Diana Clement

Your Money and careers writer for the NZ Herald

Diana Clement: Income protection ignored by most Kiwis

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Half of all adult Kiwis have life insurance. They can imagine the catastrophe if the family breadwinner died.

Yet we face a much bigger risk financially than death. That is losing the breadwinner's income through "disability" from illness or accident. As I wrote a few weeks back, ACC will replace income in cases of accident. Yet Kiwis are much more likely to be prevented from working through illness. Just look at the people in hospital beds - most are there through illness.

Online research by insurer AIA last year found that 87 per cent of us have car insurance, 50 per cent life insurance and only 11 per cent income protection insurance.

Ask any insurance broker and the stories come tumbling out. Michael Cave, managing director of Cave Financial Consulting, cites the case of a 47-year-old customer who suffered a stroke while playing Pictionary. The man couldn't return to work in his profession as a rock driller for the rest of his life.

Thankfully his income protection insurance will support him financially until retirement.

Income protection insurance is quite simple. If you lose your income due to temporary or permanent disability through illness or accident you will be paid up to 75 per cent of your previous salary for the period of cover, which could be two years, five years, or until age 65. Related, but not as comprehensive, are mortgage protection insurance and total permanent disability (TPD) insurance.

People will often take life insurance cover and reject income protection insurance as "too expensive", says industry analyst Russell Hutchinson of Chatswood Consulting, even though it is the more valuable cover. They underplay their chances of having an accident or falling ill.

Other common reasons that people don't take out income protection or related insurances, says Cave, are that they:

* don't know what it costs

* get confused by analysing too many policies, or

* fear they won't be covered for an illness they've suffered in the past.

The irony, says Cave, is that most people would take out insurance to cover a machine in their business that would produce $1 million worth of net profit over the next 20 years. Yet they don't cover their own income, which is worth roughly the same.

There are two main ways to buy income protection insurance: through a bank, which will usually only sell its own policy, or an insurance broker (financial adviser), who will sift through a number of policies from insurance companies.

As a very broad-brush statement, the bank policies may be cheaper and often include redundancy cover for the mortgage, but can have more exclusions.

The advantage of an insurance company policy is that it will usually be more flexible, and providing clients disclose all relevant medical history, they will be covered for all conditions unless specifically excluded. Someone like Hutchinson, who has asthma, may have that condition excluded or the premium loaded to cover it, but he will know what he's covered for in black and white. Or at least he will if he has read and understood the policy, which too few people do.

Knowing exactly what you are not covered for gives you the ability to say, "Hey, I don't think that's fair", when the policy is taken out, says Conor Sligo, director of LifeDirect.

I can hand on heart argue that it's best to buy income protection and related insurances through an insurance broker. A professional who deals with this insurance day in, day out can help navigate the matrix of options, which would fill the rest of this page if I spelled them all out.

Some of those options are straightforward, such as:

adding trauma cover, which pays a lump sum if you're diagnosed with a named illness

waiver of premium benefits - so that your premiums are paid when you're off work

whether you want to cover your own occupation or any occupation, and

if you want your KiwiSaver contributions covered.

Other more complex considerations include "buyback" options, which allow the cover to be reinstated after a claim. Some people may need cover for working overseas, or if returning to their home country to live after being permanently disabled, says Sligo,

A broker will ask whether you want premiums that are fixed for a certain number of years, says Cave. And insurers such as AIA, Tower, and Sovereign offer various "split cover" options, which may, for example, cover your mortgage only for the first 13 weeks and then your income after that.

Another thing to be aware of is that most policies cover "indemnity". That means you only get 75 per cent of your current income if you're incapacitated, even though you may be paying premiums on a higher salary you were getting when you took the policy out.

For this reason some people choose an "agreed value" policy, where the amount to be paid is set in stone at the outset. This is particularly important for self-employed people who may keep their income artificially low.

Income protection insurance isn't anywhere near as cheap as standard life insurance, which sometimes puts people off. Some cover is better than none, however, and the price can be cut back by increasing wait periods (which are much like excesses), or reducing cover, Hutchinson says.

Policy costs are the length of the proverbial piece of string. I spent quite a bit of time this week playing round with hypothetical scenarios at Quotemonster.co.nz, which insurance brokers can use to compare policies (Quotemonster.co.nz is not open to the public but the Lifedirect.co.nz system is based on the same database of policy details). A policy for a 45-year-old employed male covering $50,000 income (75 per cent of the total) for claims of up to five years with a four-week stand-down period would cost from $76 a month - providing he didn't work in a high risk industry.

Add $100,000 of "trauma" cover and then the premiums move up to $141 a month. Change the stand-down period to 13 weeks and the premium drops to $102 a month. Reduce the trauma cover to $50,000 and the premium drops further to $75.

Some people prefer to cover themselves to age 65 instead of for a maximum benefit of five years. Using the same scenario above with $50,000 trauma cover and a 13-week stand-down period, the monthly premium for a five-year benefit period is $75.26, and to age 65 is $90.

The trick with insuring to age 65 is that more than 90 per cent of claims are concluded within two years, says Hutchinson, which means that you're paying to insure against a risk that isn't as likely as you may think. Nonetheless it gives people peace of mind.

It's unusual for insurance company policies to include any type of redundancy cover. Asteron does, however. For the above income protection scenario the Asteron policy with $3000 a month redundancy cover for six months cost $40 more a month than it would without.

My final word on cost is that in some cases income protection insurance premiums are tax-deductible, which brings the cost down indirectly.

There are, of course, fish hooks with income protection insurance. For example, if ACC pays weekly compensation following an accident, then the income protection policy won't pay. This is more logical than it sounds. Insurance companies factor in ACC when pricing the premiums, says Cave.

Conversely, if the loss of income is due to redundancy or illness, the income protection payout will usually cancel out any Work and Income benefits.

Another not uncommon issue is claims declined for non-disclosure. In one case heard by the Ombudsman last year a company turned down a claim on the basis of "non-disclosure" because it said that the client hadn't properly revealed a "sore hand" a decade earlier.

The insurance company argued that it wouldn't have provided cover for the hand had it known about the non-disclosure.

Insurance companies may void the entire policy from inception in cases such as this.

They can also decline an unrelated claim on the basis of "non-disclosure".

- NZ Herald

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