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Income Protection Made Easy

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I was going to call this article “IP for Dummies”, but figured there might be some trademark issues. It is not something we often think about, but what would you do if you became sick and were unable to work? You may have heard about Income Protection (or ‘IP’) already. You may know that if you are sick and cannot work, this insurance will pay you out each month. This sounds great, but you may have also heard that it is too expensive, not worth it, or is just too boring and hard to understand. As a result, you do nothing.

However, what if the worst does happen? What plan do you have in place to protect you, your family and all the things you have worked so hard for? Don’t let a lack of understanding about Income Protection stop you from taking steps to protect all that is important to you. Read on to find out more.

Key Ideas:

  • What is IP (and what it is not)?
  • When would you need it?
  • How is the cost figured out?
  • What is Agreed Value, Indemnity and LOE all about anyway..?
  • Pricing examples

What is IP (and what it is not)?

Your ability to earn is often your biggest asset. Being suddenly disabled or suffering an illness or injury can prevent you from working for an extended amount of time. This can dramatically impact your life, especially if you have family to take care of and financial commitments.

Income Protection insurance is there to provide you with a monthly payment while you are not receiving your salary or wage. This means that you can continue to pay your ongoing financial commitments such as mortgage/rent and your day to day living expenses. This gives you peace of mind so that you can focus on recovering and getting back to work.

Depending on your income protection policy, you can receive up to 75% of your pre-disability income. A number of the insurance providers also offer rehabilitation and support benefits with the aim of assisting you with returning to work, or improving your capacity to work.

It is important to note that Income Protection will not pay out if another source of income is paying, such as ACC which is the most common one. If you have an accident, ACC will pay you up to 80% of your declarable earnings. This is easy for an employee to figure out but can cause problems for those self-employed. The caveat here is that IP can be used to ‘top-up’ your cover where ACC isn’t paying you. This might be because you are using ACC’s ‘agreed value’ product (CoverPlus Extra), or your income exceeds the maximum benefit amount under the ACC policy.

If you are self-employed you may want to look at ACC CoverPlus Extra (here) this allows you to have an ‘agreed value’ policy with them. This can mean you have certainty should you need to claim. It also takes some of the guesswork out of ACC benefits, which can be a bit of a minefield. Talk with your adviser to find out how to save on your ACC, while increasing the cover that you can have. Many times, you can pay less, but have more cover.

There is often the misconception that Income Protection is there to cover you if you ‘lose your job’, this is not the case. This type of cover will not help you if the company goes bust and leaves you without work. This cover will not help you if you take voluntary redundancy. As with all personal insurance, it is around your physical and mental health. If you have a condition or injury that means you cannot work, you have the option to make a claim. It is there to cover a portion of your income and to plug-the-gap until you can get back on your feet again,

When would you need it?

Many people may manage for a few weeks with a combination of sick and annual leave if they get sick. What happens when this runs out and you are unable to work for months or even years?

Here are some common reasons for having an income protection policy:

Here are some other stats to consider from Asteron:

  • More than 8-in-10 of Asteron Life claims were made by men
  • The youngest person to claim was just 23 years old
  • 7 out of 10 of people who claimed on their Asteron Life Income Protection were aged between 36-55 years old

We all know that these things can happen to anyone. How financially prepared would you be if one of these things happened to you? Would it be good to have Income Protection Cover to ease the burden, by paying you a monthly benefit for the period of cover or until you are able to work again?

Having income protection has been a godsend. If we didn’t have it, we would have had to sell our house in order to have something to live on, and go rent somewhere. Everything would have been so different.” Pam, Asteron Life customer

How is the cost figured out?

The amount you will pay for Income Protection depends on a number of things including your age and occupation. The more risky your occupation, the higher the premium can be. That said, here are 3 key components to how Income Protection premiums are priced:

  • Monthly amount sum insured (normally up to 75% of your gross income)
  • How long the insurance company will pay you for – this is normally 2 years, 5 years or through to Age 65 (and beyond in some cases)
  • How soon the insurance company will start paying you. This is called the waiting period and is normally 4, 8, 13, 26, 52 weeks.

Once you know which insurance option is right for you, you then choose the time you will wait before you start receiving payments and how long you want to receive them for. For example you can choose the wait period for your first payment to be as soon as 4 weeks and for payments to last for 2 years, 5 years or until  age 65 or even to age 70.

In some cases a 1 or 2 year wait period might suit you best.  It all depends on how well you’d cope financially before the payments kick in.

Things to keep in mind, which impacts the cost to you in terms of higher premiums are:

  • The longer the insurance company pays you out (i.e. through to Age 65)
  • The shorter the waiting time for your payment (i.e. 4 weeks)

 

Many providers offer optional ‘extras’ that you can have, but you’ll pay more for these, these could include:

  • Death benefit
  • Total & partial disability
  • Special injury / Specific illness condition
  • Claims escalation
  • Mental health exclusion (you will pay less but will not be covered for any mental health condition resulting in you taking time off work).
  • Redundancy (this only pays for 6 months, and voluntary redundancy is not a valid reason to claim)

In terms of premiums (payments), you can choose to go with a yearly renewable premium that is fixed for a year at a time and increases as you age or you can choose a fixed-price premium for the life of your policy. This type of pricing plan is often known as ‘levelled premium’. It can be a great way to save on the cost of the policy over time.

Everyone’s circumstances are different and your adviser can recommend the best cover for your situation.

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What is Agreed Value, Indemnity and LOE all about anyway..?

Income Protection policies can come in different shapes and sizes. However, some common variations are as follows:

  • Agreed Value

Benefit payments are based on a proportion of your income agreed at the time you take out your cover, this is calculated on your gross income. If you are self-employed your gross income is averaged over the last two to three years. This approach allows certainty about how much your monthly claim payments will be.

  • Indemnity Value

Your benefit payments are based on a proportion of your income at claim time, before you suffered the illness or injury. Up to 75% of your gross annual income can be insured if you select this benefit. This type of cover is often more cost-efficient, though there can be downsides if your income fluctuates. In most cases, the premium cost of this can also be an annual tax deduction (check with your accountant).

  • Loss of Earnings Cover (LOE)

This option allows you to choose at claim time how your benefit payments are calculated. Based on either an agreed value or indemnity, whichever is higher. This is helpful if your income fluctuates, for example as a contractor or if you’re self-employed. Often, this type of policy will be the most expensive.

Pricing examples

Here are some examples of pricing, based on a number of different factors.

The examples I am using are as follows: An Occupation Class 2 (e.g. office worker), non-smoker with an average gross income of $60,000 per annum. With insurance up to 75% of their gross annual income, they would get a monthly payout of approximately $3,750.

Based on this situation the tables below provide two examples across 3 age bands; 25, 35, 45. I have used fortnightly payments under two different scenarios. All prices are indicative only, based on figures provided from 5 of the top providers in New Zealand.

Example 1 –   4 weeks wait for 2 years benefit- prices per fortnight

 

Age 25

Age 35

Age 45

Female

$25.58

$34.44

$54.66

Male

$19.01

$22.35

$34.40

Example 213 weeks wait through to Age 65prices per fortnight

 

Age 25

Age 35

Age 45

Female

$27.37

$34.40

$63.10

Male

$20.60

$22.26

$38.45

[Does not include waiver of premium costs or policy fee, which are likely to be added to any policy taken.]

As you can see from these tables, women are deemed to be a higher risk earlier in their lives, certainly around their late thirties to late forties. The actuarial data shows that women will have a higher claims rate during this time.

Men have an easier time until they hit mid-to-late forties, then unfortunately, it is all downhill from there. While the men are struggling in their later years, women will generally have less claimable events and survive past their male counterparts.

Please Note: all of this information is illustrative only, please consult your financial adviser for a personalised quote for your situation and stage in life.

Income protection is a great product, but it can be hard to grapple with as there are many variables that need to be considered based on your requirements. Add to that, all of the industry jargon to understand, and it can be easier to see why some people feel it is all just too hard. Less than one in five eligible people in New Zealand have this type of financial protection in place. By not having it, the financial ramifications for people who have a sickness or injury, can be huge.

Essentially, Income Protection is providing you with the assurance that should anything happen to you, you will get some financial stability from your insurance to help you get through. The tricky part is getting the right cover and keeping the cost within your budget. This is why having a good adviser is really important, as they will tailor your Income Protection to your needs and circumstances.

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#DominicBish

Dominic started Bolster Risk Management to help people along their personal finance journey.

He believes that personal insurance is the bedrock to financial security and wealth creation. You have to protect your greatest asset, your ability to earn an income. 

Underpinning this is a philosophy that says Your Money Matters.

Dominic Bish

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