Clients often believe they have a guaranteed income benefit regardless of the type of income protection they hold, which can lead to significant disappointment at claim time if they receive a reduced benefit because their financials don’t support the monthly amount they thought they were insured for.
The good news is the risk of this occurring can be minimised by providing the full financial information of your clients upfront at application time.
As an insurer, our objective is to make a difference in the lives of our clients and pay their claims, and in doing this, we want to provide transparency and certainty for clients and advisers.
However, not all income protection policies are the same, and as such, it’s important to understand the type of income protection policy you are considering for your client, the approach at underwriting and what this means in the event of a claim. In Australia, there are also three types of income protection policy, which can add to the confusion – endorsed agreed value (EAV); agreed value (AV); and indemnity.
It’s vital to appreciate the differences in these policies, what is required at application or underwriting time and what this means in the event of a claim and calculation of benefits payable to clients. It is also critical to appreciate the difference between ‘claimable income’ and ‘pre-disability income’ in the event clients make a claim under either an agreed value or indemnity policy in the future.
While Indemnity cover may mean lower premiums and a simpler application process with no proof of income required, there is significantly less certainty for you and your client regarding what benefit will be paid in the event of a claim.
This is because Indemnity policy payments depend on the definition of pre-disability income, which depending upon the insurer, can range from the income earned in the 12 months immediately prior to the date of claim or the more generous definition of the best consecutive period of income over 12 months in the 36 months prior to the date of claim.
For example, take a 45-year-old, male, self-employed tradesperson who took out a $9,000 monthly benefit Indemnity income protection policy in 2009 based on a monthly income of $12,000 per month and who becomes totally disabled in 2013.
On review of the client’s financials at claim time to determine his pre-disability income, it is found that his 2011 income of $10,000 per month is the client’s best consecutive 12-month period of income in the 36 months prior to the date of claim and the benefit payable is limited to a $7,500 monthly benefit, $1,500 less than what the client may have expected.
As shown in the illustration, had the less generous Indemnity benefit definition applied in this case, where the pre-disability income is measured by the income earned in the 12 months immediately preceding the date of claim, it would have resulted in the benefit payable being limited even further for the client.
This limited benefit outcome could have been avoided if the level of cover was reviewed on an annual basis and/or converted to a lower Endorsed Agreed Value benefit based on the review of actual financial proof.
If you are going to use an Indemnity policy for your client, possibly because they are a business owner and unable to provide financials for the last two years at application time, it is important to:
- Understand your client’s business and ownership structure
- Ask questions to establish an accurate estimate of what the client’s income is
- Ask yourself if the level of income makes sense considering the nature of the client’s occupation, business structure, industry and location of the business
- Make sure the client understands the type of policy they are taking out and what it means in the event of a claim.
When considering an Indemnity policy, the client’s income or insurable income is one of the most important things to establish at application time, especially for business owners. As such, it is important to understand how insurers calculate income both at underwriting and at claim time. Key factors to consider include:
- A business owner’s income or revenue is not considered their insurable income – their insurable income is the business net income or revenue less expenses plus add-backs
- Taxable and accounting income generally do not equal insurable income
- Insurers will generally ignore drawings, dividends and distributions and go back to the source to determine the client’s share of revenue less expenses plus add-backs for all entities that make up the business structure
- Insurers will not consider cash or other income that a client does not report or declare in tax returns as insurable income.
To aid advisers in this process, Macquarie Life has a copy of the disability insurance calculator our underwriters use to calculate insurable income for business owners, which also outlines the various add-backs able to be considered.
While there will be occasions where an Indemnity policy is the best income protection solution, to provide certainty and peace of mind for your client and yourself at claim time, where possible obtain their full financials at application and have the policy endorsed. Alternatively, be sure to regularly review your client’s income protection policy to make sure their actual income supports the level of cover in place.
Tony Baker is an underwriting and claims manager at Macquarie Life Financial
