Knowing what to do to avoid major pitfalls at claim time is where advisers’ true value lies, according to Col Fullagar.
“This is an agreed-value income protection insurance policy and I am recommending it because the benefit amount is guaranteed and no proof of earnings is required if you claim.”
The “earnings” being referred to are, of course, those generated by the personal exertion of the insured.
The perception of onerous claim requirements and benefit assessments are key concerns for many clients and advisers, thus an offer such as that above can sound very attractive.
The one small problem is, of course, that what the client hears and relies upon may be different to what the adviser said and meant; but worse still, both of these may be quite different to what actually occurs when a claim is made.
Certainly, if there was a reduction in earnings between the date of policy inception and claim, this would not affect the amount payable under a total disability claim and thus, to that extent, the benefit is guaranteed and the generally held definition of agreed value satisfied.
The statement concerning proof of earnings is, however, more problematic. Even if a total disability claim is made, proof of earnings can still be required.
Common reasons include:
- If the insurer wishes to undertake prudent claims investigations and check the earnings figure disclosed at the time of application;
- If income from another source is being received and an offset is to be made; and
- To ensure there is no self-generated earnings during the claim.
The most obvious reason is, however, when the claim is being assessed not as a total but as a partial disability.
Under the partial disability formula, the benefit payable derives from an assessment of the proportional reduction in generated earnings resulting from the disabling sickness or injury.
Even with so-called ‘guaranteed policies’ for which proof of earnings are provided and assessed when the application for insurance is made, the management of a partial disability claim will require the provision of proof of earnings each month.
The relevant and important questions with partial disability claims are therefore:
- What constitutes generated earnings at the time of claim?;
- How best to calculate the quantum of those generated earnings?; and
- What is the most effective way of demonstrating the above to the claims assessor?
It is not possible to consider all scenarios in the confines of this article. However, several indicative ones will be reviewed by way of case studies and for simplicity, where relevant, in each case study:
- Pre-disability generated earnings (PDE) will be $10,000 a month;
- The insured benefit amount will be $7500, (ie, 75 per cent of PDE); and
- It will be assumed that the proposed outcomes are in line with the policy terms and conditions.
Case study 1: Ernie the employee
Ernie is an employee of a small retail outlet. After a period of total disability he returns to work part-time (ie, two days a week) and is paid $4000 a month.
This represents a 60 per cent reduction in earnings, so 60 per cent of the benefit amount is payable – ie, $4500.
The employee situation is generally held to be straightforward; however, complications can arise if Roy, Ernie’s boss, wishes to “do the right thing” and tops up earnings above the generated amount on an ex-gratia basis or continues to similarly provide pre-disability fringe benefits.
A recognition that these payments are not generated earnings will assist Ernie’s adviser to either position the payments appropriately with the insurer, or alternatively with Roy.
Case study 2: Sole trader Sally
Sally works by herself as a real estate agent.
She is an avid skier as distinct from a good skier and one day she loses control and collides with an onlooker.
Sally has three weeks off work following the accident and then, like Ernie, she returns to work two days a week, generating $4,000 – ie, 40 per cent of PDE.
In addition, however, Sally receives a payment of $2000 for a property sale made prior to the accident.
Saul, Sally’s adviser, recognises that the $2000, when added to the proposed benefit payment of $4500 and the $4000 of generated earnings, would total $10,500 or 105 per cent of PDE, which might cause the insurer to reduce the partial disability payment.
Saul submits to the insurer that the $2000 should not be included as it was generated prior to the period of claim and the insurer’s reasonable concern is countered at the other end of the claim.
The insurer agrees.
Four weeks later Sally has fully recovered and is back working five days a week. Disability benefits have ceased.
Unfortunately, the nature of Sally’s work is such that it will take some time to build up appointments again following the claim absence.
Therefore, notwithstanding Sally is able to work at full capacity, 100 per cent of pre-disability earnings will not be received immediately.
Fortunately, Saul recognised this possibility and recommended a policy that contained an ancillary benefit designed to make up the post-claim shortfall.
Saul also pointed out to Sally that the likelihood of a post-disability shortfall in part supported the position he put to the insurer: ie, earnings generated prior to but received during the period of claim should not be included within the partial disability formula, because after the claim has ended there may be a lag before 100 per cent of pre-disability earnings is generated again.
Again, understanding the possibility of this will enable the adviser to better identify and position it with the insurer.
Case study 3: Roy’s revenue-generating employees
Roy runs a small clothing outlet across the road from Sally. In addition to himself, he has two other sales staff.
Roy and his sales staff each work on commission.
Roy’s personal generated earnings are $10,000; however, in addition he receives a further $5000 a month which is his split of the net revenue generated by the other two sales staff.
Total pre-disability income for Roy is $15,000 a month.
Roy is injured while holidaying at a ski resort when he is knocked down by an out-of-control skier.
After a month away from work, Roy returns two days a week, generating $4000 personally.
The question is, however: what happens in regards to the split of net revenue generated by the other two sales staff?
This question may best be answered by referring back to Roy’s application for insurance.
At the time of application, was it necessary for Roy to “supervise” or “manage” the other sales staff to keep them productive?
If ‘yes’, the net revenue Roy receives from their sales would be considered to be generated by the supervisory “personal exertion” of Roy, and thus included within the partial disability formula at the time of claim.
If ‘no’, the profit split will form part of the “unearned” profit distribution of the business, which may reduce the level of cover or lengthen the waiting period recommended to Roy at the time of application.
In the latter scenario, the profit-split would not be included within the partial disability formula as it is not in any way generated by Roy’s personal exertion.
If this analysis is not undertaken and presented as part of the application, the insurer may simply apply an offset within the policy such that disability benefits are reduced by the ongoing net profit received by Roy.
Roy’s situation also highlights the fact that ‘personal exertion’ can occur in different ways depending on the insured’s occupation – for example, by way of:
- physical work;
- supervisory work;
- management directive; or
- intellectual application.
A final word on Roy: if the position in regards to the profit-split altered after the date of application, a review of Roy’s insurances should identify this such that the basis of cover could be appropriately amended.
Case study 4: Billy’s blurred earnings
Billy is the part owner of a small manufacturing business with seven employees, each of who contribute in different and overlapping ways to the generation of revenue.
Billy suffers an acute depressive illness brought on by the unexpected injuring of his two best friends at the ski fields.
Business revenue is maintained at around the same level as that prior to Billy’s illness by virtue of additional casual staff being hired and the remaining staff “putting in an extra effort”.
After an absence of three months, Billy returns to work; however, he is not only working reduced hours but also demonstrates reduced productivity during those hours.
In this type of scenario, ascribing a concise revenue contribution to Billy’s personal exertion will not be possible; however, far from being a drawback, this makes moving forward with a claim assessment somewhat easier.
Once impossibility is recognised and accepted, it follows that amicable discussions between the adviser, client and insurer should commence and flexibility be demonstrated, so that a reasonable basis for arriving at a generated earnings contribution can be agreed upon.
For example:
- Billy may be working 50 per cent of pre-disability hours;
- A pre- and post-analysis of duties performed may reveal that he is able to perform his pre-disability duties, but at an estimated 50 per cent efficiency.
Faced with the above, it might be agreed that Billy is capable of generating earnings at around 25 per cent (50 per cent of 50 per cent) of his pre-disability level – ie, there is a 75 per cent reduction in earning capacity.
Following on, a partial disability benefit of 75 per cent of the insured benefit amount might be paid.
Periodic reviews of Billy’s medical condition would ensure that any material changes, improvements or deteriorations would be recognised and taken into account.
Case study 5: Peter Passive (v) Arnie Active
It is often the case that people will not only generate earnings within their chosen occupation, but they will also receive additional income by virtue of direct or indirect investments.
Peter Passive returns to work on a part-time basis and generates $4000 a month by way of personal exertion work.
In addition, however, a further $2000 is received from an investment portfolio.
The relevant question becomes: at what point and on what basis would Peter be considered a Passive investor as distinct from Arnie who is an Active investor?
The same question could extend to a total disability claim: ie, when would the level of investment activity be such that the insurer deems Peter to be no longer totally disabled in his pre-disability occupation, but partially disabled as an Arnie Active investor?
To assist in arriving at a distinction, two extremes can be considered:
- Peter has a managed investment under the oversight of a financial adviser. Peter calls the adviser every now and again to check on balances and returns; whereas
- Arnie takes direct control over an investment portfolio and undertakes considerable research and makes multiple trades each day.
It is unlikely Peter would be considered anything other than a passive investor and therefore any resultant investment profit would be ignored for the calculation of partial disability entitlements.
Arnie, however, is more likely to be considered an Active investor, with investment profits being included in the partial disability formula.
It is clearly not possible to draw a line the crossing of which turns Peter into Arnie, but broad guideline criteria can be identified, for example:
- Frequency of activity;
- Nature of activity – for example, research, share trades, property purchases or sales;
- Quantum of trades – for example number of units or amount of money involved; and
- Investment retention period, days, months, etc, bearing in mind the nature of the investment also needs to be taken into account.
Another relevant factor might be whether investment earnings were or were not deemed to be generated earnings at the time of application.
It would be a lean argument to include investment earnings at the time of application but exclude them subsequently – unless of course there had been a material change in circumstances either before or after the disability claim started.
The role of the adviser
These case studies highlight the importance of a client having access to professional financial advice, with that access providing five levels of protection.
Level 1 is ensuring that appropriate insurance safeguards are in place – this is called initial advice.
Level 2 recognises that a client’s circumstances may well change over time and regular reviews need to occur to ensure these changes are recognised and considered in adjustments to benefit levels, and waiting and benefit periods that apply.
Good advice is not about getting as much cover as possible; it’s about getting appropriate cover.
Level 3 is the identification of real life financial issues that may be faced at the time of a claim so that, if and when a claim occurs, the chances of unpleasant surprises are mitigated.
Level 4 is alerting the client to the potential claim proofs that may be required so that the necessary records can be kept, retrieved and produced in a timely manner.
And finally, Level 5 is helping the client to understand the practical application of the policy terms and conditions, and the insurer’s reasonable claim requirements, so that the claims assessment process can proceed with minimal disruption and cost.
This is a very real value-add an adviser can provide throughout every point of the risk insurance advice process – irrespective of whether adviser remuneration is by way of commission or fees.
Col Fullagar is the principal of Integrity Solutions Pty Ltd.
