Income Protection Insurance Explained

Income protection insurance is a branch of life insurance designed to protect the worker in the event of a total or partial disability which prevents them from working. Income protection will replace a percentage of your salary while you recover or find new employment.

If you work in a typically non-threatening environment and aren’t at significant medical risk, you might not see the need for income protection insurance. However, high-risk occupations, such as trade work, might find income protection insurance more relevant.

Naturally, the salary percentage and the duration of cover (benefit period) will vary depending on the insurer you choose. It is also worthwhile to identify the type of income protection insurance that will best suit your circumstances.

Related: Cost of Life Insurance Policies in Australia

There is a range of more specific insurance options worth considering during the research phase. Some of these types include:

• Personal accident insurance,
• Redundancy insurance,
• Self-employed worker insurance,
• Sickness and accident insurance, and
• Mortgage protection insurance.

There are many other types of income protection, offering different levels of cover for specific areas of concern. If, for example, you are self-employed then a more tailored level of protection may be necessary. Discussing your circumstances with your insurance provider can be an excellent first step.

In terms of the value of your policy, there is only one type on offer these days: an indemnity value policy.

An indemnity value policy insures you based on your salary at the time of the claim. Therefore, if you purchase your insurance when you are earning a higher salary and then take a lower paying job, your level of cover will decrease in line with this change. If you have a variable income, the percentage will be based on your average annual income over an occupation-appropriate period.

For those purchasing income protection insurance for the first time, an indemnity value policy is the only product on offer. Prior to March 31, 2020, it was possible to choose between an indemnity value policy and an agreed value policy when signing up.

An agreed value policy allowed you to claim insurance for a percentage agreed upon at the time of the purchase. However, APRA felt that a policy’s benefit should not exceed the policyholder’s economic loss. If the benefit is larger than a person’s typical income, they may find themselves unenthusiastic about returning to work. Therefore, the product was considered to have ‘adverse financial impact’ on insurers and was removed from the market.

Each policy is different, but generally speaking income protection insurance will be provided to workers with a partial or total disability. In terms of how much income protection insurance will cover, as Moneysmart notes, it will usually cover up to 90% of your pre-tax income in the first six months, and up to 70% for a specified time after six months.

These figures are based on your ‘pre-disability income’: the 12 months prior to your injury or illness. Some insurers will cap this at a monthly figure; for example, CommBank comes with a caveat that caps your ‘pre-disability income’ at $10,000 per month.

Your level of cover may also vary based on whether you have a full or partial disability. Therefore, it is strongly recommended that you read the product disclosure statement (PDS) before taking out any policies.

Your benefit period is simply how long the insurance will cover you for. Typically, your policy will give you the option of two to five years of cover. Alternatively, it may last until you are a certain age. A longer benefit period means a more expensive policy, so you will need to consider how much protection you feel is necessary.

When applying for your income protection insurance you will need to provide your insurer with a list of information, including:

• Occupation (hours, location, physical requirements)
• Financial information (pay slips, tax returns, etc.)
• Medical history (reports or tests may be necessary)
• Age
• Lifestyle (do you smoke or participate in high-risk sports or hobbies?)

Answer your insurer’s questions honestly and note whether your insurer asks for your medical history. If they do not, it’s possible that the policy has more exclusions or tighter definitions.

It is important to note that most types of income protection policies come with an attached waiting period. This period will typically be somewhere between fourteen days and two years from the purchase. During this wait period, claims cannot be made. The injury or illness must take place after the waiting period for you to be eligible for the payments.

But why take a policy with a longer waiting period? Typically, if you opt for a longer wait period your policy will be cheaper. It may be best practice to evaluate your accrued sick leave and emergency savings when selecting your policy’s wait period.

When it comes to paying for your income insurance you will likely have the choice of stepped or level premiums. The decision you make will largely impact how much you pay in future.

Stepped premiums recalculate every time your policy renews. It’s likely that at each renewal your costs will increase, as you age and become more prone to injury and illness.

Alternatively, level premiums are not based on the policyholder’s age. Instead, you pay a larger premium when you first take out the policy. Price increases then happen at a much slower rate as the policy ages.

There are several exclusions that are typical to most insurance policies. Reading the PDS is the best way to ensure you are aware of these exclusions, but, for reference, excluded injuries or illnesses may result from:

• Self-harm,
• Pregnancy,
• War or civil unrest, or
• Military service.

Additionally, if your injury or illness is minor enough that it is reasonable to assume you could still work, you are unlikely to have your claim approved.

When purchasing a policy, keep an eye out for some of the following:

• Does the policy offer additional benefits? (Rehab support, childcare benefits etc.)
• Will your insurance policy be tax deductible?
• What are the maximum benefits and cover periods?
• What will the wait period be?
• Which premium type is on offer?
• Will your provider tolerate smokers (if applicable) ?
• Any exclusions?

When it comes to purchasing an income insurance policy there are several sources to choose from. You may already have income protection without realising, so ensure you properly research each of the following before committing to a provider.

Super fund

Superannuation funds are known to offer default income protection insurance, either as automatic cover attained by meeting certain criteria, or as an ‘add-on’ that you can purchase. Buying income protection insurance through your super fund is often a cheaper alternative to other insurance providers.

Premiums are usually deducted from your super balance to cover the cost of this insurance. However, there are some downfalls to insurance through your super fund, such as no tax deductions and often fewer benefits and features. Make sure you take the time to research your coverage within your fund to determine whether it’s right for you.

Direct and Advisor Providers

Once you’ve investigated your superannuation, you can then explore your other options; namely, whether to purchase a direct or advised policy. Direct income protection insurance can be purchased from an insurer. Advised income protection insurance is obtained through any other financial institution, such as a bank, a financial advisor, or a broker. Note that while financial advisors are not able to receive commission on investment advice, according to ASIC’s Moneysmart site, they can still receive commissions from selling you life insurance products so do your due diligence and make sure it is the right product for you.

The direct approach is regarded for its speed and simplicity, whereas an advised approach often comes with the backing of a financial professional to guide you through the process. There are also downsides to each, such as a lack of underwriting and lengthy procedures respectively. You must research each to determine which option is best suited to you.

If you bought your policy through an advisor, then they should be your first port of call. Providing your wait period has passed, applications for income-related claims are often reviewed within two months. Contact the institution or provider directly to make a claim.

If you require more urgent assistance, contact your policy provider: it is possible that an advanced payment can be made to you while your claim is reviewed. Note that any payment received as part of an income protection policy must be declared as part of your tax return.