Those of us who have existing income protection policies have either received or are about to receive a rude shock when it comes time to renew our policies. In some cases, income protection premiums have increased by up to 70% in one year. I have received many enquiries from holders of policies over the last six months who are presented with the dilemma of affordability and cancelling cover, often which they have had in place for many years.
The two main reasons premiums have increased
Premiums are increasing because the benefits provided under many policies have historically been overly generous to the point where there becomes a disincentive or moral hazard, where people on claim have no incentive to rehabilitate and return to work. This is particularly the case for agreed value policies where the benefit paid is fixed, irrespective of the income the claimant was earning prior to claim. For example, you may have someone with an agreed value policy for $120,000 p.a.(typically 75% of their income when they first took out the policy plus annual indexation) who is now only earning $80,000 p.a. and they would still get paid $120,000 p.a. if they were to go on claim.
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The second contributor to increased premiums is low interest rates which has reduced the returns on statutory funds life insurers are required to hold to back their issued policies. This has resulted in losses in the sector according to the Australian Prudential Regulation Authority (APRA) of -$1.3 billion for FY20 and a further -$346 million for FY21.
Regulatory response from APRA
In response to ongoing losses APRA has imposed the following restrictions on new income protection policies including:
- Capping the income replacement at 90% of income for the first 6 months of claim and 70% thereafter.
- Banning issuance of new Agreed Value policies altogether.
- Tightening rules around how indemnity policy benefits are paid. For policyholders with relatively stable income at time of claim, income used to calculate the maximum benefit payable will be the last 12 months. For policyholders whose income is more variable, such as self-employed or small business owners, income is based on average annual earnings over a period appropriate for the occupation of the policyholder. This may also apply to those whose income has fluctuated due to parental leave or contract workers.
- Limiting policy contract terms to five years after which, a new policy must be entered into that reflects the terms and conditions that apply to new contracts on offer by the life company.
Don’t cancel your policy just yet – what you can do to manage premium increases
Being confronted with a 20 – 70 percent increase in your annual premium it may be tempting to just cancel the policy. Don’t do this until you’ve considered other options that will reduce the risk to the insurer and the cost to you and may not necessarily require underwriting. Avoiding underwriting can be essential as you simply may not be as healthy as you were when you took out your policy all those years ago. If you are looking at replacing cover, always ensure this cover is in force before cancelling your existing cover.
Options to Reduce Your Premium Cost:
- Extending the waiting period before a benefit is paid. This can reduce the cost of premiums by 25 – 35 percent in cases where the waiting period is extended from 30 days to 90 days.
- Move from Agreed to Indemnity. Here, you may see premiums reduce to more in line with what you were previously paying.
- Reduce the benefit period. Benefit payments periods typically range from 2 years right up to age 65.
- Reduce the benefit amount.
- Ownership of the policy. If it is held in superannuation there are limitations on the tax deductibility of the premiums and the tax rate offset is only 15%. Policies held in your own name are mostly tax deductible and the offset or refund will be at your marginal tax rate which for most people will be 34.5% and for high income earners up to 47%.
Other strategies can also be considered such as looking at increasing total and permanent disability insurance (TPD) in lieu of income protection. This typically involves reducing the benefit period of income protection and taking out TPD working off the assumption that say after 5 years on claim for income protection insurance there is a high probability that you will also be classified a totally and permanently disabled if you genuinely can’t return to work.
Insurance is complex seek advice
Not only are there a myriad of policies available there are hundreds of legacy policies issued by life insurers. These require careful analysis and comparison to alternate covers. In addition, your current financial situation and future needs require assessment to determine what life insurance, TPD, trauma and income protection insurance is actually required. In many cases as people get older and accumulate assets they may be in a position where they are over insured. In other cases, children may have arrived on the scene, or a large mortgage, and additional or new insurance cover may be required.
If you would like to review your insurance requirements, please book a complimentary 15-minute phone call to discuss further.