Major changes to income protection policies from 1st October 2021
In December 2020 APRA announced it would be intervening in the Individual Income Disability Insurance (income protection) industry. This was after insurer losses had blown out to $3.4 Billion in the five years to 2019.
The intervention meant that major life insurance companies had to change the income protection policies they offered to comply with APRA’s Sustainability Measures.
The benefits of existing income protection policies were not affected by the changes. However restrictions now apply to all new retail income protection policies issued after 1st October 2021.
What were the APRA changes to income protection policies?
Changes from 1st April 2020:
Insurers had to cease issuing Agreed Value income protection policies
Changes from 1st October 2021:
All new Indemnity policies had to comply with the following:
- Income replacement ratio restricted to 70% of income, excluding superannuation (previously this was up to 75% of income, including superannuation)
- Other benefits in the first six months of a claim to be restricted to an additional 20% of income, i.e. a limit of 90% overall (previously comprehensive cover could offer up to double the benefit during this period).
- Indemnity definition of Pre-Disability Income to be calculated over the 12 months before the claim (previous definitions could use the highest 12 months income in the last 2 or 3 years to reduce the impact of fluctuating income)
- Long benefit periods, such as to age 65, to be managed to maintain a motivation to return to work e.g. changing from “Own Occupation” to “Any Occupation” definition after 2 years on claim and capability clauses (previously “Own Occupation” cover was available to age 65).
There was another change foreshadowed by APRA which was to restrict policies to being guaranteed renewable for periods no longer than 5 years, rather than for terms of up to age 65 to 70. It is uncertain whether this will continue to be a requirement after APRA granted insurers an extension to implement this measure.
There had been demands from other parties such as the Actuaries Institute for even more restrictive measures. Also different interpretations of APRA requirements initially led to a range of offerings from insurers.
However with the dust now settled, and after several iterations of the new products, there are many features which are common to the new policies on offer.
What to look out for in income protection policies post October 2021
Income Replacement ratio: 50%, 60% or 70%
While the maximum income replacement ratio allowed is 70% some insurers have introduced products which are limited to 50% and 60% income replacement ratios.
Opting for a product with a lower income replacement ratio will cost less because you are accepting a lower cap on the proportion of your income which can be covered. You may have determined that you and your family could cover your expenses with just half of your income (allowing for the tax that would need to be paid on the income protection benefit).
However if your circumstances change, for example your income reduces or your expenses increase, and you would like to cover more of your income you will be unable to due to the 50% cap. If you had taken out a policy with a maximum cap of 70% this would have given greater flexibility to increase the amount you could cover in the future.
70% Flat vs 70% Reducing:
Even if you select a policy with a 70% income replacement ratio, your benefit may change depending on whether you have a 70% Flat or 70% Reducing policy.
A 70% Flat policy will pay your monthly benefit to the end of your benefit period without the period being reduced. However a 70% Reducing policy will only pay this benefit for the first 2 years on claim and then reduce your benefit to a lower amount equivalent to 60% of income or lower. This will be the case even if you did not cover the full 70% of your income at the start of the policy.
A 70% Reducing policy will be priced cheaper than 70% Flat policy but will pay less in the event of long term claim.
Our online comparator allows you to Compare Income Protection Quotes from 10 insurers and view the benefits of the new policies.
If you are not sure what income protection policy will suit you, you can complete our online Fact Find at Get Advice and one of our advisers will contact you to discuss your situation.
What will the Income Protection changes mean for the future?
With less protection being provided by income protection policies, there will be a greater need to have a comprehensive insurance package in place for the following reasons:
- Increased reliance on trauma insurance to top up income protection payments in the early stages of an illness or injury
Many old income protection policies had Specified Injuries, Hospitalisation/Nursing care and Critical Illness benefits which were paid out in the first few months of a claim, sometimes even within the waiting period. These extra payments could assist at times when medical costs were at their highest. With the removal of these benefits from income protection policies there could be an increased need for trauma insurance.
The lump sum provided by trauma cover can be used as a booster amount to cover medical expenses, to replace income during waiting periods and also to provide the funds for a partner to stop work to be a carer.
According to the FSC, cancer accounted for 58% of all income protection claims, which means that trauma policies can effectively supplement income protection payments.
- Increased reliance on TPD to top-up income protection payments in the later stages of a claim
There has always been a certain degree of crossover between TPD insurance and income protection. If you suffer a permanent disability, you can potentially receive a lump sum TPD payout as well as payments from an income protection policy.
With the percentage of income covered by income protection falling (and some policies reducing payments after 2 years on claim) a greater burden will fall on TPD cover. Larger TPD lump sums could be required to top up income so that living standards for families can be maintained. With “Own Occupation” income protection cover no longer available to age 65 there could be a greater demand for “Own Occupation” TPD.
Unfortunately, TPD policies are not tax deductible like income protection.
- Switching income protection policies will likely result in a loss of benefits
Due to the gap in features and benefits between old and new policies, switching to a new policy is likely to result in a loss of benefits. The new policies will generally be priced lower than old policies. This premium differential is likely to be become larger over time as insurers raise premiums to reflect more frequent and longer claims under the more “generous” older policies. Existing policyholders must therefore weigh the potential to make premium savings against the benefits/features they will lose and understand what this may mean for them in the event of long term claim.
The outlook for Income Protection
APRA described the 2021 changes as being “in the interest of both life companies and policyholders”. In order to make the industry more sustainable they believed that income protection policies need to be affordable and available into the future with greater stability of premiums in the long term, while also allowing the insurers to earn an adequate return on their capital.
On 16th December 2022 APRA published an article considering whether the income protection insurance market was back on track. For the 5 quarters from September 2021 to September 2022 the industry had been profitable again. APRA predicted that, following an average 35% increase in income protection premiums from June 2018 to June 2022, looking forward the new products should have much more stable premiums over the long term than the pre-intervention products. However while APRA felt that there was light at the end of the tunnel, they believed there was still a way to travel, given the challenges of a high inflation and post COVID environment.
This article provides general information only. Before considering taking out an income protection policy or switching policies you should read the insurer’s Product Disclosure Statement and seek advice on your personal situation to determine whether this is appropriate for your goals, needs and financial situation. Complete our online Fact Find at Get Advice to have a qualified Insurance Watch adviser contact you to discuss your options.