond for nursing home.

While the lifetime costs associated with trauma events such as heart attack, cancer, etc. may be relatively consistent irrespective of where in Australia someone lives, the costs associated with dementia may require a geographical load to be applied in respect of the nursing home bond.

If it was assumed that nursing care costs were $30,000 a year and the nursing home bond was $400,000, the personal lifetime costs of dementia might be estimated as:

• Loss of carer's earnings - 5 x $30,000 = $150,000;
• Nursing care — 5 x $30,000 = $150,000;
• Medical, pharmaceutical and associated expenses = $50,000; and
• Bond for nursing home = $400,000.

Thus a trauma insurance benefit amount recommendation in the above example might be $750,000.

Note: Because the extent of health insurance held by a particular client is not known, no allowance has been made for this by way of a benefit amount reduction.

Within the advice process, the health insurance contribution and any other relevant factors could be identified and the recommendation adjusted accordingly.

Lifestyle changes

Within the context of trauma insurance benefit amount recommendation, it is not only necessary to consider medical and rehabilitation costs, but also the various lifestyle changes the client may want to implement subsequent to suffering a major medical trauma.

While the range of lifestyle changes is effectively endless, certain more typical ones can be identified and quantified, either generically or specifically.

Typical lifestyle changes might include:

(i) Debt reduction: In seeking to make a recommendation to cover this need, the adviser would simply total the debts the client would like to clear; e.g. mortgage, car finance, credit card debts, business loans, etc.

(ii) Time off work: The quantification would be calculated by multiplying the client's monthly earnings by the number of months they would like to have away from work subsequent to the trauma recovery.

(iii) Pre-fund children's education costs: This would be the present day value of future education costs.

(iv) Pre-fund early retirement: The need would be the present day value of the unfunded contributions from the present time up to the planned retirement date.

(v) Time away with partner: Perhaps the client could see themselves taking an extended overseas holiday. An allowance for the cost of this could be made.

(vi) Discretionary home improvements: After recovering from a traumatic medical event, the client may want to treat themselves to a home makeover or renovation.

(vii) Hire home-carer or cleaner: An allowance could be made of the likely annual cost, times the number of years, to moving into a retirement home.

(viii) Top up the 25 per cent income protection insurance shortfall: If the maximum cover under income protection is assumed to be 75 per cent of earnings, the client may wish to have a lump sum available that would effectively top up this amount to 100 per cent. The amount required would be the present day value of 25 per cent of indexed earnings through to age 65.

One advantage when estimating the cost of lifestyle changes is that a relatively objective estimate can be made of the benefit amount required.

To identify which of those on the potential list would be a priority for a specific client, a question along the lines of the following might be asked:

"If you suffered a major medical trauma such as a heart attack, cancer or stroke, which of the following would you like to have the facility to undertake subsequent to your recovery?"

The client might then indicate their preference subsequent to which the appropriate monetary allowance could be made. For example:

Debt reduction, $150,000;

Time off work — one month, $15,000;

Pre-fund children's education costs, $55,000; and

Holiday — business class to Italy, $30,000.

Total = $250,000

Benefit amount recommendation

The final recommendation is simply the sum of the monetary allowance for each component. For example:

An amount to cover the general medical and rehabilitation costs; $150,000;

An additional allowance to cover the costs associated with dementia; $600,000; and

A change of lifestyle allowance; $250,000.

Benefit amount recommendation; $1,000,000.

If the client felt the premium cost was too high, the adviser would be in a position to ask which component of the recommendation the client does not wish to implement.

As each component has a tangible item attached to it, the client will need to delete specific items rather than simply opt for a lower benefit amount.

Thus, if the client indicated that cover for $1,000,000 was too outside their budget and they wished to only have $750,000, it might be, for example, they would have to be willing to remove the allowance for lifestyle changes.

This has the advantage that the client would be better informed of what is and is not covered, irrespective of whether or not a recommendation is accepted.

Summary

There will no doubt be other logical ways in which to arrive at a trauma insurance benefit amount and it may even be that the final recommendation will still be for an amount equating to "twice times salary".

The advantage, however, of having a logical basis for the recommendation is that it facilitates a consistent approach for the individual advisers as well as all advisers within a licensee.

The advantage of implementing a logical basis is that if the advice is questioned during or after it is provided, an explanation can be given such that the client can make the all-important informed decision.

All of which appear to be a great way to mitigate the chance of traumas of another kind arising.

Important note

The examples used within this article are of a general nature only and should not be used as a basis for advice. Advisers and/or licensees should undertake their own research in order to ensure that appropriate advice is provided.

Col Fullagar is the principal at Integrity Resolutions Pty Ltd.