Income Protection Insurance

What is Income Protection insurance?

UPDATED 1st October 2021: Following Income Protection changes due to APRA Sustainability Measures.

Income Protection insurance provides a replacement income stream should you become unable to work due to an injury or sickness.

Benefits are paid monthly, not as a lump sum.

The maximum income replacement ratio is 70% (this was 75% prior to 1st October 2021). Optional cover may boost this to 90% in the first 6 months of a claim.

Income Protection Insurance Premiums are generally tax deductible – find out more.

How much does Income Protection insurance cost?

Income protection insurance premiums vary depending on your age, gender, smoking status, occupation and the cover options you select.

You will need to choose how quickly the income protection payments from the insurer will start (the “waiting period” or “excess period”) and how long the benefit will be paid for (the “benefit period”).

Income Protection insurance premiums are more expensive the shorter the waiting period and the longer the benefit period. You can save up to 40% on your premium just by extending your waiting period.

Income protection insurance waiting periods are typically 14 days, 30 days or 90 days.

However it may take up to 30 days after the end of the waiting period to receive the first monthly payment depending on the insurer’s payment cycle.

Waiting periods of up to 2 years are also available to supplement super fund policies (which typically end after 2 years of payments).

Income protection insurance benefit periods are typically 2 years, 5 years or to age 65, with some insurers also offering to age 70.

The benefit period is different to the expiry age of the policy which is when the policy can no longer be renewed.

Income protection payments will stop after the benefit period ends, even if you continue to be unable to work due to injury or illness. Therefore the longer the benefit period the better.

Policies with a 6 month or 12 month benefit period may provide some short term bill paying relief but are not considered true income protection insurance policies because they do not protect against long term loss of income.

Adding a claims indexation option or claims escalation option will ensure that income protection benefits paid while on claim are escalated in line with inflation to maintain their value in real terms.

To find out how much these different features can affect the price of an income protection insurance policy see 20 tips to lower income protection insurance premiums.

Also, depending how long you expect to have your policy, there may be savings with a level premium vs a stepped premium.

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Why do I need Income Protection insurance?

Whether you are single or have a family, you need to ask yourself “how would I survive without my income?“

Your income is your biggest asset, not your house or your car. A 30 year old earning an “average” wage of $80,000 per annum which is indexed by 3% inflation each year will earn over $5 Million by the time they turn 65.

Most people rely on their income to pay the bills and maintain a certain living standard. It may be difficult to pay the mortgage payments and school fees if all you are earning is the disability pension from the government of around $23,000 per annum.

An ongoing income is also necessary to build wealth and provide for retirement. It is the foundation of any financial plan. Without income protection insurance an unexpected illness or injury can create financial insecurity and result in a less comfortable retirement.

Having a large amount of sick leave or being covered by workers compensation insurance does not mean you don’t need income protection.

Sick leave may allow you to save money by having a longer waiting period, however it does not give long term financial security.

Workers compensation insurance does not cover accidents occurring outside work hours such as car accidents and sporting accidents. Also very few illnesses are covered by workers compensation and these are by far the biggest source of most income protection claims.

Income protection is particularly important for small business owners and the self employed. They are unlikely to have the luxury of sick leave or workers compensation and may have others reliant on them who will lose their jobs if the business collapses.

There are also special risks and considerations for doctors and medical professionals and tradespeople or “tradies” who are taking out income protection.

How is income protection different to Trauma and TPD insurance?

Unlike Trauma insurance, Income Protection insurance does not specify a list of covered conditions, so any illness or injury which prevents you from working is covered. There is therefore broader coverage available for conditions like back pain and stress related illnesses which are not trauma conditions.

However trauma insurance provides an upfront lump sum benefit which can be used to meet the costs of expensive medical treatments, so there is a case to have both covers.

Unlike TPD (total and permanent disability) insurance, Income Protection insurance does not require you to prove that you are permanently unable to work and therefore claims can be paid for both short and long term illnesses or injuries (depending upon the benefit period).

Unlike income protection, TPD insurance provides a lump sum benefit which can be used to pay off debts or meet medical costs. However the TPD lump sum may not be sufficient to cover your ongoing costs and when this is exhausted you may still find yourself reliant on social security. An income protection policy with a benefit period to age 65 will ensure that you will continue to receive a monthly income stream up to age 65 if you are still unable to work.

Is Redundancy or Involuntary Unemployment covered by Income Protection insurance?

Normally Income Protection insurance policies do not pay a monthly benefit if you are made redundant or involuntarily unemployed. Where unemployment benefits are included in an income protection policy these benefits are usually limited. Some insurers will waive your premium while you are unemployed or will allow you to put your policy on hold for a period of time.

How much Income Protection insurance cover can I purchase?

The maximum amount of Income Protection insurance cover you can purchase (the “monthly benefit”) is usually limited to:

If you are employed: 70% of your current gross income (excluding employer superannuation contributions but including packaged fringe benefits)
If you are self employed: 70% of the income generated by the business due to your personal exertion less your share of expenses.

In some cases the maximum income protection cover level can be increased by up to 10% by taking out a super contribution option. However this additional 10% will be paid directly to the super fund, not to you and therefore cannot be used to pay bills.

A lower percentage of income may apply above certain income limits (e.g. for incomes over $200,000) and overall maximum levels of monthly benefit sum insured will apply. The insurer may request financial evidence of your income which can include tax returns, group certificates or a letter from your employer.

Can I have multiple Income Protection policies?

It is possible to have more than one Income Protection insurance policy, however it is important to ensure that you are not over-insured. This is because in the event of a claim all policies which cover you against loss of income will usually be “offset” against each other so that you do not receive more than the maximum 70% of your income.

It will usually be cheaper to have one policy rather than multiple policies due to the discounts available for larger monthly benefits. However there are a number of reasons why you may take out more than one income protection policy.

Many super funds offer income protection with a benefit period of 2 years only. This would usually be inadequate to provide long term financial security. A solution can be to be supplement the super policy with another policy that has a 2 year waiting period, so that it commences when the other policy ends.

Some super funds offer only a small default monthly benefit. This may be inadequate to cover your costs, requiring you to take out another policy to top up this amount.

Superannuation legislation means that income protection policies provided by a super fund can only have limited benefits and restricted definitions. Taking out a second “superlinked” policy can enable the more generous definitions and benefits provided outside of super to be accessed with only a small personal outlay.

Are Income Protection insurance premiums tax deductible?

Unlike other forms of personal risk insurance, income protection insurance premiums are generally tax deductible for most taxpayers.

This means that the after tax cost of the cover can be significantly less than the cost of the premium.

Will my Income Protection insurance claim be paid?

Total claims paid by life insurers in 2019 have been estimated to be over $12 Billion.

A review by ASIC in 2016 found that on average approximately 90% of all claims submitted were paid and of these 93% of Income Protection insurance claims were paid. The main reasons for declined claims were non-disclosure at time of application and ineligibility due to policy definitions, limitations, exclusions or pre-existing conditions.

Insurance claims statistics from the insurers show that the highest number of income protection claims are due to: musculoskeletal conditions (e.g. back pain), mental health disorders (e.g. stress), cancers, accidents/injuries and nervous system disease.

Also we have used recent statistics from ASIC and APRA to highlight the claims acceptance rates and average claim times of individual insurance companies compared to the industry average.

If you have taken out an income protection insurance policy through Insurance Watch and you need to make a claim we will help you during the claims process.

Recent Income Protection insurance claims paid to Insurance Watch customers:

• $4,800 – paid to 27 year old carpenter over 2 months for hand operation

• $66,000 – paid to 29 year old administration worker over 15 months due to mental illness

• $15,000 – paid to 33 year old physiotherapist over 3 months for shoulder injury

• $106,500 – paid to 34 year old teacher over 3 years and ongoing for depression

• $117,500 – full and partial benefits paid to 36 year old painter over 12 years and ongoing due to arthritis

• $10,000 – paid to 39 year old physiotherapist over 2 months for foot fracture

• $24,900 – paid to 41 year old surgeon over 2 months for fractured bone in arm

• $232,000 – paid to 44 year old accountant over 3 years and ongoing for chronic fatigue

• $32,900 – paid to 44 year old truck driver over 3 months with tennis elbow

• $8,400 – specific injury benefit paid to 45 year old engineer for fractured hand

• $3,800 – partial benefit paid to 52 year old doctor over 1 month after bicycle accident

• $2,300 – paid to 52 year old tiler for 1 month off work due to injury at work

• $10,300 – partial benefit paid to 56 year old admin officer over 7 months and ongoing for multiple sclerosis

• $230,200 – paid to 57 year old property manager over 4 years and ongoing for back pain

• $13,400 – paid to 63 year old teacher over 3 months for shoulder pain

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Other topics

Choose your Income Protection insurance waiting period carefully

The waiting period dictates how long you have to wait before you are eligible to receive payment under your Income Protection insurance policy following a claim.

You will not be able to lodge a claim until the expiry of the waiting period and as payments are made in arrears it could be at least a month after you have lodged your claim before the insurance company makes it first payment i.e. if you have a 30 day waiting period your first monthly payment will be become payable 30 days after this or 60 days after you first became sick or injured.

In choosing a waiting period for your income protection insurance policy 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 income protection insurance premiums can be achieved by accepting a longer waiting period.

When the Claims Escalation Option is important

The Claims Escalation or Claims Indexation Option is an extra cost option which can be added to your income protection insurance policy. This option is important in the event of a long term claim as it will ensure that the income protection monthly benefit paid by the insurer is increased each year in line with inflation.

If you choose to purchase income protection cover with a benefit period to age 65 this option is highly desirable, as your claim could extend over a prolonged period.

For example, if you are a 30 year old and you suffer a long term illness or injury which prevents you from working, with an age 65 benefit period you may be entitled to receive payments for up to 35 years under your income protection policy. If these payments are not increased with inflation each year they would decrease in real terms, leaving you progressively worst off in terms of your purchasing power as each year passes.

However if you choose to take out income protection cover with a benefit period of only 2 or 5 years you may decide the claims escalation option is not as important as it will only provide 1 or 4 years of indexed payments should you make a claim. In this case you may decide to save the extra premium cost and not include the option.

Occupation is a big influence on Income Protection insurance premiums

One of the major factors influencing the size of Income Protection insurance premiums is occupation. White collar workers and professionals will generally be charged lower income protection premiums than blue collar workers due to the generally lower risk of injury.

This is also a major point of differentiation between the insurance companies with some choosing to target particular occupation groups with lower income protection premiums, e.g. nurses or doctors.

There are some occupations which are not covered for income protection by any insurance companies or by only a few, e.g. actor, model, pilot, bicycle courier and armed forces.

Comparing income protection insurance premiums using Compare Insurance 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.

"Total Disability" definition key to a successful Income Protection claim

Income Protection insurance policies are very complex products and policy definitions can differ greatly between companies. One of the most important definitions to compare between income protection policies is “total disability”.

There are three types of total disability: inability to perform duties, reduction in income and reduction in hours. Some income protection policies only have one definition of total disability while others have all three. Being able to choose between definitions at the time of an income protection insurance claim can increase your probability of success.

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 under an income protection policy. Some of the weaker policies define employment to be any employment, including lower paid unskilled work. It is important therefore that your policy will cover you if you are unable to work in your regular or “own” occupation i.e. the occupation you were performing prior to becoming sick or injured.

The income protection insurance policies compared by Insurance Watch offer “own occupation” cover for most occupations. However “own occupation” may only apply for the first 2 years of the policy. After that the definition may change to “any occupation” which means any occupation you are suited to by training, experience or education. This means that you may need to consider a wider range of occupations, including those which would require some retraining. Also if you are unemployed or on unpaid leave for more than 12 months prior to making a claim an “any occupation” definition may be applied.

AIDS/HIV cover under Income Protection insurance policies

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

Stepped versus Level premiums for Income Protection insurance policies

Both stepped and level premiums are available for income protection insurance policies.

The cost of a level premium will be higher than a stepped premium initially because it is an average of future stepped premiums. However if you intend to hold your policy over the long term e.g. more than 10 or 15 years then a level premium may work out cheaper than a stepped premium over this time period.

Indemnity versus Agreed Value Income Protection insurance policies

With an Indemnity Income Protection policy the monthly sum insured is not a guaranteed amount – it is the maximum benefit payable. The actual benefit is calculated as a percentage (usually 70%, but may be 60% or 50% depending on the policy) of the average monthly 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 your income protection cover your claim will be based on this lower income amount. Indemnity income protection insurance policies are best suited to salaried employees who expect their incomes to be constant or rising in the future and who do not expect to take any breaks from employment (e.g. to have children) or unpaid leave.

Agreed Value income protection policies offer a guaranteed minimum monthly sum insured. Evidence of income must be provided to the insurer at the time of application. These income protection policies remove the uncertainty that you may be paid less if your income has fallen over the period preceding your claim.

Agreed Value policies are particularly suited to self employed applicants who can meet the past income evidence requirements.

Note that due to an intervention by APRA Agreed Value policies are no longer being issued by insurers from 1st April 2020.