31 March 2020: Income protection insurance
Written and accurate as at: Mar 11, 2020 Current Stats & Facts

In terms of funding our lifestyle expenses and accumulating wealth, one of the biggest resources is our capacity to earn an income.

Although, this income-earning capacity can sometimes be taken for granted.

When we are feeling fit and healthy, we may think we are less likely to experience an unexpected financially adverse event, than others.

For example, being unable to work for a period due to a sickness or injury:

• In our working life, we have a 60% chance of being disabled for 1 month, and a 33% chance of being disabled for more than 3 months*. Coupled with this, if we are off work for:
  • ‘20 days, the chance of ever getting back to work is 70%.
  • 45 days, the chance of ever getting back to work is 50%.
  • 70 days, the chance of ever getting back to work is 35%’^.

Importantly, this ‘optimism bias’ can affect whether or not we put in place a safety net, for example, insurance, to protect us from such an event. As it stands, 33% of Australian workers have income protection insurance#.

Income protection (IP) insurance

General overview (exceptions apply)

A core provision of IP insurance is providing us with an ongoing monthly benefit payment in the event we are unable to work for a period due to a totally disabling, or partially disabling, sickness or injury.

We receive the benefit payment after satisfying the waiting period (e.g. 90 days, 2 years, etc.) and the claim definition (e.g. own occupation, home duties, etc.) entered into with the insurer when cover was established.

How long we receive the benefit payment depends on whether we continue to satisfy the claim definition. And, the benefit period (e.g. 2 years, to age 65, etc.) entered into with the insurer when cover was established.

The benefit payment is calculated from our pre-disability earnings. And again, how our pre-disability earnings are calculated depends on the benefit type entered into with the insurer when cover was established.

There are two key benefit types, indemnity and agreed value, and the main difference between the two is:

• Indemnity. Pre-disability earnings calculated at time of claim.
• Agreed value. Pre-disability earnings calculated at policy inception.

The benefit payment is usually up to 75% of our pre-disability earnings. However, insurers may pay up to 85% (75% paid to us directly and the remaining 10% paid to our super account as a super benefit).

Also, depending on our pre-disability earnings, the benefit payment can be capped. And, the benefit payment can be reduced where there are other sources of income present (e.g. another IP insurance benefit payment).

The reason for these limits (%, $, etc.)? IP insurance, and the benefit payment payable, is there to help us with the financial stress associated with being unable to work, so that we can focus on recovery and return to work – not to provide us with a financial disincentive to return to work.

Australian Prudential Regulatory Authority (APRA) measures

APRA has released several measures*^ aimed at improving the long-term sustainability of individual (not group) IP insurance, for the benefit of both insurers and policyholders.

The measures that we cover below have been broken down into four main groups:

• Income at risk:
  • From 31 March 2020, APRA expects insurers to discontinue writing IP insurance contracts where insurance benefits aren’t based on income at time of claim, including agreed value (and endorsed agreed value) contracts.
  • From 1 July 2021, APRA expects that income at risk for all new IP insurance contracts be based on annual earnings at the time of claim, not older than 12 months.
• Income replacement ratio:
  • From 1 July 2021, APRA expects new IP insurance contracts will be designed so that:
    • insurance benefits don’t exceed 100% of earnings at time of claim for the first 6 months of the claim, taking account of all benefits paid under the IP insurance product, as well as other sources of earned income; and
    • after the initial 6 months, insurance benefits are limited to 75% of earnings at time of claim (capped at an upper limit of $30,000 per month).
• Policy contract term:
  • From 1 July 2021, APRA expects insurers will only offer new IP insurance contracts where:
    • the initial contract is for a term not exceeding 5 years; and
    • there is a right for the policyholder to elect to renew the contract for further periods (not exceeding 5 years) without a medical review on the terms and conditions applicable to new contracts that are then on offer by the insurer. Changes to occupation and financial circumstances should be considered on renewal.
• Benefit period:
  • From 1 July 2021, APRA expects insurers to:
    • have effective controls in place to manage the risks associated with long benefit periods (e.g. having a stricter disability definition for long benefit periods); and
    • set internal benchmarks for new IP insurance products with long benefit periods which reflect the risk appetite and the effectiveness of the controls.

It’s important to note that with some of the aforementioned measures, APRA has advised that they are seeking feedback from the industry on specific design details – but not necessarily on the direction of their expectations.

Lastly, these measures shouldn’t impact the IP insurance contracts of existing policyholders, unless their current policy ceases and needs to be replaced.

Moving forward

Despite the measures released by APRA, for many of us, IP insurance can still form an integral part of a comprehensive personal insurance plan – life, total and permanent disability (TPD), IP and trauma insurance.

A comprehensive personal insurance plan can’t prevent unexpected financially adverse events from occurring. However, it can help to protect us from the financial risks associated with such events, if they were to occur.

Please consider watching our animation, ‘Personal insurances: Managing risk’, to learn more on this.

Lastly, when looking to establish or review your personal insurances, please remember we are here to help.

If you have any questions regarding this article, please do not hesitate to contact us.

*The Institute of Actuaries of Australia. (2000). Interim Report of the Disability Committee.
^The Institute of Actuaries of Australia. (2015). Actuaries Summit: Super, Life and General meet at the Crossroads.
#Rice Warner. (2017). Underinsurance in Australia 2017.
#Australian Government, APRA. (2019). Sustainability measures for individual disability income insurance.