Offsets are one of the most contentious and least understood provisions of an Income Protection contract with policy holders.
Simply it's not a selling point so it's glossed over in the advice discussion.
Keep in mind, having some cover is better than no cover, but having the right cover is even better.
I'm going to explore offsets in this article so you have a better understanding of what this may mean to you.
Your disability insurance adviser is the best person to advise on your particular situation, hopefully that's me. This article will assist with your understanding of some of the finer points.
First some background for you.
Income Protection is an insurance product designed to replace your income if you are disabled though a medical illness or accidental injury.
It can be an expensive product when compared to life cover premiums but this is reflective of the financial risk the insurer takes on. Keeping in mind this policy insures your future income, so is relative to this financial risk.
Grab a calculator and do your numbers. The number of years you have until retirement multiplied by your annual income, this is what Income Protection is potentially worth to you in today's working dollars.
Insurers understand premium affordability is a concern for policy holders and they look to find ways to reduce their risk and subsequently reduce your premium. Doesn't sound like an insurance company? No
You might be right, but remember insurance companies make their money from people paying their premiums, they do plan for claims. If the products are unaffordable, they won't have policy holders paying the premiums.
One of the ways insurance companies reduce Income Protection premiums is by applying offsets.
What is an offset?
An offset is income, or replacement income, you are entitled to receive which is taken away from the benefit the insurance company pays you. In New Zealand an ACC weekly compensation payment for an accident disability, is a good example and one which is quite common.
To look at it from your point of view, if you have a disability and you have the majority of your income deposited into your account while you are disabled, is this taking care of you financially? This is the way the insurance company looks at offsets and insuring you.
To expand this out. If 40% of new disability claims are accident related and Income Protection offsets the ACC payments, then there is a reduction in financial risk to the insurance company right? Yes.
However, it's not a reduction in risk by 40% though. Insurers know that a certain percentage of ACC claims develop other non-accident disabilities. Sometimes the accident doesn't allow a person to return to their own job once they have recovered either. This is more likely to be a 20% than a 40% reduction in the insurers risk, which translates into the calculation for your premium. Each insurer will have their own experience with this and their numbers can be quite different. I've used something middle of the road as an example.
Back to the ACC and another job comment I made above.
If you have recovered and can't return to your own job, ACC will move you off into another job or the sickness benefit. This is where your Income Protection becomes really valuable to you, as it insures you if you cannot return to your own occupation.
This means if you have an accident, recover, but not fully, and you can't do your own job, but you can do another, you have the choice about weather you take the other job ACC says you can do or not. That's a long sentence for a reason, so is the process and decisions around this.
I've got a bit side tracked, back to offsets.
So we've established that it is in both, yours and the insurers, benefit for your Income Protection policy to have offsets, it helps maintain affordable premiums.
There is another reason for this. Again I'll use an ACC example and assume you have Indemnity Income Protection (makes the tax calculations easier to understand). Our preferred approach is non-tax assessable agreed value. Keeping in mind insurance is about replacing your financial loss and not about setting you up for a lotto win.
You've had an accident and you were earning $60,000 per year before tax. ACC is going to pay you 80% of 1/52nd of $60,000 per week less tax, or $923 per week less tax, after the 1st week off work. At week 4 off work your Income Protection is going to kick in, lets go with no offsets for the moment, and pay you 75% of 1/12 of $60,000 (because it pays monthly), you're going to receive $3,750 from the insurance company which you have to pay tax on. Combine this with ACC, and your second month on disability will have you receiving $7,749 into your bank account. With your normal gross income at $5,000 per month you are substantially ahead of where you normally are. If you're receiving 155% of your normal income sitting on the couch, where's your incentive to return to work?
Let's look at this from another angle. Premiums pay for the policy, from this the insurer pays claims. If people don't have the financial incentive to return to work it will increase the amount the insurer has to pay for claims. This will in turn put pressure on the insurer to raise premiums to pay these claims.
As the policy holder who isn't claiming, wouldn't you want the insurer to manage the claims to deliver the required benefits to the policy holder while maintaining premium stability? This is another reason why insurers apply offsets.
So what do these offsets look like. Depending on the insurance company they can be as follows (each insurer will be slightly different in their own approach, but often the outcome for the client is very similar)
Things insurers can and often offset
- ACC payments
- Other Income Protection policies (not so much with the same company but certainly if they are with different companies)
- Other Income Protection policies, specifically your employee staff insurance you forgot about.
- Mortgage Repayment Insurance
- Government benefits
- Retained earnings in your business
- Profits you are entitled to
- Commissions and bonus's earned
- Any income you generate while being disabled under the terms and conditions of the policy
- Superannuation payments (some not all)
- Sick pay and other ongoing income of an earned nature from your employer.
- Keeping in mind, if your income is above ACC's maximum threshold, $120,070 per annum self-employed and $122,063 per annum for employees (2016/2017), you need Income Protection to cover this even in an accident situation.
How do you avoid offsets?
In the case of pure Income Protection, you can't. In situations of business start up and key person protection, you can as these situations often don't have offsets but they have limited term benefits to mitigate the insurers risk. The most common situation of all, which we come across, is protecting someone's mortgage payment.
The major differences are:
- It's based on your mortgage payment and not your income.
- Mortgage Repayment Insurance doesn't offset ACC and other Income Protection (if there is a mortgage present, though another discussion)
- Claims are assessed on work capacity, hours worked/working not income
- Mortgage Repayment Insurance sometimes doesn't have features found in Income Protection, like the rehabilitation and vocational retraining benefits. Most on offer today do, though often older policies may not.
- The way partial claims are handled can be different too. Hours worked not income earned, there are some which are the same as Income Protection but don't have offsets.
Improving the certainty, you will receive enough money on claim to pay your bills.
If you want to have a chat about how your current cover will work or have a look at what solutions are suitable for you, gives us a call we are happy to help.