Protecting your income
If someone asked you what your most valuable asset is you'd probably say it was your house. But, unless you are retired or close to it, you're almost certainly wrong.
Sunday, August 20th 2000, 4:40PM
The best way to illustrate the size of this asset is to look at the potential earning capacity of a 40-year-old on $65,000 a year. Now this person can expect to earn $1.63 million (in 2000 dollars) in the 25 years to his retirement.
So yes it is a big asset, but the odds are that it is unprotected. With other big assets, such as your house and car, you will more than likely have them insured. However, it is far less likely that your future income streams are being insured against events such as an accident or disability which may force you out of work for lengthy periods of time.
Income protection, or disability income insurance, has been a strong growth market in New Zealand in recent years, yet despite this growth less than 100,000 people are covered.
Currently there are 21 standalone guaranteed renewable income protection contracts on the market in New Zealand. Being guaranteed, renewable contracts insurance companies can't cancel individual policies and they can't single you out for a premium rise - instead, the contracts have to be treated as a group.
The basic philosophy behind income protection is that the life office will pay you a portion of your wage or salary in the event that you have to stop work because of accident or injury.
Income protection insurance has traditionally been bought by self-employed business people, whether they run a small landscaping business or they manage a medium size manufacturing business. However, there is a growing case for wage and salary earners to consider buying a policy.
There is a perception that the Accident Compensation Corporation (ACC) will cover you in these situations, but the reality is it won't payout in all situations, and it is paying less and less than it did in the past.
For instance if you are forced out of work for an extended period due to, say, a health-related condition such as hepatitis or a stroke, then you won't have any income unless you have insurance.
Likewise, ACC isn't likely to cover you for non-medical events such as stress and depression.
Tower Health managing director Jim Minto says that more than 50 per cent of claims against income protection contracts are for these types of non-medical events.
For these reasons income protection is "a core element" of any financial plan, he says.
The simple appearance of income protection insurance belies the complexity in the product.
It's not like term life insurance which is essentially a commodity product sold on price alone.
"Price is only one factor and it is not the determining factor," American International Assurance general manager David Whyte says.
Picking the right income protection insurance policy is about getting three elements right: the type of policy, the definitions used in the policy document including what is a total disability and what is a partial disability, the track record of the insurer and finally the premium price.
This type of insurance comes in two forms, namely: indemnity and agreed value policies.
Sounds complicated - but it isn't. With an indemnity option the insurer will pay you 75 per cent of your pre-disability income. With an agreed value policy the payout is determined by you and your insurer at the time you pay for the cover. The catch is that the payout can't be more than two-thirds of your pre-disability income.
The second point you need to consider is the actual wording of the policy document. While it's fair to say that most people can't be bothered reading the fine print on the policy which explains all the ins and outs it's something which is well worth doing with income protection,
You will find that insurance companies use different definitions of what is a disability and whether it is partial or total.
This may sound minor but it can have a significant bearing on the level of payments which are made if you have to claim.
Further issues arise in the way the company may treat other income earned while you are off work and the calculation of these may also impact on the level of payouts.
Mr Whyte says because of the complexity of this type of insurance, "it is unlikely that the average consumer is going to be able to make a useful comparison without the help of a qualified adviser."
The other big warning for people contemplating buying an income protection policy is what is likely to happen to premiums in the future.
Currently all other types of life insurance in New Zealand have either static or falling premium levels, and in some cases improved benefits.
Yet, many life companies are taking a bath on income protection insurance, consequently premiums are likely to skyrocket.
Already in the past year most of the companies have pushed up their premiums, and in some cases the increases have been significant - double digit increases, not just one or two per cent.
The reason for these increases is that companies aren't making profits on these policies due primarily to poor past underwriting practices and longer-than-expected claim periods.
This situation isn't unique to New Zealand. Companies in Australia and the United States have also been struggling with these problems.
AXA, for instance, said that in the 12 month period to September 1999 it lost A$22 million on income protection in Australia, and its New Zealand arm also suffered losses.
It comes as no surprise then that life companies are tightening up their claims management and trying to get people back to work as soon as possible.
One of the impacts of this is that companies may start to make it much harder for people to have extended lengths of time on a claim.
In the United States, for instance, it is now difficult to buy a policy which has a waiting period of less than 60 days (that is you have to be off work for 60 days before receiving a payment for the insurer), also benefit periods are reducing and many occupations have been moved into higher categories, thus they have higher premiums.
Also, in the United States some companies have withdrawn from this market totally, and others have removed the bells and whistles in their policies to bring costs down.
Mr Whyte says the key lessons out of these changes are that you should know the track record of a life company's premium history before signing on the dotted line.
He contends that if a company has been increasing its rates significantly it is likely to continue doing so in the future.
"Advisers need to look for (life) offices with a stable price and benefits history," he says.
A final point people should consider when looking at buying an income protection (or any sort of life policy) is the claims paying ability of the company. At present it's mandatory for non-life companies to get an independent rating from an agency such as Standards and Poors. While it is not required of life insurers, a number have gone through the ratings process as it gives customers a better feel for the strength of the company.
After all with a life policy you want to know if the company is likely to be around in the future if you need to make a claim.
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