Trauma insurance: what it covers, and how it differs from TPD and income protection

Trauma insurance, also called critical illness or recovery insurance, pays a lump sum if you suffer a critical illness or serious injury listed in the policy, such as cancer, a heart condition, a major head injury or a stroke (Moneysmart). It does not cover mental health conditions. Super funds can’t offer new trauma cover, so it is bought outside super, and for individuals the premiums are not tax-deductible.

We’re Maciej Stanek and Imran Amjad, financial advisers at Véurr Financial Planning in Canberra. This guide explains what trauma cover pays for, how it sits beside TPD and income protection, and the rules behind it. It is general information, not a recommendation to take out, keep or cancel any cover.

What does trauma insurance cover?

Trauma insurance pays a lump sum when you suffer one of the medical events the policy lists. What is covered, and how each condition is defined, differs between insurers, and Moneysmart notes that trauma cover does not include mental health conditions.

Three definitions are standardised across the industry. The Life Insurance Code of Practice, which subscribing life insurers follow, sets minimum definitions for cancer, heart attack and stroke. When a claim involves one of those conditions, the insurer assesses it against both its own policy definition and the Code’s current definition, and the claimant gets the better of the two. This applies to the first $2 million of trauma cover in policies issued on or after 1 July 2017. That $2 million is the limit of the Code’s promise; the most a policy will pay is set in its PDS. It does not apply to cover reinstated after a claim, to benefits where the amount paid varies with how severe the condition is, or to benefits included with income protection or TPD.

The Code’s own definitions have limits: its cancer definition, for example, excludes certain early-stage cancers. For individual policies still offered to new customers, subscribing insurers also commit to reviewing their medical definitions at least every three years with medical specialists. A specific policy’s list of conditions, definitions and exclusions is set out in its Product Disclosure Statement (PDS).

Moneysmart lists out-of-pocket medical costs, living expenses while someone can’t work, therapy, nursing care and special transport, changes to housing, and paying back debt such as a mortgage among the costs the lump sum can help with.

How is trauma insurance different from TPD and income protection?

Trauma cover is triggered by a medical event named in the policy. Total and permanent disability (TPD) cover pays a lump sum only if an illness or injury leaves you permanently unable to work, as the policy defines it, and income protection pays part of your income each month while illness or injury stops you working. The three answer different questions, so one can pay when another does not.

Sources: Moneysmart pages on TPD, income protection and insurance through super; ATO, Income protection insurance; APRA on income protection benefit limits; Income Tax Assessment Act 1997, section 295-465; Moneysmart, Tax and super.

If trauma cover is packaged with life cover, a trauma payment can reduce the life cover by the amount paid, so the PDS is worth reading on that point. How the four covers fit together in a household plan is on our page on income protection and life insurance advice in Canberra, and how own-occupation and any-occupation TPD definitions differ, and how they are tested at claim time, is in our guide to claiming TPD.

Can you get trauma insurance through super?

Not as new cover. Since 1 July 2014 the Superannuation Industry (Supervision) Regulations have barred super trustees from providing an insured benefit unless the insured event is consistent with a condition of release: death, a terminal medical condition, permanent incapacity or temporary incapacity. A trauma diagnosis is not one of those, so trauma cover is bought outside super.

The rule does not stop a fund continuing to provide benefits to members who joined before 1 July 2014 (regulation 4.07D). That is why Moneysmart says someone who was in a fund offering trauma cover before July 2014 might still have it; the member statement or the fund will confirm. For anyone whose cover has so far come through super, the practical difference is that trauma premiums are paid from take-home pay, not the super balance.

Is trauma insurance tax deductible, and is the payout taxed?

For individuals, the premiums are not tax-deductible: the ATO lists trauma and critical care insurance premiums among those you can’t claim, because the policy pays a capital sum rather than replacing income. For cover held outside super, a payout is generally not taxed either, because the tax law disregards a capital gain from compensation for an illness or injury you or a relative suffer personally, and the ATO’s view is that a trauma payment made because of an illness may be exempt under it.

The exemption is in section 118-37 of the Income Tax Assessment Act 1997, and the ATO’s Taxation Determination TD 2007/4, which is mainly about a related exemption for life insurance, says a trauma payment for an illness may be exempt under that section, and gives an example of a payment for a relative’s illness that is. It is written around an illness suffered by you or your relative, so how a policy owned by someone else, such as a business or a trust, is treated is a question for an accountant.

What affects the cost of trauma insurance?

Insurers price trauma cover on the answers given at application: age, job, medical history, family history, lifestyle such as smoking, and high-risk sports or hobbies. Moneysmart stresses answering honestly, because misleading or incomplete answers can lead an insurer to cancel or vary cover or decline a claim. If an insurer doesn’t ask for medical history, Moneysmart notes, the policy may have more exclusions or narrower definitions.

Premiums can generally be paid in one of two ways. Variable age-stepped premiums are recalculated at each renewal based on age, so they generally rise as you get older. Variable premiums start higher, but changes aren’t based on age, so increases generally come more slowly. These are Moneysmart’s current names for what used to be called stepped and level premiums. A cheaper policy may have more exclusions, or become more expensive later.

Is trauma insurance worth it?

There is no general answer: it depends on what a serious illness would cost a household and what would already cover it. Moneysmart suggests thinking about how much income you and your family would need if you couldn’t work for some time, whether income protection or TPD cover would replace lost income, whether private health insurance would pay some medical costs, and what support family or friends could give.

In Maciej’s experience as an adviser, insurance fills the gap between what a household could cover from its own savings and what it couldn’t. Where savings would carry someone through a serious illness and time off work, cover may not be needed; where a trauma event would derail the household’s financial plan, it becomes a serious consideration.

The questions an adviser works through usually include:

• What would treatment and recovery cost beyond what private health insurance pays, and for how long?
• How long would accrued personal leave and savings last?
• Would existing income protection pay soon enough, and for long enough, to cover a long recovery? (More on income protection waiting and benefit periods.)
• If trauma cover were packaged with life cover, how would a trauma claim change what the family receives on death?
• Could the premiums still be met from take-home pay as they change over time?

For how debts, dependants and existing cover change the overall amount, see our five illustrative scenarios on how much life insurance a household needs. Moneysmart’s life insurance claims comparison tool shows, for each insurer, the percentage of trauma claims accepted and the average time taken to accept or decline a claim. For any policy you look at, the PDS and Target Market Determination set out what it covers and who it is designed for.