Working out what terms, features and benefits has never been harder

The rules have tightened across income protection insurance and the industry is making sure just about everyone comes under the new rules.

For the average consumer trying to work out what terms, features and benefits they should take out for an income protection policy, it has never been harder. Picture: JOE RAEDLE / Getty Images via AFP

After $3.4bn worth of losses over a five-year period, insurance regulator APRA has stepped in and forced life insurance companies to change their ways when it comes to how they offered income protection insurance contracts to consumers.

Although the changes have been successful in turning the tide and life insurance companies: For the 12 months to 30 June 2022 APRA statistics show a 136 per cent increase in the net profit of Australian life insurance companies.

However, for the average consumer trying to work out what terms, features and benefits they should take out for an income protection policy, it has never been harder.

From 2021 onwards, insurers can no longer pay the full income protection claim amount without assessing the insured‘s income prior to claim. And if employment income has dropped, so will the income protection benefit amount. Life insurance companies also reduced the level of coverage from up to 80 per cent of income coverage to 70 per cent and imposed stricter claim triggers.

Sydney based risk specialist Mahesh Viswanathan says: “We expect insurance premiums to remain stable into the future.”

Prior to the 2021 changes, income protection insurance was relatively easy to understand. You could insure up to 75 per cent of your employment income and decide whether you wanted to ‘lock-in’ your income at the time of application, known as an ‘agreed value’ contract, or pay about 15 per cent less insurance premium under an ‘indemnity’ style contact where the insurer would assess your income at the point of claim.

Today there are no more ‘agreed value’ policies and only ‘indemnity’ policies remain.

Previously, the definition of disability was relatively standard – you could make a claim if you were unable to do one of the important duties of your occupation. Today, there are multiple definitions of disability when making a claim and multiple variations of when these claim definitions kick in.

Other policies are offered under an ‘any occupation’ definition of disability which means that if you cannot do your own job, but you can still do another job that you are suited to based on your previous training, education and experience, you will not get the income protection payment.

Some insurers will offer the stronger ‘own occupation’ definition for two years then revert to the weak ‘any occupation’ for the remainder of the benefit period while other insurers will offer ‘own occupation’ for five years, but then cancel the policy after five years instead of letting it run to age 65.

The next barrier is the underwriting process. If you have experienced relationship issues and saw a doctor about stress or anxiety, expect a mental health exclusion on your policy. If anyone in your immediate family has heart issues, this could trigger a loading, which means your premium will be higher than the standard premium by anywhere from 25 per cent to 200 per cent.

If you think you are in the clear by having a pre-2021 income protection policy under the stronger, more lucrative ‘agreed value’ contract, think again. Insurance companies have been actively trying to update their books by increasing the insurance premiums on these grandfathered policies in an attempt to make them cancel and move on to the weaker, watered down income protection policies offered in the market today.

Here are my top tips on income protection insurance:

● Take out a policy sooner rather than later. Not only will your health be better and result in less medical underwriting issues, premiums are cheaper when you are younger;

● Compare stepped versus level premiums on a cumulative basis. Generally stepped premiums are cheaper for the first 10-15 years, then are higher than level premiums. On a cumulative basis over the expected lifetime of the policy, level premiums usually work out cheaper;

● To reduce the premium, review the waiting period which is the number of days you need to wait before starting to receive the monthly benefit payment. The ‘sweet spot’ tends to be a 90 day waiting period;

● Premiums can be funded from super for cash flow purposes however for higher income earners, as income protection premiums are tax deductible, a higher tax benefit will be received if the policy is owned outside of super;

● 85 per cent of income protection claims are concluded within 6 months, while 95 per cent of claims are paid for less than 2 years. With this in mind, decide whether you want to pay more for a policy that will continue to pay you until age 65, or whether you opt for a more cost effective policy that pays you a benefit for 5 years then stops; and

● Before taking out a policy, check if your work or super fund provides you with an employer paid policy. If so, taking out a separate income protection policy is likely to be doubling up on premiums unnecessarily

James Gerrard is principal and director of Sydney financial planning firm www.financialadvisor.com.au