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How to find the best income protection insurance policy

Peace of mind if you lose your income – is it worth the premiums and will it pay up?

piggy bank wrapped in bubble wrap

Income protection insurance is a type of life insurance that provides an income if you're unable to work. It's often overlooked, because being out of work is not the cheeriest thing to think about. 

The insurance payment kicks in after a certain period and covers a portion of your income. And, like many things in life, it's not as simple as it sounds.

Do I need income insurance?

It depends. Income protection policies are designed to meet the costs of 'living', rather than ensuring family members receive a payout after your death. If you're young and single with no dependents and limited fixed expenses, income insurance is useful. If you're a family type who needs to look after loved ones, life insurance may be a better bet.

There are two main types of income protection insurance:

  1. Agreed-value insurance, the most expensive option pays out a benefit agreed to reflect your income at the start of the policy. This type is not affected by any fluctuations in income – kind of like 'agreed value' car insurance cover, rather than market value.
  2. Indemnity value policies are cheaper and more common. These verify your income at the time of making a claim and may adjust your benefit accordingly. So your payout salary can depend on things like maternity leave, working part time or becoming unemployed.

Indemnity value policies provided by super funds are the cheapest, with fewer features and less flexibility. They may also be limited to a shorter time period.

How long will I get paid for?

This depends on how much you want to cough up for better contract terms. The more you pay for the insurance, the longer they'll pay you in the case of illness or injury. Policy terms range widely, from two to five years, or up to age 60 or 65.

How much cover do I need?

Here you'll need to do some homework. Income protection covers roughly 75% of your income if you're sick, injured or unable to work. To get the best cover you'll need to budget your standard costs – like monthly mortgage or car loan payments – along with any dependents you want to provide for, plus the cost of managing any investment assets. This will help you decide what level of cover you need.

Shop around and compare cover and prices – they differ greatly

How much will it cost?

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

  • age (premiums may increase or cover may decrease as you get older)
  • gender
  • health and pre-existing conditions
  • whether or not you smoke
  • occupation (for example, a manual labourer pays different premiums to an office worker)
  • the time you choose to wait before receiving payment.

Stepped or level income protection insurance premium?

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

It's important to read all the terms to make sure you're not caught out at a tough time

Tips and traps of income protection insurance

This isn't an exhaustive list. Before committing to a policy you should compare product disclosure statements. You might also 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? What will the insurance premiums cost now and later?
  • Consider getting a policy with index-linked premiums and cover so you know it 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 things like buying a home or having a child.
  • Offset clauses allow insurers to reduce payouts if you have other income (for example, sick pay 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. This may make the claim and payout less straightforward. 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 if you're unable to perform your regular occupation.

Watch those terms

When taking out any insurance policy, you should check carefully the terms and conditions. You should also check the way the key terms of the policy are defined.

Nick, a farmer from Gloucester, found this out the hard way:

Nick had an income insurance policy with a large insurer. The policy was fine, but Nick had a not-so-typical income situation, because the money he made varied depending upon the success of the farm each year.

When Nick had an incident, the company refused his claim because they had defined his assessable income as being based on his taxable income. Sadly for the year in question, Nick had no taxable income. Instead, his income that year came from a legitimate repayment of money he'd lent to the family company in previous years.

Nick had seen no mention of 'taxable income' being the basis of assessing the insured's income. Luckily he was able to use an independent claims assessor to help negotiate with the insurer and eventually reach a compromise.

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