What’s your most valuable financial asset? Your house? Your superannuation? Your car?
Did you know that the ability to earn an income is the most valuable asset for most working-age Australians, yet only 33%1 of the adult population have taken steps to protect that asset through income protection insurance?
What is income protection and why does it matter?
Income protection insurance, also known as individual disability income insurance or salary continuance insurance, provides replacement income to policyholders when they are unable to work due to illness or injury.
In 2019 life insurance companies paid out $12 billion in claims to 101,821 Australians and their families2, and $4.9 billion was paid out in income protection claims alone over the 5-years to 2018.
The number of disability income claims has doubled in the 5-years to 2018, and the average length of time that a person is on claim also increased by 36% in 2018 compared to 2013.
So more people are needing to claim, and for longer.
Big changes are coming…
The Australian Prudential Regulation Authority (APRA) is now worried that the life insurance industry is unsustainable, with the life companies collectively having lost $3.4 billion on the sales of income protection policies to individuals over the past five years3.
It’s a very competitive industry, and the features and benefits of income protection policies have expanded to the point where the value of claims paid out now consistently exceeds the value of the premiums being paid.
As a result, APRA has stepped in to introduce a range of changes that all life insurance providers must adhere to.
APRA has introduced restrictions on the types of features or benefits insurance companies will be able to offer for income protection policies.
‘Agreed value’ policies no longer available
One of the most significant changes has already happened, with insurance companies unable to offer ‘agreed value’ income protection policies from 31 March 2020.
Prior to this, you could take out a policy where the insurance company agreed (or guaranteed) the monthly amount you would be paid in the event of a claim, with this figure based on the income you were earning at the time you signed up for the policy. If a claim under this policy is subsequently approved, the insurance company has to pay you that agreed amount, even if your income has subsequently decreased.
APRA considered these types of policies to be riskier for the industry, as some claimants might be financially better off if they remained on claim, discouraging them from returning to work.
So with all new policies taken out after 31 March 2020, the monthly amount payable would be based on your actual income at the time of claim. Note that some insurers will base this on the best year of earnings in any three years prior.
Several significant changes will come into effect from 1 October 2021:
Changes to the definition of ‘income at the time of claim’
For all new policies written after 31 March 2021, income at the time of claim will be based on your actual earnings. From 1 October 2021, the stability of your income will also become important.
For new policyholders with stable incomes, the monthly amount paid will be based on your annual earnings at the time of the claim event, or within the last 12 months.
For policyholders with a variable income, APRA has determined that the benefit payable “is based on average annual earnings over a period of time appropriate for the occupation of the policyholder and reflective of future earnings lost as a result of the disability.”4 This flexibility would seem to cover those on unpaid parental leave.
Policy contract terms now limited to 5 years
Most income protection policies currently have long benefit periods, usually to retirement age. From 1 October 2021, income protection policies can’t last for more than 5 years. After the 5-year period, a new policy must be entered into, reflecting the terms and conditions current at that time.
Whilst medical underwriting will not be required if a policyholder takes out a new policy at the end of the initial 5 years, any changes to occupation, financial circumstances and dangerous occupations or pursuits or pastimes must be updated and included in the new policy. And even if your circumstances have not changed at all, you will still have to enter into a new policy agreement – the insurer won’t be able to extend the current one.
Changes to benefit periods
In addition to long benefit periods, the current definition of ‘disability’ was that you were unable to perform your ‘normal job’.
From 1 October 2021, APRA will require stricter disability definitions for policies with longer benefit periods. This is to encourage those people who could return to paid employment – even though it may not come under the definition of their ‘normal job’ – to do so, whereas they may not be currently motivated to do so if they qualify for a monthly benefit under their agreed policy.
Limitations on certain policy features
APRA has introduced the following changes to policy contract terms for policies written from 1 October 2021 to avoid creating situations where claimants are in a better financial position being on claim than returning to full-time employment:
- Benefits are capped at 90% of earnings at the time of claim for first six months and capped at 70% from month 7.
- The rate of indexation of the income level covered will be limited to a suitable inflation index, such as CPI.
- Payments to support ‘return to work’ initiatives such as rehabilitation and retraining may be made in addition to the 90% then 70% income replacement limits, and
- Where the income at risk excludes superannuation, any insurance benefits related to these contributions can also be paid in addition to the 90% then 70% income replacement limits.
What do these changes mean for you?
If you have an existing policy – you are not impacted by these changes. The terms of your current policies will remain the same as those agreed at the signing of the policy.
If you’re one of the 66% of adult Australians who don’t have income protection insurance – now might be the time to consider it. Doing so before 1 October 2021 will ensure your policy falls under the current (more generous) arrangements, whilst giving you the peace of mind that your most valuable asset – your ability to earn an income – is protected.
Have any questions or concerns about the changes looming for new income protection policies, click below to request further information.
1Financial Services Council (FSC), State of the Industry Report 2019, p. 50
2https://www.fsc.org.au/resources, Media release dated 23 June 2020