I wrote a blog in February 2020 highlighting the first phase of government mandated changes to income protection insurance products. The second phase of changes were implemented at the beginning of this month, and they are very significant. This blog discusses these important changes and how they may affect you.
In December 2019, the insurance industry’s regulator (APRA), released a report outlining a number of compulsory changes that it mandated for income protection insurance products. Income protection insurance pays you a benefit if you cannot work due to accident or illness (it does not protect you from involuntary unemployment).
These changes were deemed necessary because insurance companies were losing literally billions of dollars on these products i.e. cost of paying benefits far exceeded premium revenue. However, no insurer wanted to make the first move to stem the losses. Fearing that insurance companies may eventually exit the Australian market (if no action was taken), the regulator stepped in and mandated changes to make products more sustainable.
There were two main issues that caused these products to be so unprofitable:
- An inability for insurance companies to change terms to accommodate new risks. Mental health is a good example. Mental health claims were immaterial when policy terms were written 20 years ago. However, today, claims due to mental health are more substantial.
- Long term benefits are very costly. If a 30-year-old claims on a policy and is never able to return to work, the insurer could be paying a benefit for the next 35 years. That is very costly. Therefore, it is important that policies only provide for genuine claims. Unfortunately, for the insurers, some policy terms are so generous that they sometimes act as a disincentive to cease being on-claim. This exacerbates losses.
Summary of the changes made this month
All insurers launched new product suites at the beginning of this month (existing products are no longer available). These new products reflected four important changes:
- The amount of income that can be insured has reduced from 75% to 70% of your gross income. Replacing less of your pre-disability income gives you a greater incentive to return to employment as soon as possible.
- The total benefit paid within the first 6 months of claim cannot exceed 90% of your pre-disability income. Many pre-October 2021 products offered ancillary benefits such as lump sum payments for specified conditions and rehabilitation benefits.
- Pre-disability income is based on your actual personal exertion income received the 12 months prior to becoming incapacitated. Many older products used to allow you to select the highest 12-month period over the past 2 to 3 years (prior to incapacity).
- Typically, you may be able to claim an income protection benefit if you are unable to perform the duties required in your ‘own occupation’ i.e. the occupation/role in which you are employed. However, the new products typically loosen the definition for any claims that last more than 2 years. In this case, the occupational definition is reduced to ‘any suited occupation’. The insurer will determine what is a suited occupation based on your skills, training, qualifications and experience. Some policies will pay a reduced benefit amount after 2 years if the insurer person is not “seriously disabled”.
An additional change expected
At the moment, many insurance contracts are non-cancellable which means as long as you keep paying the insurance premium, the insurance provider is locked into providing coverage and it cannot alter the terms (depth and quality of coverage).
However, we expect that contract terms will be limited to maximum of 5 years only. That means every 5 years the insurers can alter the terms of your insurance cover, which you can either accept or choose to cancel the policy.
(A) Implications if you have existing cover
If you have an income protection policy that went into force prior to 1 October 2021, then you should think very carefully before making any changes, such as reducing the benefit amount or cancelling it. That is because you will never be able to obtain a commensurate replacement policy in the future.
The reality is that you may be forced to change, eventually
The reason that older policies are no longer available is that they are becoming too expensive for the insurers to maintain. It will be very tempting for insurers to continue to increase the premiums for legacy products to encourage more people to move over to the new, more sustainable products. Premiums have already risen significantly over recent years so it’s quite possible that trend will continue.
If the cost of your existing policy comes too expensive
Whilst it is true that the new products provide less comprehensive cover, having some cover in place is better than none. Therefore, one way to manage the cost of cover, is to switch to a new product, even though it provides less comprehensive cover. For some people, a hybrid structure might be more appropriate e.g. retain your existing product but reduce the benefit amount so that half of your total cover is under the old comprehensive cover and that other half via a new product.
Of course, whether the option to replace your existing cover is available depends on whether you will pass medical (i.e. your medical history) and financial underwriting. It’s important that you obtain financial advice before cancelling any existing cover to ensure you accurately understand all the pros and cons.
A recent analysis for a client highlighted that the cost of the new product was approximately 21% cheaper than the existing older products. It is important to note that premium costs can be unpredictable so savings will vary significantly.
(B) Considerations if you plan to get cover in the future
If you do not have a pre-existing income protection insurance policy and need some cover, it is important that you obtain insurance advice from an experienced financial advisor, as product terms and conditions vary significantly.
If contractual terms are eventually limited 5 to years, it will be important that your advisor reviews your policy every 5 years to ensure its still appropriate for your circumstances. This has been less critical when contracts were non-cancellable. That is, it was almost forgivable to ‘set and forget’ your insurances. However, in this new product environment, you (your advisor) must be more proactive.
Finally, one way to mitigate some of the risk of new products being less comprehensive is to obtain trauma cover. Trauma cover provides a lump sum benefit on diagnoses of a ‘specified condition’. Typically, trauma policies list 30-35 specified conditions. Statistically, for females it is more likely to be a cancer event and for males a cancer or cardiovascular event. Trauma insurance can be used to fund out-of-pocket medical expenses and voluntary time off work, which may be more common given new income protection policy definitions convert to ‘any suitable occupation’ definition after 2 years.
The below table sets out claims statistics (from TAL).
Your ability to earn an income is your most valuable asset
For many people, particularly in their 30’s and 40’s, income protection is the most critical insurance product because:
- Often their financial plans are entirely dependent on their ability to earn an income over the next 10 to 20 years. If they were not able to do that, their financial plan would fail; and
- Their ability to earn an income over the next 20 to 30 years is an incredibility valuable asset (i.e. annual income multiplied by 30). In fact, it is likely to be their most valuable asset. Valuable assets should be insured. You insure your car, and that’s only worth a fraction of what your income is worth. When you compare the cost (premium) to the asset value, it highlights how cost-effective income protection insurance can be.
It is even more important if you are the sole or main income earner for your family. Therefore, it makes sense to ensure that you have good value-for-money insurances in place to protect you, your family and your financial plan.