The complexity of income protection insurance plans presents a great challenge when opting for cover, writes Chris Kirby.
Income protection policies provide a wide range of structures and options that allow planners to balance the client’s needs with their affordability.
While the bespoke nature of income protection policies provides great flexibility, this flexibility also creates a challenge.
The challenge for planners and clients is to weigh up the pros and cons of choosing one option over another and how to effectively use the full range of options available to provide truly meaningful protection for all clients.
Unless the implications of each option are addressed and deeper considerations are taken into account, the advice process could be inappropriate.
The waiting period
The waiting period is the length of time the insured must be disabled prior to becoming eligible to claim a benefit. The premium reduces as the waiting period increases.
The key issue to consider when determining the length of the waiting period is the client’s ability to self-insure and manage their cash flow for an extended period of time.
‘Advanced’ income protection policies generally provide a range of ancillary benefits that pay during the waiting period (eg, if you suffer a specified injury or trauma).
Opting for a longer waiting period, in tangent with an ‘advanced’ income protection policy, means that for many situations, the insured will be eligible to claim without having to be disabled for the waiting period.
The percentage of income insured
Income protection policies generally allow for insurance of a monthly benefit up to 75 per cent of income (and an additional 9 per cent as superannuation contributions). The higher the monthly benefit, the higher the premium.
When thinking about the percentage of income to replace, the client’s fixed living expenses and what, if any, other sources of income they have access to is paramount.
Clients can have multiple income protection policies to manage both the short and long-term financial implications of a disability.
For a client who can manage with a lower replacement level of income in the short term, a strategy to consider is to have one income protection policy with a two-year benefit period covering, for example, 60 per cent of income, and a second policy with a two-year waiting period that replaces the maximum 75 per cent of income with cover through to age 65.
An agreed value or indemnity monthly benefit
An agreed value policy provides certainty that should income fall, the client will still receive the full monthly benefit if they are totally disabled.
An indemnity policy generally pays the lesser of the monthly benefit and 75 per cent of income in the last 12 months.
The key issue to consider when determining if an agreed value or indemnity policy is appropriate is stability of income, and in particular, the likelihood of income falling in the future.
Employment status is usually seen as the factor that drives income stability. Self employed clients are generally going to be more concerned that their income may fluctuate, so an agreed value policy may be more appropriate to their needs.
For employed clients with stable income, an indemnity policy may be appropriate and a way to save money.
When considering an indemnity policy it is vital that not only current but future income stability is considered.
If a client is considering working reduced hours after maternity leave, a ‘sea-change’, leave without pay or becoming self employed, their income will most likely be affected and agreed value may be the appropriate solution.
The benefit period
The benefit period is the maximum length of time that a claim will be paid. Benefit periods are either expressed as a defined period (eg, two or five years) or until a certain age (eg, to age 55 or 65).
The longer the potential claim period, the more expensive the cover.
The key issue to consider is how the client will manage financially if they are disabled long term. If they cannot work, do they have enough capital working for them to replace their income to age 65?
If the answer is no, long-term income protection is the most appropriate solution. Arguably, the benefit period is ‘non-negotiable’. If a client has access to income protection through to age 65, this should be recommended.
Flexibility and choice is crucial with income protection insurance, but so is taking the time to consider all options before a particular course of advice is considered.
Chris Kirby is head of technical strategies for personal wealth protection at AMP.
