Does your current adviser really understand income protection?

Does your current adviser really understand income protection?

Having spent 15 years in the industry and during that time I've worked on a significant number of difficult income protection claims. I still don't understand why the indemnity first approach for income protection still prevails with the majority of advisers in today's environment.

Well I do; it's not the client first approach we'd all like to expect, advisers have to do less and get paid more, but that's another story here.

The following was the explanation from a client's former adviser on the differences between indemnity and agreed value. While some of it is correct and some of it is justified on the surface. It's not the level of understanding you as the consumer need from your adviser

The previous advisers assertions;

The main differences between an agreed value and an indemnity value policy:

  • An agreed value/loss of earnings policy has a maximum insured benefit of 55% of income at application time whereas an indemnity value cover has an insured benefit of up to 75%
  • In the event of a claim, (subject to the policy terms), an agreed value policy would pay the insured benefit amount irrespective of what the insured’s income was prior to the claim whereas an indemnity value policy would pay the lessor of the insured benefit amount and 75% of income prior to claim using the best consecutive 12 months in the three years prior to the claim
  • Any benefit received from an agreed value policy would not be subject to income tax whereas the benefit from an indemnity value cover is subject to income tax
  • The premium payments for an indemnity value policy are an allowable tax deductible expense whereas those for an agreed are not
  • Essentially an agreed value policy is more suitable for a self-employed person and/or one that has a fluctuating income so as to provide more certainty at claim time as to the benefit received.
  • Any ‘other’ ongoing income (including ACC) may be offset in the event of a claim. (at the other end, ACC also asks the question ‘are you receiving any other income in respect of this claim so the insurance benefit made be offset from any ACC benefit

Let's have a closer look at each of these statements

  • An agreed value/loss of earnings policy has a maximum insured benefit of 55% of income at application time whereas an indemnity value cover has an insured benefit of up to 75%

Yes, this was true at the time, now we can insure up to 62.5% on agreed value. What needs to be understood is the difference in cover amounts is to account for the different tax treatment, the 75% cover is tax assessable the agreed value is not. The perception is you can get more cover on indemnity. The reality after tax in your hand agreed value will almost always pay you more.

  • In the event of a claim, (subject to the policy terms), an agreed value policy would pay the insured benefit amount irrespective of what the insured’s income was prior to the claim whereas an indemnity value policy would pay the lessor of the insured benefit amount and 75% of income prior to claim using the best consecutive 12 months in the three years prior to the claim

The point here is lessor. Agreed is agreed, that’s the level you pay for and the level you get paid. With CPI or indexation operating on the policy it will grow in claimable value over time. 

With Agreed, the agreed value amount is what is paid; the indemnity cover would pay 75% of what you could prove or the sum insured whichever is lower. If you had a drop in income or you hadn’t had the pay increases keeping up with inflation, then on the indemnity policy, you will be over insured for what you could claim.

  • Any benefit received from an agreed value policy would not be subject to income tax whereas the benefit from an indemnity value cover is subject to income tax

Correct, this is a key point to understand what you are actually covered for.

  • The premium payments for an indemnity value policy are an allowable tax deductible expense whereas those for an agreed are not

Correct, keeping in mind with the 55/75% ratio from point one the agreed policy would be 20% fewer dollars in cover amount and this would come at a relatively lower premium. 

Once the tax deduction was claimed on the 75% policy, you typically ended up in much the same place premium wise. The ‘sales’ technique, "buy this one you can claim the deduction", is just that, a sales technique. This sales technique results in you having less secure cover for a higher perceived value that’s actually not there.

  • Essentially an agreed value policy is more suitable for a self-employed person and/or one that has a fluctuating income so as to provide more certainty at claim time as to the benefit received.

I flatly disagree. If, as a self-employed person, your income was fluctuating, the insurance company generally wouldn’t offer agreed value and would only offer indemnity value. Real estate agents are a great example; we can generally only get indemnity cover for a real estate agent as their income fluctuates with the market. It's not stable enough for the insurance company to offer an agreed risk. 

Agreed value provides certainty for everyone and should be the preferred cover in all cases. In my client's case we can protect their high salary earnings now and if they do go contracting or self-employed, then this is locked away regardless of what they earn self-employed. If their income ends up being higher, then we review and increase as required. In all cases locking away the ability to claim the benefit, you are paying for.

This statement also demonstrates a lack of understanding in a degenerative claim. Take multiple sclerosis, with this condition it affects people over a long period of time. If it takes eight years to go from good health to disabled health, then the indemnity policy is going to come up short. 

The earnings at the beginning are likely to be the highest, with the last three years before disability being the lowest. The agreed value policy will pay the agreed amount, from way back at the beginning plus cpi increases since it was taken. The indemnity policy is going to pay 75% of the best 12 months of the 36 months directly preceding the date of disability. Date of disability being the date eight years after the diagnosis. Potentially the indemnity policy is going to be almost worthless at this point.

  • Any ‘other’ ongoing income (including ACC) may be offset in the event of a claim. (at the other end, ACC also asks the question ‘are you receiving any other income in respect of this claim so the insurance benefit may be offset from any ACC benefit.

Yes, this applies equally to agreed and indemnity covers. Typically ACC pays and then the income protection pays a top up if there’s still a shortfall. I'm yet to see ACC offset a claim because an insurance policy was paying, as they are legally obliged to pay in an accident disability. The key difference with offsets is the Agreed Value policies offset the life assured’s exertion based earnings where indemnity offsets all earnings. 

So you put another person into your business to run it and they maintain the profit, your indemnity policy wouldn’t pay a claim. Take the same situation with an agreed value policy; the profit comes from the business because someone else made it and not the insured person's exertion, and an agreed value claim gets paid.

To mitigate the offset of ACC, we would also look at mortgage repayment protection which has no offsets, where there is a mortgage payment that is able to be insured.

The answers for you:

If you want cheap cover, any adviser can find you a cheap policy, if you want an effective income protection cover have a chat with us, so you get it right at claim time. Often our approach results in a similar or lower premium with the security of claim and without additional hassles.

You pay good money to be covered if you never expect to claim why do you pay a premium? If you're paying a premium, make sure you're covered with the right cover.

Get in touch with J-P for a free review to assess your needs

Jon-Paul Hale

Written by : Jon-Paul Hale

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Donald M Fink
Donald M Fink a Disability Income Protection
Thank you for your post!This tutorial is fabulous! Lots of great info including to this post, Income protection is essentially disability insurance. It ensures you are protected if you lose one of your most valuable assets-the ability to earn income.disability income benefits plan on your own can help protect your financial security by helping you cover all monthly expenses.
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Jon-Paul Hale
RE:So much to think about
Thanks for the comment Sharon, like most things today, put it in the hands of a specialist, it usually doesn't cost any more and you get what you pay for. I feel the same way about creative, I'm not so good with that, so I hand it off :)
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Sharon
So much to think about
I'm a more 'hands on' creative type, so this is usually something I leave to the professionals. Great read Jon-Paul.
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Jon-Paul Hale
RE:Samantha
Thanks for your comments Samantha, there's more on the subject with this FAQ http://www.willowgroveinsurance.co.nz/faqs/24-income-protection
& this blog http://www.willowgroveinsurance.co.nz/blog/agreed-vs-indemnity-cover-what-s-better
which expands on the topics touched on here.

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Samantha
Samantha
Wow, great to know there is something out there to cover us self-employed people, I've always wondered! Something to seriously consider!
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Jon-Paul Hale
RE:Lots of food for thought!
Thanks for the comment Amanda. Yes, an area that is not well understood and can be quite complicated to get right. Most people first looking at income protection ask, 'So what does it cover". When they get the answer "Anything disabling that means you can't work more than 10 hours per week" most struggle to comprehend just how vast that is. It's a very flexible policy that does have some non-negotiables that always need to be considered.
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Amada
Lots of food for thought!
Wow, lots of info to digest - definitely something that's best to leave to the professionals. Wouldn't want to go cheap as in the long run, if you need it, it won't be cheap at all!

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