Australians keen to take out income protection insurance are being told to act sooner rather than later before sweeping changes in October.
Financial regulator APRA announced a series of reforms in 2019 to ensure the long-term viability of the life insurance sector after it lost about $3.4 billion over five years through the sale of income protection insurance.
The reforms reduce the amount of benefits available to policy holders and many must be implemented before October 1.
But customers who take out a policy before then have a good chance of locking in more generous terms.
Here are the key changes on the way.
October 1 changes
Income replacement limits
From October 1, benefits paid to policy holders will no longer be allowed to exceed 100 per cent of their earnings.
New caps will be introduced that limit the maximum benefits payable to 90 per cent of earnings (at the time of the claim) for six months and 70 per cent of earnings thereafter.
This means policy holders will soon have access to less-generous benefits and helps explain why financial planners are encouraging clients to take out policies sooner rather than later.
Policy contract terms
At the moment, most policies in the market can be renewed on a yearly basis and contain underlying terms and conditions that do not expire until the policy holder reaches retirement.
Such terms are favourable for consumers, offering them the same benefits at retirement as they had when they first signed up.
But APRA is cracking down on them, as it says locking in the same terms and conditions for such a prolonged period of time means the only way insurers can adapt to changing circumstances – as they relate to the individual policyholder and to broader society – is to increase premiums.
As a result, from October 1, 2022, insurers will not be be allowed to offer contracts that last for more than five years.
Policy holders will be able to enter into a new policy contract without a medical review upon the expiry of the existing policy contract. But the new contract will be based on the terms and conditions that the insurer is offering to new customers at that time.
This means an insurer will be able to increase your premiums and make it harder for you to make a claim every five years. And changes in your personal circumstances over this time are likely to have a major effect on the new terms of your contract.
How income ‘at the time of claim’ is defined
Insurers today must calculate payouts based on what the customer is actually earning at the time of their claim.
But the way in which these calculations are carried out will be guided by two new changes coming into effect on October 1.
Where a policy holder has a predominantly stable income, the amount of income insured (“income at risk”) must be based on annual earnings at the time the claim is made, or within the past 12 months.
But if the policy holder has a variable income, insurers will base their ‘income at risk’ on the policy holder’s “average annual earnings over a period of time appropriate for the occupation of the policyholder and reflective of future earnings lost as a result of the disability”.
This should provide some extra leeway for people on maternity or unpaid parental leave.
Agreed-value policies: Up until March 31, 2020, Australians could take out an ‘agreed value’ policy that, in the event of a claim, promised to pay out a specific amount of income based on whatever the customer was earning at the time they took out the cover.
Such policies are no longer available.
Why you should get in quick
The bottom line is that insurers will offer less-generous income protection insurance after October 1 than they did before it.
And so the key message is to get in sooner rather than later, according to certified financial planner Gianna Thomson.
Ms Thomson said it can sometimes takes months for an insurer to process an application, meaning customers have very little time to lock in more generous terms before the October 1 deadline.
She said “time is ticking with these changes” and those unsure of whether to insure their income should know they can deduct their premiums from their taxable income.
“If it’s held outside super and paid personally, then, generally speaking, most of it is tax deductible,” she said.
“I say most of it, because some of the bells and whistles that you add on are not tax deductible … but around about the end of July, everyone gets a letter from their insurer showing them the amount that they are able to claim.”