Time to check health of your income protection

There are looming changes to income protection rules

Suddenly the prospect of a coronavirus-led global slowdown is a reality and whatever your occupation, job security has just taken a hit.

Depending on our age, our ability to earn an income can be one of our biggest financial assets. If we cannot work due to injury or sickness, it can be millions of dollars of future income at risk.

Protecting this income is relatively simple by taking out an income protection policy, but the Australian Prudential Regulation Authority has finally put its foot down and forced loss-making insurance companies to water down this type of insurance.

Of course, not everyone needs income protection insurance and it depends heavily on the nature of your work arrangements — but if you need it, you will want to get across some important developments.

After $1bn of losses in the past 12 months, changes are afoot and for those wanting to secure a deal from the current generation of income insurance products — with all the bells and whistles — time is running out.

The staggered implementation of APRA’s new measures commences at the end of next month with the first being the removal of what’s called “agreed value” coverage on income protection policies.

Currently, insurers allow people to take out an income protection policy and “lock in” their incomes. In other words, the insurance company agrees to pay you up to 75 per cent of your insured income should you not be able to work, regardless of your actual income at the time of making a claim.

APRA is concerned that this creates a situation where people who have reduced their working hours or changed to a lower-paying occupation could make a claim on their income protection policy and, due to the “lock in” of their higher income at the time of initial application, could be paid more money on an insurance claim than they would actually working.

The industry is split over the changes and, while many agree things need to change, some have concerns.

Serena West, a senior adviser at risk insurance specialist firm Capital Partners, says: “The overall intention of the change is good. However, new legislation is being rushed through without all the future consequences considered. Under the new rules, insurers will look at your income over the 12 months prior to claim.

“What about if you take an extended holiday, have a baby or go on study leave? If you make a claim during this period you’ll get a reduced insurance payout. It is like a part of your income never existed, which doesn’t seem fair.”

From April, people will not be able to take out an income protection insurance policy that guarantees a benefit payment based on income at the time of application.

All life insurance companies are working to this deadline and most require application forms by the last week of March and with all policy requirements finalised by the end of June.

Life insurer TAL has communicated to the industry that customers with existing agreed value income protection policies can continue to maintain and amend their cover in accordance with existing policy terms. They are not subject to any new restrictions as a result of APRA’s measures.

This means that the availability of CPI increases, policy alterations, change of ownership, reinstatement options and underwritten increases will remain unchanged in line with existing product terms and processes.

This creates an issue in itself that needs to be monitored: life insurance companies are notorious for offering products, closing the product range and then increasing the premiums in the “closed” product. In essence, existing customers get slugged more than new customers.

West says: “There is a lot of uncertainty over premiums into the future for those who got in before the changes happen. As it will be a shrinking book of customers over time, how will the insurance companies reprice the premiums as costs go up?”

So what to do now?

Amanda Cassar, senior adviser with Wealth Planning Partners, says: “I will be contacting all clients who have not locked in their income as part of an income protection policy. This means getting tax returns up to date and lodging this with the insurance company to get the ‘agreed value’ coverage.”

People who think they may be covered by an income protection policy should also check as they may be in for a rude shock. Under the recent Protecting Your Super reforms, super funds have cancelled life insurances, including income protection policies where a member has not made a contribution over the last 16 months.

Cassar says: “Call your super fund and see what insurance coverage you have. You may not realise that it has cancelled and you only have a short window to get something back in place.”

And for those with income protection policies as part of their work package (also known as salary continuance), it is worth reviewing these arrangements before the changes hit.

Cassar says: “If you change jobs you might not be able to take your income protection policy with you and are thus thrown into the new system with weaker policies. If your employer currently pays for your income protection insurance, it may be worth negotiating with them to provide you with another benefit so they can cancel the policy and you fund it yourself.”

APRA Stage 2 changes come into play from July 1 and mean lower benefit periods (currently up to age 70). There is also a new rolling five-year policy review so if your occupation has changed to something more risky, expect premiums to shoot up at the next review.

The clock is ticking; if you need to bulk up your current income protection policy or, alas, think that you need one, now is the time to investigate your options before it’s all too late.

James Gerrard is the principal and director of financial planning firm FinancialAdvisor.com.au