Should I Replace My Expensive Income Protection?

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A renewal notice arrives. The premium is up again, materially, for the third year running. Someone offers to replace the policy for close to half the cost, and the comparison sheet shows the same monthly benefit on both sides.

Two policies with the same monthly benefit can produce outcomes that differ by more than a million dollars. The monthly benefit is the least useful number in the comparison. This page works through the numbers that actually decide it.

Why did my premium go up so much?

Because the product was repriced across the market, not because your insurer singled you out.

The Australian Prudential Regulation Authority intervened in individual disability income insurance in December 2019, after the industry reported large and sustained losses on the product. The measures that followed changed what could be sold and, by extension, what existing books were worth.

From 31 March 2020, life companies could no longer write contracts where the benefit was not based on income at the time of the claim. That is the end of agreed value.

From 1 October 2021, benefits had to be calculated on annual earnings at the time of the claim event, no older than twelve months, or on an appropriate average for people with variable income. Income replacement was capped at 90 per cent of earnings for the first six months and 70 per cent thereafter, and insurers were required to put controls around long benefit periods.

A separate measure would have limited policy contract terms to five years. APRA suspended that measure in March 2022 for at least two years and it has not applied to policies written since.

The consequence for you is straightforward. Policies written before those dates cannot be bought today. Insurers have been repricing those legacy books, which is why your premium is rising, and the increase is the market telling you what the contract you hold is worth.

What would I actually be giving up?

Read your policy schedule and write down these seven items, for the old policy and the proposed one, side by side. Everything else is noise.

1. The monthly benefit and how it is calculated: agreed value or income at the time of claim.
2. The waiting period.
3. The benefit period.
4. The definition of total disability, and whether it is assessed against your own occupation.
5. The definition of partial disability and how a return to reduced work is paid.
6. The offsets: what other payments reduce your benefit.
7. Whether the contract is guaranteed renewable and whether the insurer can change the terms.

The rest of this page prices four of them.

Agreed value or income at time of claim: how much is that worth?

This is the largest single difference between a pre-2020 contract and anything available now, and it is invisible until you claim.

An agreed value contract fixes the benefit at the outset based on income evidence provided then. An income at time of claim contract calculates the benefit from what you were actually earning immediately before the claim.

That distinction only costs you money when your income has fallen before the claim, which is precisely when many claims arise.

Take someone insured on $250,000. An agreed value policy paying 70 per cent produces $175,000 a year.

The people most exposed to this are the people whose income is most variable: business owners, practitioners in private practice, anyone on commission or bonus, and anyone who has reduced their hours for any reason, including the early stages of the illness that eventually becomes the claim.

If you hold an agreed value contract, you hold something that is no longer manufactured. That does not automatically make it worth keeping. It does mean the decision to release it is permanent.

How much does a longer waiting period really save?

Less than you think, and it costs more than you think.

Moving from a 30 day waiting period to a 90 day waiting period is one of the standard levers used to bring a premium down. On a $14,500 monthly benefit it means two extra months with no payment.

Two months of benefit is $29,000 before tax. Income protection benefits are assessable income, so at the marginal rate applying to that slice the after tax value is about $17,690.

Now hold that against the saving. In the worked example below the whole after tax premium saving is $2,597 a year. One claim, with a waiting period 60 days longer, costs close to seven years of the saving.

A longer waiting period is a sensible decision when you hold sick leave, cash reserves or a business that can carry you for the extra period, and you have deliberately decided to self insure the first three months. It is a poor decision when it is chosen only because it lowered the quote.

Benefit period: what is the five year policy actually costing me?

This is where the money is, and it is the item most often traded away without being priced.

Take a 45 year old on $250,000, with a $14,500 monthly benefit. The existing contract pays to age 65. The replacement pays for five years. Assume the premium falls from $9,800 to $4,900 a year.

Premiums for a policy protecting your income are deductible. At the top marginal rate the after tax cost of the old policy is $5,194 and the after tax cost of the replacement is $2,597, so the real saving is $2,597 a year, or $51,940 over the twenty years to age 65.

Now price the thing being sold. A claim beginning at age 50 that runs to 65 pays for fifteen years under the old contract and five years under the new one. Ten additional years at $174,000 a year, after tax, is $1,250,700.

So the trade is $51,940 of certain after tax savings against $1,250,700 of contingent after tax benefit.

Divide one by the other and you get the number that actually answers the question. Replacing this policy is the better decision only if the probability of a claim lasting beyond five years before age 65 is below about 4.15 per cent.

That is the whole decision, expressed honestly. It is not a claim that the old policy is better. It is a statement of the price. Some people will look at 4.15 per cent, look at their savings, their spouse’s income and their family history, and decide the cheaper contract is a reasonable trade. That is a legitimate decision made with the number in front of them, which is different from a decision made from a comparison sheet showing the same monthly benefit on both sides.

The premium figures above are illustrative and are used to show the method. Your own figures will differ.

What are offsets, and why do they decide the claim?

Offsets are the clauses that reduce your benefit by other amounts you receive. They rarely appear on a comparison sheet and they routinely change the outcome.

Contracts commonly offset against workers compensation, motor accident compensation and other disability income policies. Beyond that, they vary considerably. Some contracts offset against employer sick leave. Some offset against income earned by a business you own even where you did not personally produce it. Some offset against superannuation contributions made on your behalf. Some offset against payments from a total and permanent disability policy.

Two contracts with an identical $14,500 monthly benefit can produce very different amounts once the offsets are applied, and the difference is largest for exactly the people who buy the most cover: business owners, professionals with several income sources, and anyone with cover both inside and outside superannuation.

If you are being shown a cheaper contract, ask for the offset clause specifically, read it, and ask what it would pay in your circumstances rather than in general. The reason the claim assistance side of this work exists is that offsets and definitions decide claims, not brochures.

Am I even insurable today?

This is the question that should be asked first and is usually asked last.

Underwriting reprices you at the moment you apply. A policy taken out at 35 was underwritten on a 35 year old with no history. Ten years later there may be a back injury, a mental health episode, a raised marker on a blood test, a specialist referral, or a family history that has since become relevant. Any of those can produce an exclusion, a loading or a decline.

The rule that follows from this has no exceptions. Never cancel an existing policy until the replacement has been formally issued and accepted, with the exclusions and loadings in writing. Not quoted. Not conditionally approved. Issued.

The most damaging outcome in this entire area is not paying too much. It is cancelling a broad contract, being declined or loaded on the replacement, and holding nothing.

Does moving it inside superannuation fix the cost?

It changes who pays the premium. It usually narrows the cover.

Held inside superannuation, the premium is paid from the fund rather than from your after tax income, which is why it feels cheaper. It is being funded from concessional contributions taxed at 15 per cent, so it consumes part of your concessional cap, which is $32,500 for 2026 to 2027, and it reduces what is left accumulating for retirement.

Three things typically change with it.

The policy is usually the trustee’s policy, and its terms are usually narrower than a comparable contract held in your own name. Ancillary and specified injury benefits are commonly not available.

A benefit can only be released to you if a condition of release is met, which for income protection is temporary incapacity. A claim can be admitted by the insurer and still be held by the trustee if the condition of release is not satisfied.

And the tax position moves. Premiums for cover inside a fund are deductible to the fund, at 100 per cent for an any occupation total and permanent disability definition, 67 per cent for own occupation, and 80 per cent where own occupation is bundled with death cover. Held personally, income protection premiums are deductible to you, and life and trauma premiums are not deductible at all.

Inside superannuation is a legitimate structure and it is the right answer for some people, usually where cash flow is the binding constraint. It is not a way of getting the same cover for less.

What does the net outcome look like once tax is counted?

Bring the pieces together for the same 45 year old.

The saving is real. It is also small relative to everything in the right hand column, and it is being paid for out of the outcome that only matters once.

This is why we do not frame insurance decisions on which policy costs less. We frame them on what the contract will actually pay in the situation you are insuring against, net of tax, and what the premium buys you in that situation. That approach is set out on our risk insurance strategy page and it runs through everything on protect my wealth.

So when is replacing the right decision?

Six situations where it genuinely is.

The cover no longer matches the income. A policy written on $120,000 for someone now earning $400,000 is under insured regardless of how good the terms are. The answer here is usually to add, not to replace.

The policy is a group or default contract. Default cover inside a superannuation fund is typically two years of benefits, an any occupation definition and no ancillary benefits. Replacing it with a properly underwritten contract is almost always an improvement, not a downgrade.

The structure is wrong. Cover owned by the wrong entity, or held inside superannuation where the condition of release will not be met, or owned personally where a business should hold it.

Your occupation has changed favourably. Occupational ratings move. A move out of a hazardous classification can reduce premiums without giving anything up.

Your health has genuinely improved. Some contracts allow a loading or exclusion to be reviewed. Ask before you shop.

The premium is genuinely unaffordable and the alternative is lapsing. Reduced cover is better than no cover. Where this is the constraint, the levers to pull first are the sum insured and the waiting period, in that order, and the benefit period last, because that is the one the arithmetic above says is most expensive to give up.

What we do before anyone cancels anything

We take the existing policy schedule and the product disclosure statement it was written under, not the summary. We list the seven items above for the existing and proposed contracts. We price each difference against your actual income and marginal rate, the way this page does. We check insurability before any recommendation, and nothing is cancelled until a replacement is issued and accepted in writing.

That is the whole method, and it applies whether the answer is keep, replace, restructure or add. It is the same work we do for the high income professionals we advise across Australia.

If you have a renewal notice in front of you, request a consultation or call 03 7034 4888. Bring the policy schedule.

Sources

1. Australian Prudential Regulation Authority, Final individual disability income insurance sustainability measures, for the cessation of agreed value contracts from 31 March 2020 and the income at risk, replacement ratio and long benefit period measures from 1 October 2021.
2. Australian Prudential Regulation Authority, Individual disability income insurance: suspension of policy contract term measure, 24 March 2022.
3. Australian Taxation Office, Income protection insurance, on deductibility of premiums that protect income and the non-deductibility of life, trauma and critical care premiums.
4. Australian Taxation Office, Income protection insurance payments, on the assessability of benefits.
5. Australian Taxation Office, Expenses you can claim as an APRA fund, for the deductible proportions of insurance premiums held inside superannuation.