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Income Protection Changes – Everything You Need to Know

Written by Aaron Alston – Financial Adviser

Effective October 1 2021, all major life insurers ceased offering their current range of income protection polices and were instructed to comply with APRA’s sustainability measures.   This was in response to APRA being concerned that life insurance companies have been keeping premiums at unsustainable low levels to compete for customers.

Major changes effective October 1

  1. Income Replacement ratios reduced from 75% pre-disability earnings to a maximum 70%.  Some insurers may reduce to 60% of even lower.
  2. Additional benefits in the first 6 months of claim to be restricted to an additional 20%.  This compares to the current benefits which can be double this.
  3. Pre-disability income will be 12 months prior to disability (may AVERAGE of the last 2-3 years if you are self-employed).  This is compared to current policies which can use the HIGHEST 12 months pre-disability income in the last 3 years which can assist clients with fluctuating incomes.  If you currently have an “agreed value” definition (agreed value polices no longer available as they ceased for new business 31st March 2020) your income is assessed at 75% of your pre-tax earnings at the time of the application plus CPI increases annually.  This means that if your income was lower at time of claim you’re your initial application (e.g. Income decreased $50K), you will still be entitled to your full 75% benefit.
  4. Disability definitions to change over the duration of long-term claims.  All current income protection policies are assessed under an “Own Occupation” definition.  After 2 years the insurer will now assess you under “Any Occupation” definition which is any occupation that you are suited to by education, training, or experience.  An example of this may be a Carpenter that can no longer work on the tools, however, has office experience.  The insurer under “Own Occupation” must honor the claim if he can’t fulfil the duties of his own role, however under “Any Occupation” the insurer may believe he has the capabilities of working in an office and may cease the claim.

On 12th May 2021, APRA also announced that insurers have 12 months to implement changing the policy contract term to 5 years.  This is vastly different to current policies that are guaranteed renewable (terms and conditions cannot change) up to age 65 or 70 regardless of changes to your occupation, finances or pastimes.  This future measure will impact those who decided to change careers and move to a higher risk role (office worker to miner).  Currently you are not affected if you change occupation, however with the future measures you will be after 5 years and your premiums may double or worse no longer be eligible for Income Protection.

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What will the Income Protection changes mean for the future?

With weaker protection being provided by income protection policies, there will be a greater need to have a comprehensive insurance package in place for the following reasons:

  1. Increased reliance on trauma insurance to top up income protection payments in the early stages of an illness or injury
    Many existing income protection policies have Specified Injuries, Hospitalisation/Nursing care and Critical Illness benefits which are paid out in the first few months of a claim, sometimes even within the waiting period.  These extra payments assist at times when medical costs can be at their highest.  The likely removal of these “bells and whistles” from income protection policies means there will be an increased need for trauma insurance.
    The lump sum provided by trauma cover can be used as a booster amount to cover medical expenses, to replace income during waiting periods and also to provide the funds for a partner to stop work to be a carer.
    According to the FSC, cancer accounted for 58% of all income protection claims, which means that trauma policies can effectively supplement lower income protection payments.
  2. Increased reliance on TPD to provide a top-up income stream in the later stages of a claim
    There has always been a certain degree of crossover between TPD insurance and income protection. If you suffer a permanent disability, you can potentially receive a lump sum TPD payout as well as payments from an income protection policy.  With the percentage of income covered by income protection falling, a greater burden will fall on TPD cover.  Larger TPD lump sums will be required to top up income so that living standards for families can be maintained.  Unfortunately, TPD policies are not tax deductible like income protection, so this is likely to mean that more TPD cover will be taken out within super, with the associated weaker definitions and tax implications.
  3. Less switching opportunities for income protection policies in the future
    Due to the gap in features and benefits between existing policies and the proposed policies, there are likely to be fewer opportunities to switch policies without a loss of benefits in the future.  Existing policyholders are therefore more likely to hold their current policies for longer. 
  4. It remains to be seen if the new policies will be priced at a significant enough discount to entice customers who are price sensitive to switch to the new policies with less benefits.

If you already have an income protection policy

You will be able to maintain your policy in its current form (the terms and conditions will not change).   However, it will be much harder to switch policies in the future without a significant loss of benefits.

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