Major and important changes to income protection insurance

Investopoly

I wrote a blog in December last year about how difficult personal risk insurance (e.g. income protection, Life and TPD) is becoming to obtain. Also, in December, the government directed Australian insurers to make some very significant changes to their products. I have been waiting to measure the insurers response to these directives. These changes will have a significant impact on your future insurance options. What is currently offered Before I discuss the changes that the government has asked for, it's important to appreciate the status quo. Most income protection policies have four main variables: 1. Benefit amount This is the amount of income you are insured for. Most insurers allow you to insure up to 75% of your current gross income (not 100%, otherwise there's little financial incentive to return to work). Benefit amounts are typically expressed as a monthly amount. This monthly benefit is taxed at your marginal tax rates - so a $10,000 benefit will result in an income of circa $7,140 per month after tax. 2. Waiting period This is the period of time you must be incapacitated for before you are able to claim a benefit from the insurer. Typically, the options include 30 days, 60 days, 90 days, 6 months or 2 years. Often, the most economical wait period is 90 days. Benefits are paid one month in arrears. So, a 90 day wait period means you won't receive any income for 4 months. 3. Agreed or indemnity If a policy is agreed value, it means that if you become fully incapacitated, you will receive the benefit irrespective of the level of your income prior to you becoming incapacitated. Therefore, someone could have an agreed value policy for $10,000, subsequently become unemployed and then have an accident and they will be paid the full benefit. Alternatively, an indemnity policy requires the insurer to measure your level of income in the period prior to you becoming incapacitated and pay the lesser of up to 75% of that amount or your insured benefit. This means, if your income was nil, you would not receive a benefit, despite paying the premiums for insurance cover (I elaborate on this further below). 4. Benefit period The benefit period is how long you will receive a benefit for whilst you are still fully or partially incapacitated. Given we want protection against long term incapacity, we typically advise clients to obtain a benefit period to age 65. This means if you become incapacitated, the insurer will keep paying you until you attain age 65. This blog discusses income protection insurance in more detail. Why has the government stepped in? According to the Australian Prudential Regulatory Authority (APRA), over the past 5 years, Australian insurance companies have lost $3.4 billion in respect to income protection policies. In the 9 months to September 2019, they lost $1 billion alone. This means that insurers paid out a lot more money in benefits (to insured persons) than they received in premiums (and investment returns). APRA is worried that insurers may start withdrawing from the Australian market. If they did, income protection insurance would no longer be available, which would be to the detriment of Australians. However, none of the insurance companies have been brave enough to be the first one to make changes to their products or pricing (to make them more sustainable) - for fear of losing too much...