Income protection insurance

What type of cover should I get?

There are two types of income protection insurance: indemnity and agreed value. Indemnity policies can be provided by superannuation funds and premiums deducted straight from the member account.

• Agreed value insurance, the most expensive option, pays out the benefit agreed to reflect your income at the start of your policy, and is not affected by any fluctuations in income.
• Indemnity value policies, which are more common and less expensive, verify your income at the time of making a claim and may adjust your benefit accordingly. This can be an issue if your salary fluctuates, for example if you have taken maternity leave, worked part time or become unemployed.
• Policies provided through superannuation funds are the cheapest option, are indemnity value-based, and offer fewer features and less flexibility.

There are benefits to all three types of policy. Agreed value, which will cover you regardless of employment status, is particularly useful for self-employed people. For those who have a reliable, regular income, an indemnity policy may suffice. Some superannuation funds offer IP as default cover and automatically accept applications without medical checks - and offer a choice for those who would otherwise not be covered. CHOICE recommends choosing a policy with the right level of cover for your situation – limitations on how, when and for how long you are covered are the last thing you want to be dealing with if you do need to make a claim.

How much do I need?

The amount of income protection insurance you need will be determined by the salary you want to insure. Generally income protection provides cover for about 75% of your salary in the event of illness or injury preventing you from working.

You need to consider what the costs are of meeting a mortgage and other debts; providing for a spouse, children or other dependents; and maintaining your assets and investments. Remember the point of income protection insurance is to provide an income stream if you can no longer work.

What should I pay?

Shop around and compare cover and prices; they can differ greatly. Premiums are set depending on:

• Age (premiums may increase or cover decrease as you get older)
• Gender
• Health and pre-existing conditions
• Whether or not you smoke
• Occupation (for example, a manual laborer pays different premiums to an office worker)
• The time you choose to wait before receiving payment.

Stepped or level?

You can pay for IP in stepped or level premiums.

• A stepped premium starts out cheaper, but increases over time.
• Level premiums stay constant but will vary depending on age at entry. They start out more expensive, but after 10 to 12 years of cover become the cheaper option. If you plan on sticking with the same provider, a level premium is better in the long term, but if you like to shop around, a stepped premium is wiser.

Tips and traps

This isn’t an exhaustive list, so compare product disclosure statements and consider getting professional financial advice.

• When taking out a policy, ask these key questions: what’s covered; what’s not covered; how much will I be paid after a claim; and what will the insurance premiums cost now and later?
• Consider getting a policy with index-linked premiums and cover so you know the cover will keep up with inflation.
• Consider a non-cancellable policy; otherwise companies may reassess your health or other factors on each renewal, possibly raising your premiums or refusing to continue cover.
• Look for a policy with Guaranteed Future Insurability, a benefit that allows you to increase your level of cover without further underwriting. This is important if your circumstances change due to such things as buying a home or having a child.
• Offset clauses allow most insurers to reduce payouts if you have other income (for example, sick pay from your employer or Centrelink benefits). Check the relevant section of the policy for details.
• With group insurance provided through super: the agreement is between the fund trustee and insurer. Make sure both know who your nominated beneficiaries are.
• Check the waiting period (how long before you receive payment, often 30 or 90 days) and the benefit period (for how long payments will be made — typically two years or sometimes until your normally expected retirement age).
• Some policies pay out if you’re unable to perform your normal occupation; others only pay if you can’t perform any occupation for which you’re suited by education, training or experience. Look out for policies that pay on if you're unable to perform your own occupation.

Watch those terms

When taking out any insurance policy, you should check carefully the terms and conditions, and also the way the key terms of the policy are defined. As Nick, a farmer from Gloucester, discovered, it can really make a difference when it comes to insurers paying out.

Nick was insured with a large insurer to cover for his income should something happen to him. The policy was fine except for Nick, who’s income derived from working his family farm, had a not so typical income situation, as his income varied depending upon the success of the farm in different years.

When Nick had an incident, the company refused his claim because they had defined his assessable income as being based on his taxable income, but for the year in question, Nick had no taxable income, as he had been legitimately repaid from money he had lent to the family company in previous years.

What Nick couldn’t understand was that there was no mention in the policy of ‘taxable income’ being the basis of assessing the insured’s income.

Nick used an independent claims assessor to help negotiate with the insurer, and was able to reach a compromise. But it's important to read all the terms to make sure you're not caught out at a tough time.