Income protection insurance traps
Income protection insurance is an interesting financial tool, but of
all life and health insurance products, it is the most misunderstood by
customers and insurance industry people alike. Here are 11 traps for the
Friday, 30 May 2008
By Graeme Lindsay
Make sure you have a guaranteed right to renew the policy until age 65! Do
not accept a policy that the insurer can cancel for any reason – there are
a few of these out there. The last thing you need is to have your first
heart attack the day after the insurer cancelled your policy.
Look out for the benefit period – i.e. how long they will pay you if you
have a long-term disablement. We sometimes see policies with two-year and
five-year benefit periods. These are unacceptable – we only ever recommend
benefit periods to age 65. If you're sick long-term, you don't need the
insurer saying 'sayonara' after two or five years!
not accept a policy that does not have a benefit payable if you are
partially disabled! A recent study of income protection claims showed that
over 70% of claims go from totally disabled to partially disabled before,
in most cases, full recovery. Don't get caught out in the cold with a 'no
partial disability claim' policy.
Watch for a two-year limitation on partial disability claims. This is
almost as bad as no partial disability claim – I have two clients now who
have been on partial disability claim for over two years – in one case,
almost 10 years.
not accept a two year limitation on mental health (read stress and
depression ) claims. Anecdotal evidence shows the greatest single cause of
IP claims is stress and depression. Why would you have income protection
that limits benefits for the largest cause of claims?
Beware the policy that says that the partial disability claim ceases if you
are able to work full time. Many claims for partial disability involve
conditions that reduce your productivity, but not the hours you can work.
For example, we have one professional client who prior to his breakdown,
worked 60 hours per week. On medical advice, he now works 40 hours per week
and at a less frenetic pace than previously. He is earning about one half
of his pre-disability income. If he had the bad policy, he would be out in
the cold. He has a good policy that recognizes reduced productivity as a
Watch out too, for the policy that allows the insurer to deem that you are
earning if you are medically able to work but are unable to earn. For
example, you can't hold down the responsibility of partner or business
owner, but medically you are able to work as a clerk. But, you can't find a
job – after all, who wants to hire someone who had a nervous breakdown 18
months ago and has lost his/her business? The bad policy can deem that you
are earning what they say you are capable of earning, and will offset that
amount against any benefit you expect.
careful of "group" policies that are cheaper than
"retail" – they often have restrictive clauses. One that we see
and don't like provides that a partial disability benefit is only payable
if you are working for the original employer! So, if your illness means
that you can't work as an accountant, but can as a gardener, you are out in
the cold! Discounts usually mean reduced benefits!
Watch for restricted cover policies. Some insurers offer policies that only
pay benefits if you suffer a major trauma type illness/injury. These do not
cover stress and depression, but are cheaper and some salespeople find them
easy to sell. We will not use them.
Agreed value policies do not automatically pay out the "agreed
value" if you are disabled. All income protection policies offset any
on-going income you receive or are entitled to receive for the "agreed
value". It is logical that they do, but many salespeople are unaware
of this, or overlook it.
The tax treatment of agreed value policies is still an area of concern. Two
insurers believe that any benefit will be taxable as income and accordingly
the premium is deductible. These insurers will allow you to cover up to 75%
of income. Four other insurers believe that the benefit is not taxable and
the premium non-deductible. These insurers will only allow you to cover 55%
of income. IRD has a working party considering the issue and we await their
decision. The risk is if you have the 55% cover and IRD rule that they are
taxable/deductible and you have become uninsurable. You now only have cover
of 55% of income and it is taxable! Our preference is for the
In summary, there are excellent polices, offered by quality
insurance companies with none of these traps, so you don't need to settle
for second best.
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