Can Income Protection Coverage Be Guaranteed?

Income protection contracts come in many shapes and forms. From basic cover (primarily designed for affordability) to premier cover (containing all the bells and whistles), contracts are as many and varied as the range of occupations they insure.

The underlying principle of income protection insurance is to replace a proportion of the insured’s income in the event of debilitating illness or injury. And so it follows, the actual amount payable (the monthly benefit) and the point at which it is determined is a key consideration.

Indemnity value income protection insurance

Under an indemnity contract, the insured typically receives the lesser of 75% (or a similar proportion) of their pre-disability income, or their monthly amount insured. The contract is not financially underwritten at time of application, so financial evidence is required at claim time to verify pre-disability income.

There are varying definitions of ‘pre-disability income’. However, it is normally measured as income earned over the last 12 months, or the best 12 months over a specific period (for example, the previous two years).

Consequently, if the insured’s income has decreased since policy inception, their payable benefit may also be reduced (to 75% of actual pre-disability income). Under an indemnity contract, the insured person must accept this risk of volatility in income i.e. if their income decreases, they’re likely to receive less than their insured benefit.

Depending on the client’s circumstances, this risk may be entirely acceptable. For example, employed persons who traditionally receive year-on-year increases in income are ideally suited to indemnity contracts (so long as this trend is maintained).

Indemnity contracts are also the most affordable form of income protection. This is because the insured - not the insurer - assumes the risk of any volatility in income.

Agreed value income protection insurance

Agreed contracts differ from indemnity in that a person agrees, or ‘locks in’, their monthly benefit at time of application. An agreed contract ensures at claim time, the insured’s benefit is based on income earned prior to application (instead of pre-disability income, earned in the period prior to claim).

Under an agreed contract, the insurer accepts the risk of reduction in the insured’s income after issuing the policy. Where income does decrease post-application, the insurer will not reduce the monthly benefit. This is the main difference (and advantage to the life insured) between an agreed and indemnity contract.

A key factor with agreed contracts is the point at which financial evidence is required. The financial evidence requested at claim time (to verify the insured’s income) usually relates to pre-application income - that is, income at the time when the monthly benefit was originally locked in. The evidence supplied must support this original amount. If the original monthly benefit cannot be supported by financial evidence, this may lead to a reduction in benefit to the actual amount that could have been supported at application time.

Guaranteed (or ‘endorsed agreed’) value income protection insurance

A variation of an agreed value policy offered by select line insurance companies is a ‘guaranteed’ contract (you may otherwise hear of an ‘endorsed agreed’ contract, which operates in similar fashion). Under a guaranteed contract, financial evidence is assessed prior to policy issue (in certain situations, it may be possible to guarantee the monthly benefit without even reviewing any financial evidence e.g. for graduates whose qualifications correspond with a particular level of income.

It is worth noting that while a guaranteed contract and an endorsed agreed contract are largely the same, some endorsed agreed contracts may only provide a partial endorsement. Where this applies, further evidence needs to be supplied at claim time to verify pre-application earnings.

Generally speaking, guaranteed contracts usually offer the monthly benefit guaranteed upfront (at application stage). For this reason, financial evidence is not required at claim time to verify the monthly benefit. This eliminates a key step in the process – resulting in faster administration of claim - during a stressful period of illness or injury.

A client can be assured the contract has been fully underwritten, removing any uncertainty around the benefit to be paid. This also assists in preventing overinsurance, as underwriters have assessed the financial evidence, and ascertained the amount can be insured.

It should be noted that only a select number of life insurance companies offer this particular type of income protection insurance.

Which type of income protection policy is right for you?

Certainty lies at the heart of any income protection contract. You would like to believe your income protection policy will support you at time of illness or injury. That’s why it is important to seek advice on which income protection policy suits your life situation.

Finding and comparing income protection quotes from xLife can give you peace of mind. Rest assured that a qualified financial adviser can analyze your needs and find a competitively priced type of policy to protect your greatest asset – your income.

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February 2010