Six Stones – 2. Income Protection Insurance

Welcome (back) to our Six Stones series. Our financial adviser, Jordan, is sharing as many tips, ideas and advice for people going through a divorce as a humble blog will allow.

He’s staying away from specific financial advice – it’s all general advice over here, be sure to get personal financial advice before doing anything – but we hope you find some useful information in here as you navigate through/out of your divorce.

The insurances we’ve discussed so far have had one thing in common – they pay lump sums out. You make a claim, meet the definition, and bang, here’s a (probably large) amount of money.

The fourth part of a full insurance portfolio, Income Protection, is quite different.

When you think about how critical an income is to every part of your financial future, you can see why income protection is so important.

What Is It?

It is designed to replace part of your regular income in the event you can’t work for medical reasons.

Instead of one lump sum payment, you could potentially receive monthly payments from now until you turn 65.

Think of Income Protection as the cousin of TPD insurance. If you’re ‘disabled’, you will receive a payment every month until either you can return to work, or you reach the end of the policy’s benefit period.

Things You Should Know

There are, as ever, some defining features of the policy to be aware of:

The Benefit

That monthly payment is dictated by a few things.

First, there’s a maximum percentage of your current income that it’ll cover. Or, more technically, a percentage of your ‘pre-disability income’.  

You can get up to 85% on some policies, but there’s some creative and self-serving maths normally at play, so we’ll use the more-common 75%.

Meaning that, for every $1,000 of pre-tax income you are paid each month, you could insure up to $750 of it. 

It’s important to note that the benefit is based on your pre-tax income, and it’s taxable. So you have to pay tax on that $750 in the above example.

Say it works out that you pay 30% tax – that means that you’ll receive, in your pocket, $525 per month.

The Waiting Period

One key component of any Income Protection policy is the waiting period. As the name suggests, this is how long you’ll have to wait before receiving a benefit payment.

The shorter you want to wait, the more expensive the premium.

The most common one is 30 days, but you can set it as short as 14 days, or as long as 2-years.

Another important point about the waiting period – it’s the period from the date of ‘disability’ to the date of becoming eligible for the payment. The insurer will then, generally, pay your benefit 2-4 weeks in arrears.

This means that for a 30-day waiting period, you may not receive your first payment until day 44, or 58, depending on the nature of your policy.

Ideally, you want as long a waiting period as your resources – savings, leave entitlements, timing of salary payments – can support.

There is a tension here, though, in that the longer the waiting period, the lower the odds of actually receiving a benefit payment.

The Benefit Period

And then you can adjust how long the benefit will actually be paid for. There are quite a few options, but the most common are 2-years, 5-years and to the age of 65.

This is a critical part of the policy.

Statistically, the chances of somebody returning to work decrease the longer they’re away.

If you have a 2-year benefit period, it’s possible that your disability will outlive the benefit payments.

It’s hard to put a blanket rule on this but really think about how long a benefit period you’d like. In my opinion, a longer benefit period is better, but every person’s situation is unique.  

There are quite a few variables that go into determining how much an Income Protection policy costs, but these three are the most influential. Pulling one, or all, of these levers can make a serious difference to the price of a policy – and to how useful it ends up actually being.

When Does Income Protection Pay?

The easy answer here is when somebody meets the policy definition.

But, like TPD Insurance, those definitions are based on your ability to work, so often the answer is anything but easy.

It centres around whether you are ‘disabled’ and whether that disability is ‘total’ or ‘partial’. There are some common terms between this and TPD insurance, so bear with me – it can get a little confusing.

First, the insurer will assess whether you are ‘totally’ disabled. To do this, they’ll refer to the definition in your policy terms or contract.  

For an example, I’ve taken this definition from one of the largest insurers in the country:

“Total Disability and Totally Disabled under Income Protection insurance means that, solely because of a Sickness or Injury, the Life Insured is following the advice of a Medical Practitioner and:

• is not working in any Working Occupation and is unable to perform one or more duties necessary to generate income in the Life Insured’s Own Occupation; or

• is not working in any Working Occupation and has suffered a reduction of 80% or more in the ability to generate Earnings in the Life Insured’s Own Occupation…”

More legalese, right? But there are some key terms in there:

–           Sickness or Injury – Income Protection does not pay if you lose your job or made redundant. It has to be because of Sickness or Injury that you can’t work anymore.

–           …one or more duties… is comparatively generous compared to TPD insurance’s requirements.

–           …reduction of 80% or more… means that even if you can perform all of your duties, if your income has fallen by 80% or more, you may still be considered disabled.

If your claim meets these requirements, then the insurer should begin paying you a monthly benefit.

‘Partial’ Disability

But, if it is decided that you do not meet these conditions, the insurer will then consider you under a ‘partial’ disability definition.

From the same insurer:

“Partial Disability and Partially Disabled under Income Protection insurance means that, solely because of a Sickness or Injury the Life Insured:

• is working in his or her Own Occupation or any Working Occupation, but in a reduced capacity; and • is following the advice of a Medical Practitioner; and

• has suffered a reduction in the ability to generate Earnings.

You’ll notice there’s no required level of Earnings drop to meet this definition, but rather just a requirement to show that your capacity has reduced.

I don’t want to get too far into the nitty-gritty details here – it’s a fine line! – so let’s stop this particular thread here.

But I do want to highlight that there is a process that’s followed in these assessments and these claims do get paid.

In my next post, we’ll get into some of the other details about Income Protection, like how much it pays, other things you should be looking out for and why superannuation might not be the best option for you.