How does income protection insurance work?

Income Protection – what does it cover, how does it work?
At Moneyworks, we are regularly asked how income protection insurance cover works. As an essential personal insurance, it is important that you understand how it works for you. We have covered some common initial questions below.

How is the price calculated?
This depends on a number of variables – most of which you can’t manipulate – as you need to tell the truth. Factors that are taken into account are:

1. Your age
2. Whether you are male or female
3. Whether you are a smoker or a non-smoker
4. Your occupation
5. Your income
6. Your wait period and your benefit period (see notes below)
7. Which insurance company you choose to use

What is the wait period and how does it work?
This is the time period that you believe you can survive financially without the benefit being paid from the insurance company. Traditionally this will be four weeks, eight weeks, thirteen weeks or twenty six weeks.

For some people, 52 weeks (1 year) or 104 weeks (2 years) might be relevant, if their employer already provides cover for that time period (sick leave or an existing income protection insurance policy with that benefit period).

The longer that you can afford to wait before the benefit is paid to you – the lower your premium will be (but 13 weeks and 26 weeks aren’t usually that different in cost).

The factors that you will take into account are how much sick leave you have, how many cash reserves/investments you have that you wish to use and how much other income is coming into the household, when deciding which wait period is suitable for you.

What is the benefit period and how does it work?
This is the time period that the insurance company will pay you the benefit – either until you are aged 65/70 or until you are better. You can purchase a shorter benefit period – till age 60, or for 5 years or 2 years, but in the last 16 years, at Moneyworks, we have only met one person where a short benefit period could be seriously considered. The default that you look at should be a long term benefit.

Basically, if you are unable to work and need your income replaced for 2 years, or 5 years, you are highly unlikely to return to work after that time period, and as such, you will need your income paid until retirement date – age 65.

Some insurance companies pay the benefit four weeks or a month in arrears, after you become entitled to it. Therefore if you have a four week wait period – you won’t receive your first payment for 8 weeks.  However, there are a number of companies that pay the benefit in advance - so it is important to understand how the insurer pays the benefit before you sign up.

How do I work out what benefit is suitable for me?
For the majority of us, we need to protect the maximum available to us – 75% of our income. Remember, as the premiums on the majority of policies that Moneyworks recommends are tax deductible (they are 'indemity policies' , the benefits are taxable when they are paid. However, if you have an 'agreed value' policy, the premium and benefit may not be taxable.

However, every now and then, we meet someone who is saving a large amount of their income into investments, and who can genuinely live on a lower amount than 75% of their income after tax, if they are disabled. For most people though, the extra saving in premium is not worth reducing the benefit paid.

What happens when I go to claim on my policy?
We are concerned that some of our clients aren’t aware of the situations when they are entitled to claim on their policy. We would encourage you to contact us if you are ill or injured for any reason – for longer than four weeks. You never know whether there may be a benefit that you can claim on your policy – regardless of your waiting period.

For example – if you have been hospitalised for three days or more, regardless of your wait period, you may well be entitled to a 'daily hospitalisation benefit'.

If you have a 'specified sickness benefit'  and you contract one of the specified sicknesses, you may be entitled to claim on the policy, even if you are still earning an income.

There are many other benefits on different policies – rehabilitation benefits being one of them – that might start paying you when you need it – not necessarily waiting until your wait period is completed.

When you claim on your policy, you need to be aware of the following things:

1. Any income that you are receiving from other sources is likely to offset any benefit that you are entitled to receive.
2. In general, if you are working more than 10 hours a week in your occupation, you are not considered to be totally disabled, and therefore may not be able to claim. (If your policy is not one arranged by Moneyworks, the definition may be different.)
3. The income protection insurance policies recommended by Moneyworks do not cover redundancy.
4. You need to note any exclusions that have been put on your policy because of pre-existing conditions.
5. If you had a pre-existing condition and you didn’t declare it, and you wish to claim for that condition – it is likely that your claim will be turned down.

What happens with ACC if I claim on my policy?
If you have an accident, and ACC assesses it under their criteria as an accident (not everything that we would logically think was an accident fit their criteria) – then any income payment that you receive from ACC will be counted as income, and it will be offset against any benefit that you will potentially receive from your income protection benefit.

However, don’t forget that there are many other benefits on your income protection insurance policy – that aren’t provided by ACC. It is still worth lodging a claim on your income protection insurance policy – in case you can claim on a benefit. The other point to note is that the definition of income for ACC and income protection are not necessarily the same. Because of these different definitions, you may end up claiming for additional amounts on your income protection insurance policy.

Don’t forget, as we get older, we are statistically less likely to have an accident, and more likely to be ill and unable to work!

Why don’t Moneyworks recommend all policies available?
In our opinion, income protection insurance cover is the most important personal insurance cover that you will have in place. Therefore, you want to make sure that it will work for you when you need it the most – at claim time.

When we assess which policies we will recommend we look at a number of factors including:

1. The definitions in their policy of ‘income’, ‘totally disabled’ and a few other relevant definitions.
2. The added benefits that they include in their policy – ie rehabilitation benefits, specified sickness benefits.
3. Their historical policy on increasing premiums – compared to how cost competitive they are for your situation at present.
4. Their attitude towards ‘underwriting’ – whether they will insure anyone anytime (which is generally referred to as ‘buying business’) or whether they have a more structured underwriting process. We want to make sure that they will still be offering income protection in the future – so the way they conduct their business is very relevant.
5. The organisations claim paying history and reputation (ie whether they are likely to try and ‘weasel out’ of paying your claim.)
6. The organisations credit rating and likelihood of remaining in business for as long as you need your policy.

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