We have all heard about the importance of income protection but what does income protection insurance actually cover?
What Does Income Insurance Cover?
Income protection insurance keeps the money flowing when you can’t work due to serious illness or injury.
For an income protection policy to be triggered you must have suffered an illness or injury that renders you:
- unable to perform all the important income producing duties of your primary occupation (the job you did before the injury event)
- unable to work (whether remunerated or not); and
- under the care, treatment and following the advice of a registered doctor.
So if you are capable of working part-time in your primary occupation or if you are working in any capacity, you would not be considered disabled.
Look at the Claim Statistics
To get an idea of what income protection covers, it is useful to look at some actual claim statistics from the insurer TAL:
CHART: Income Protection Claims by Type in 2014
* 2014 TAL claims statistics
Income Protection Does Not Cover
It is worth noting that income protection does not cover you for:
- losing your job (being fired, or made redundant); or
- your business failing.
There are other insurance covers which you can get for such as redundancy cover and business expenses cover.
Did you know:
Not Just for Old People
Here is the income protection claims TAL paid out in 2014 according to the age of the claimant:
Video: Real Life Stories
Let’s Take a Closer Look
To find out exactly what your policy covers you need to review the product disclosure statement, which outlines all the terms and conditions for your income protection policy.
In this blog we will examine a TAL income protection insurance policy as outlined in the PDS pictured below:
All Insurance Policies Differ
Unfortunately there is no one size fits all income protection insurance policy.
Insurance companies are in business to make a profit, so they have developed a range of products with different bells and whistles in the hope of attracting new customers.
In the disclosure document we can see that TAL is offering different levels of cover, much the same as an airline offers economy, premium economy and business class airfares.
The offering you choose will determine what benefits you are entitled to when making a claim:
Most insurance companies will offer the following policy choices, which we will address in order:
When it comes to the income insurance premium there are two options:
- Stepped premium – one that will rise every year, with your age and risk level.
- Level premium – one that will remain constant.
Here is the catch; under a level premium you will generally pay a higher premium for the first 7 years, when compared to the same policy on a stepped premium.
Example: Stepped vs Level Premiums (over 30 Years)
Consider a 30 year old graduate accountant from NSW, earning $75,000 per annum. The lifetime cost of 75% income insurance until age 60 years is as follows:
- Stepped premium = $90,019.80
- Level premium = $59,788.60
As income protection insurance is such a crucial and long held cover, we often recommend level premiums.
The irony with stepped cover is that most people won’t be able to afford to premium cost at a time when they likely need it the most, between the ages of 50 – 60 years (think premiums costs of $10,000 + p.a.).
As long as you continue paying the annual premium, an income insurance policy can last up to 65 years of age.
Here is the catch; you cannot cover 100% of your income.
The maximum you can cover under an income insurance policy is:
a) 75% of income
b) 80% of income (with the super contribution option)
There must be some disincentive to receiving income protection insurance, which would make you want to return to work if possible. If you were getting 100% of your income under an insurance policy, you would probably prefer not to work. If you are only getting 75% or 80%, you are more likely to do everything in your power to return to work.
4Type of Cover
Income protection policies are provided under either an
- Indemnity basis; or
- Agreed value basis.
Under an indemnity policy, your cover is calculated on your income at the time you make a claim. In other words when you go to make a claim, you have to provide proof of that income. This could be an issue if your income fluctuates and is at a reduced level when you make a claim.
Under an agreed value policy, your cover is calculated on your income at the time you apply for the policy. In other words you have to prove your income at the time of applying and is usually calculated by looking at your last two tax returns. The premiums for an agreed value policy tend to be 20% more expensive, but that is the price you pay for certainty.
For payments to start under an income protection policy, you need to be continuously disabled for a defined period of time. This is known as the waiting period.
Ask yourself, how long could you survive without an income? For many people the answer to this question could be as little as 14 days.
The common waiting period options for income insurances are as follows.
- 14 days
- 30 days
- 60 days
- 90 days
- 180 days
A longer waiting period will result in a lower premium cost.
In most cases we believe that the sweet spot for income protection insurance is the 60 – 90 day waiting period, as it strikes a balance between the price of the premium and the length of time until the insurance kicks in.
You can choose from a very short term benefit period, such as 1 year through to a payment period of 70 years (commonly 65 years with other insurers).
The longer the benefit period the higher the premium.
7Who Can Own the Cover?
In most cases it is better to hold your income protection insurance policy in your personal name.
If you cannot afford to hold the policy personally, but still want cover you can consider holding the policy in your super fund.
Holding your policy in super can sometimes have added complications due to super preservation regulations (i.e. sometimes a claim can be paid out, but you cannot legally get the money out of your super fund).
Most insurance companies will offer other optional benefits.
For example you may choose the needlestick benefit if you work in the medical field and this is a risk, or the retirement protection benefit if you want to ensure the payout will include an extra amount to continue building your super fund for retirement.
- Income protection can keep the money coming in if you suffer an illness or injury and cannot work.
- The terms of your insurance policy are outlined in the PDS.
- Insurance companies offer different product options in an attempt to entice new customers.
- For best results match the policy choices with your personal need for insurance
Not all insurance policies are the same. Make sure you read the documentation before you sign on the dotted line.
The information on this blog and website is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision. We recommend you consult a licensed financial adviser in order to assist you with this.