Income Protection Insurance

What is Income Protection insurance?

Income Protection insurance provides an income stream should you become unable to work due to an injury or sickness. Benefits are paid monthly, not as a lump sum. The amount of cover is restricted normally to 75% of your gross salary.

Premiums are tax deductible, (see below).

What are the Cover choices?

There are a number of choices to be made on the type of cover. The claim benefit period (period over which benefit is paid), can vary from 2 years to age 65. You must also nominate a waiting period/excess before a claim will be paid, commonly 14,30 or 90 days. Claiming benefits can be escalated in line with inflation.

Why do I need income protection insurance?

The choice of cover depends entirely on an individual's circumstances. However some would argue that income protection is probably the most important type of insurance - after all where would you be without your income?

How well could you survive without your income for a period of 12 months or longer? Your income is used to maintain a certain living standard and also to build wealth and provide for your retirement. Unlike Trauma insurance, Income Protection does not specify a list of accepted conditions. Therefore greater coverage is provided, particularly for temporary illnesses such as back injury and stress related illnesses.

How much cover can I purchase?

The maximum amount of cover you can purchase is usually limited to: 

• If you are employed: 75% of your current gross income (including employer superannuation contributions and packaged fringe benefits)
• If you are self employed: 75% of the income generated by the business due to your personal exertion less your share of expenses.

A lower percentage of income may apply above certain income limits eg $250,000 and overall maximum levels of monthly benefit sum insured will apply. The insurer may request financial evidence of your income including tax returns over the last 12 months

Premiums are tax deductible

Unlike other forms of personal risk insurance, Income Protection premiums are tax deductible for most taxpayers. The after tax cost of the cover can therefore be significantly less than the cost of the premium.

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Other topics

• Choose waiting period carefully
• Claims Escalation
• Occupation influences premium
• "Total Disability" definition is important
• AIDS/HIV cover
• Stepped versus Level premiums
• Indemnity versus Agreed Value policies

Choose waiting period carefully

Typically waiting periods of 14, 30, 60, 90 days are available. In addition waiting periods as long as 1 or 2 years can be available to cater for individuals who have a limited form of salary continuance in their superannuation policies. The waiting period dictates how long you have to wait before you are eligible to receive payment under your policy following a claim. You will not be able to lodge a claim until the expiry of the waiting period and you should allow for the fact that it could take some time for the insurance company to process the claim before paying your first entitlement.

In choosing a waiting period it is important to consider your financial commitments such as mortgage and other debt payments and the short term funds you have at your disposal. Unused sick leave and annual leave entitlements may also influence your choice of waiting period. Ideally the shorter the waiting period the better such as 14 or 30 days (however some companies may not offer these options to certain blue collar occupations). However significantly lower premiums can be achieved by accepting a longer qualifying period.

Claims Escalation

The Claim Escalation Option is important in the event of a claim as it will ensure that the monthly benefit you are paid is increased in line with inflation. If you choose to purchase cover to age 65, this option is highly desirable as your claim could extend over a prolonged period. Conversely if you are purchasing cover for a benefit period of only 2 or 5 years you may decide the escalation option is not as important and save the extra cost on top of the premium.

Occupation influences premium

One of the major factors influencing the size of premium is occupation. White collar workers and professionals will generally be charged lower premiums than blue collar workers due to the generally lower risk of injury. This is also a major point of differentiation between the companies with some choosing to target particular occupation groups with lower premiums, e.g. nurses or doctors. There are some occupations which are not covered by any insurance companies or by only a few, e.g. actor, model, pilot, bicycle courier and armed forces. Comparing premiums using Run Quotes can be of help in identifying the cost effectiveness of each policy as a first step in achieving the best overall package for your particular circumstances.

See Special Considerations for Doctors.

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"Total Disability" definition is important

Income Protection policies are very complex products and policy definitions can differ greatly between companies. The most important definition to compare between policies is the definition of "total disability". Like TPD insurance, the type of duties or employment you must not be able to perform will govern whether you are considered "totally disabled" or not. Some policies define employment to be any employment, including lower paid unskilled work. It is important therefore that your policy will cover you if you cannot perform the duties of your regular occupation.

AIDS/HIV cover

Cover against contracting HIV or the AIDS virus is automatically included is some policies. However others offer the ability to exclude it and achieve a lower premium payable.

Stepped versus Level premiums

Both stepped and level premiums are available. However because of the cost of locking in a flat or level premium into the future, level premium policies are usually substantially more expensive in the early years. (top)

Indemnity versus Agreed Value policies

With an Indemnity policy the monthly sum insured is not a guaranteed amount - it is the maximum benefit payable. The actual benefit is calculated as a percentage of the income earned in the period prior to making a claim and evidence of income is not required until a claim is made. If your income falls after you take out cover your claim will be based on the lower income amount. These policies are best suited to salaried employees who expect their incomes to be constant or rising in the future.

Agreed Value policies offer a guaranteed minimum monthly sum insured (which cannot exceed 75% of gross income at the time of taking out insurance). Evidence of income must be provided to the insurer at the time of application. These policies remove the uncertainty that you may be paid less if your income has fallen over the period preceding your claim. These policies are particularly suited to self employed applicants who can meet the past income evidence requirements. Newly employed or self employed applicants may find that initial cover will only be available on an Indemnity basis until they have an established income history.