Special Communique - Income Protection cover 101*
There is not much you can do without income. In monetary terms, your ability to earn income is your biggest asset by far - which is why Income Protection (IP) insurance is so important.
IP insurance pays you a monthly benefit to replace part of your income if you are temporarily unable to work as a result of serious illness or injury. It allows you to cover everyday living expenses and maintain the lifestyle you have built for yourself and your loved ones.
When you are protecting your biggest asset, there are three things you need to understand so you know what you are covered for, and what that means at claim time:
How much you are covered for? – amount insured
How long you need to wait for your claim to be paid? – the waiting period
How long your claim will be paid for? – the benefit period
1. Sum insured
When you apply for income protection, you can generally choose to insure up to 75% of your before-tax income (which sometimes includes super contributions).
The higher your amount insured, the higher your premium will be. So, you need to think about how much money you will really need to keep up with your everyday expenses (like your rent/mortgage, bills, school fees etc.). Just because you can cover 75% of your income does not mean you have to.
For example, you might earn $10,000 per month but decide you only need $5,000 per month to keep up with your living costs. That may significantly reduce the cost of your cover (i.e. your premium).
If you have a pre-existing Agreed Value income protection policy, you can also reduce your premium by choosing an ‘Indemnity’ benefit payment type.
This means the amount you receive will be determined by your actual income in the two years before the claim (which could mean you receive less than the amount insured) – as opposed to a ‘Guaranteed’ or ‘Agreed’ payment type where, at claim time your amount insured will not be adjusted if your income has decreased.
2. Waiting period
The waiting period is the number of days before you become eligible to claim, starting from the date the doctor confirms you are disabled. The most common chosen waiting period options are 30 days, 60 days and 90 days.
Income protection payments are usually made monthly in arrears. So, if you had a 30-day waiting period, your first payment would be made 60 days after you first became disabled.
The waiting period affects the premium. Naturally, a policy with a 30-day waiting period is more expensive than the same policy with a 90-day waiting period, because you are eligible to claim sooner.
For example, if you are off work for 80 days and have a 30-day waiting period, you could potentially be paid your amount insured for 50 days. But if you have a 90-day waiting period, you may not be eligible to receive anything.
When choosing your waiting period, you should think about how soon you are likely to need financial support if your income stops:
If you have access to sick leave or annual leave, or a high level of savings, you may be able to take a longer waiting period and reduce your premium.
If you are a casual employee or business owner, or you have a low level of savings, you may want a shorter waiting period, bearing in mind your premium will be higher
3. Benefit period
The benefit period is the maximum amount of time you can receive income protection payments for any claim while you are disabled. It can be based on time (e.g. six months, two years etc.) or age (e.g. to age 65, 70 etc.) and your choice can make a difference to the total amount you receive.
Say you are aged 40 and you become permanently totally disabled, meaning you will never be able to return to work. If you had a 2-year benefit period, your benefit payments would stop when you are aged 42. But if your benefit period was to age 65, you would continue to receive benefit payments for an additional 23 years.
Choosing a longer benefit period increases your premium because the potential payout is higher. However, be aware the benefit period is the maximum amount of time you can receive payments. If you are able to return to work sooner than that, or you reach age 65, your payments will stop.
Also, if your policy offers ‘partial disability benefits’, you may be able to return to work part-time and receive reduced payments until you are able to return back to your pre-claims earnings. This can be a great benefit to have as it means you are supported if you are restricted in your capabilities, or you want to try a new occupation.
Oh, and one more thing…
One great feature of income protection is that premiums are generally tax-deductible, which can make it significantly more cost-effective to get the cover you need.
You may also be able to hold an income protection policy inside super, meaning you can use tax-effective super contributions to pay your premiums, however, policy features are generally more restricted when held inside the super environment.
Check your cover now
If your income has changed significantly since you last updated your policy, there is a chance you may be over or under-insured – in which case you should talk to your financial adviser.
Did you know?
Did you know that the Australian Prudential Regulation Authority’s (APRA) latest Life Insurance Claims and Disputes Statistics report for 1 January 2020 to 31 December 2020 confirms that clients who get advice on buying life insurance products are better off at claim time than people who do not get advice on their life insurance purchases.
Claims relating to clients who had the benefit of advice when buying their Income Protection cover were accepted 94 per cent of the time compared with just 84 per cent for those clients without advice.
APRA’s report states: “Generally, Individual Advised business shows higher admittance rates than Individual Non-Advised for the same cover type. This could be due to the policyholder having clearer expectations up front of what is covered by the product, or (related to the previous point) the adviser discouraging the policyholder from lodging a claim that is not covered by the policy.”
Want to know more?
If you would like to discuss any of the content in this article and how it may apply to you, please contact your AFRM adviser direct or email firstname.lastname@example.org.
* Please note, the information in this document has been prepared by Australian Financial Risk Management Pty Ltd (AFRM) ABN 21 001 696 868. AFRM hold an Australian Financial Services License (AFSL) 237186. The information is for general purposes only and has been prepared without taking account of your objectives, financial situation or needs. AFRM recommends that you seek professional advice before acting on any information contained within this document.