A change has come for income protection insurance
Any way you look at it, if you’re a working person, it makes sense to get income protection insurance. Your ability to earn an income and support yourself and your family is one of the most important things to protect.
The idea is simple: if you’re unable to work due to an injury, or if you fall ill and consequently can’t earn an income, then your income protection insurance covers you. You receive up to 75% of your pre-tax income for an agreed period of time, until you are back on your feet and can resume working again.
Only, it hasn’t quite worked out that way over the years. The current system of income protection insurance, with its “agreed value” policies, has been costing insurers dearly. So dearly, in fact, that the Australian regulator for life insurance companies, Australian Prudential Regulation Authority (APRA), intervened in 2019 to implement a change.
The difference between agreed value and indemnity value policies
For decades, life insurers have offered two types of income protection insurance policies: agreed value and indemnity value.
An agreed value policy allows you, the policyholder, and the insurer to agree on the amount of income that will be paid to you, based on your income at the time of signing up for the policy.
So, regardless of how your income might change years after purchasing the policy when you make a claim, you would be paid that agreed amount, because it was based on your income at the time you purchased the policy.
Agreed value policies are more expensive than indemnity policies as consumers are paying for the certainty that comes with having the payment amount “locked-in”.
In comparison, an indemnity value policy pays you a percentage of the income you are earning at the time that you make a claim. So, if you are earning less money when claiming on your policy, your insurance payment will reflect that changed amount. This is precisely what has made this type of policy more affordable to purchase for consumers.
What are the issues caused by agreed value policies?
The biggest issue caused by agreed value policies is the massive cost to insurers. According to APRA, by late 2019, the total loss to insurers over five years reached $3.4 billion. A staggering amount by any standards.
The problem with this, of course, is that it makes income protection insurance unsustainable.
For how can any industry withstand this consistent amount of loss and continue to operate viably? If insurers try to combat these losses by making income protection more expensive this would add tremendously to the cost of insurance to the consumer… likely making it unaffordable.
But APRA cited other concerns as well, with the main one being that agreed value policies alter the central principle of insurance, which is to indemnify – or protect – a policyholder against loss or damage. But if you are receiving more than you lost, then it calls this entire notion into question.
What’s more, APRA is highly concerned that the agreed value policy discourages people from returning to work, because it is possible for them to earn more from their insurance payment than they did from their actual income before they made the claim.
What are the changes and when will they happen?
When APRA first raised the alarm in May 2019, it named a total loss of $2.5 billion over the past five years. But by the time September had rolled around, the amount had become $3.4 billion. For this reason, on 2 December 2019, APRA announced it would be intervening in the industry.
So, what does this mean now?
From 31 March 2020, insurers have stopped offering agreed value income protection policies to consumers. If you already have an agreed value policy predating 31 March, then it remains unaffected. But you would now be unable to purchase a new policy that offers an agreed value of income payment.