Considering income protection? These new rules may affect you

Risk management adviser Sacha Loutkovsky looks at the reasons for industry-wide changes to income protection insurance and how it could affect your cover.

If you couldn't work because of a sickness or injury, where would the money come from? Income protection insurance is a way to safeguard yourself (and potentially your family) from the struggles that this situation brings with it. But upcoming changes to the way this insurance is structured could bring new challenges to people who have or want to get cover.

What is the problem?

The reason for upcoming changes lies in how the industry has been operating for the past several years. In early December 2019, the Australian Prudential Regulation Authority (APRA) accused life insurers of "unsustainable practices" on retail income protection policies.

What this means is that for many years, income protection policies in Australia have been a competitive field. Each insurer has wanted to out-do the competition and has bolted on innovations, lavish options and extremely generous definitions under which to claim – which is a good thing for you as a policyholder.

However, in practical terms, this has resulted in a huge number of claims that did not actually require the insured person to be off work in order to receive benefits.

Insurers have also failed to increase premiums to meet the huge number of claims being paid out under these benefits, fearing it could lead to a "first-mover disadvantage" (where the first insurer to make a change would be worse off than those that followed).

At first glance, that may not seem like a problem you need to worry about (as someone with or looking to get insurance). But in the past five years, there have been massive premium increases on income protection policies as a direct response to this problem. I know of, and have experienced, insurers increasing premiums by up to 30% in some cases.

However, it seems it is too little, too late for insurers.

To further put this in perspective: over the past 5 years, the individual disability income insurance (IDII) industry has collectively lost around $3.4 billion, with $1 billion of that coming in the 9 months to 30 September 2019 and directly attributable to retail income protection policies.

While we may have a moment of sarcastically thinking "poor insurers, they're losing money and won't be able to return a dividend to shareholders", this is a serious problem for all of us. If insurers keep losing money at this rate, we could see them withdrawing from the market and potentially even collapsing, leaving policyholders high and dry.

What is the solution?

To ensure that the retail income protection market remains viable, APRA has proposed several changes that include:

For income protection policies issued from 31 March 2020:

• Agreed value income protection will no longer be available

For income protection policies issued from 1 July 2021:

• Benefits will be based upon the insured person's income over the preceding 12 months
• Policy coverage terms shall not exceed 5 years

The changes highlighted here are the ones I am most concerned about – although all the proposed changes carry concerns for how people can ensure they are adequately protected. For the full summary of changes, please refer to details on the APRA website.

What do these changes mean for you?

Firstly, if you already hold a retail income protection policy you will not be affected by these proposals.

However, if you are considering income protection or any changes to your existing policy, you need to act now in order to avoid being affected by these dramatic changes.

Agreed value policies no longer available as of 31 March 2020

Agreed value cover means that your benefit is locked in over the life of the policy. What you are insured for is what you will be paid out in the event of a claim, regardless of whether your income has decreased during the time you have held the policy.

Agreed value is especially important to people whose income fluctuates such as self-employed people, contractors and women taking maternity leave. By no longer allowing agreed value policies this means that you will only be covered for how much you have earned over the past 12-month period. If you have had four months out of income due to redundancy, or nine months for maternity leave or your business had a flatter year than usual your claimable amount will be assessed with these events taken into account and you could find yourself short.

Benefits will be based on your income over the preceding 12 months

Current income protection policies are available under two assessment styles at claim time: agreed value, which we have covered above, and indemnity. At the moment, indemnity policies state (with some variance in definitions between companies) that you will be able to claim the average income of the best 12-month period in the 3 preceding years before the policy was issued.

But under the proposed change, the window for income assessment becomes much smaller and many people will be negatively affected by this change.

Policy coverage term shall not exceed 5 years

At present, a policy is only underwritten once – at application. This means you can hold a policy for 10, 20, 30+ years and no matter how your medical, occupational or lifestyle history changes, you cannot be re-assessed and those changes cannot be taken into account. In the new world, occupation and income changes will be underwritten every five years and could result in significant changes in coverage quality and premium. Medical changes will not be underwritten at this stage.

For example: say you took out income protection at age 30 when you were working a white-collar office job. Three years into the policy term you decide to drive trucks for a living. At the five-year renewal term, you would be underwritten as a truck driver, which is assessed as higher-risk than an office job. This means your premiums would significantly increase and the quality of your cover could change.

All three of these changes are so dramatic because they can affect many people, including you, if any of the following circumstances apply:

1. You do not have income protection but know you need it because you can't survive without income and/or have people who depend on you to provide for them
2. You only have income protection through your industry super fund
3. You are self-employed or contracting
4. You are considering starting a family
5. You have retail income protection already but have had a change in circumstances such as a change in occupation or income, medical change, want to review any loadings or exclusions
6. You have retail income protection already on an indemnity basis
7. You have retail income protection already on either a 2- or 5-year benefit period
8. You are not sure whether these changes affect you and want to speak with us about it

If you think you may be affected by these changes, you may want to reach out to a financial adviser or an insurance adviser – or speak to the insurer who provides your existing policy. You can also take this time as an opportunity to review your cover and decide whether it is appropriate for your circumstances now, and in the future.

Sacha Loutkovsky is an award-winning risk management adviser with Profile Financial Services. She has been working in financial services for more than 10 years and advises a diverse range of clients on how best to protect themselves, their families and their estates. When not advising clients, Sacha works with global companies such as Aon, Zurich and ING, guiding business leaders on how to lead with greater awareness, empathy and collaboration. She does this by using her experiences in the outdoors to reflect the challenges of leadership. Sacha has summited Gran Paradiso in Italy, done numerous multi-day unsupported hikes around the world and is currently embarking on a series of Polar expeditions. You can connect with Sacha on Linkedin, Instagram and her website.

Disclaimer: The views and opinions expressed in this article (which may be subject to change without notice) are solely those of the author and do not necessarily reflect those of Finder and its employees. The information contained in this article is not intended to be and does not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort. Neither the author nor Finder have taken into account your personal circumstances. You should seek professional advice before making any further decisions based on this information.

• Interested in being a contributor for Finder X?

Images: Getty Images, Supplied (Sacha Loutkovsky)