Changes to Income Protection Policies: What You Need to Know

APRA (The insurance regulator) announced changes to income protection policies that will come into effect on 1 October 2021. APRA’s goal is to address the fact that the current Income Protection market is unsustainable due to the generous nature of some of the existing policies and the fact that these have not been priced correctly by the insurance companies themselves.

Here’s are the four proposed changes to income protection that will commence from 1 October 2021 (likely with some extensions already announced).

Check out the accompanying video which gives more detail about these changes and my opinion about what they mean for you.

#1 - Limiting the way income at claim time is calculated

APRA has stated that those benefit payments should be linked to income at risk at the time of claim.

Currently, some indemnity contracts allow you to look at your income for up to 3 years prior to the time you claim and find the best 12 month period to justify the monthly benefit you are insured for.

The argument is that this can lead to you receiving a payment from the insurance company that is higher than the income you are earning when you claim.

APRA has stated that from 1 October 2021, your income will be assessed on the income earned in the 12 months prior to claim for those with "stable incomes" think employees.

With some scope for those with variable income (eg self-employed, commission/bonuses) to have an average income based on a period of time appropriate to the occupation.

What this means for you:

If you have a stable income then this change will not make a huge difference to you although it would still have an impact should you have taken some time off (extended holiday, maternity/paternity leave). It is unclear at this stage how this would be treated.

If you have a more variable income, if you are self-employed or receive commission or bonuses that make up a big portion of your income, this is something you may want to think about.

Most recently we have seen the impact of COVID which had a huge impact on the incomes of heaps of people. How would this be treated under the new rules? These are the things that are unclear. Would the insurance companies have extenuating circumstances for events such as this, I would imagine they would, however, this is a grey area and for me when it comes to insurance, we want as little grey area as possible.

#2 - Replacement Ratio to be capped

In simple terms, the replacement ratio means the maximum percentage of your normal income you are to protect should you need to claim on your policy.

APRA's concern is that excessive income replacement ratios and certain product features and benefits can leave you in a better position financially than if you returned to work. They argue that this reduces the incentive for you to return to work and also that this could lead to you paying more in premiums for things that aren't crucial.

Some of the examples they have given are things like excessive indexation of the amount you are insured for, not reducing the amount you receive from the insurance company if you continued to work up to 10 hours per week, and additional benefits such as rehab benefits, specific injury benefits etc.

To combat this, APRA has put a cap on the benefits at 90% of earnings at the time of claim (see the previous point) for the first 6 months and 70% from then onwards. There is also to be a limitation to the indexation of these benefits whilst on a claim.

What this means for you:

For me, this is one of the changes that I think most of you would understand and accept. Income Protection is designed to help maintain a lifestyle not improve it. These extra payments in my experience often come as a surprise to you should you need to claim.

If the removal of these additional benefits means a more sustainable product, then this is a change that for me, and I reckon for most of you, makes sense.

#3 - Limited Contract Terms of 5 years

Unlike the previous change, this is for me one of the 2 most drastic changes that could potentially have the biggest impact on you.

One of the main features of individual insurance contracts in Australia is that they are generally guaranteed renewal policies which means that as the holder of this policy, as long as you continue to pay your premiums, your policy will remain the same without a medical or financial review for the life of the policy.

As part of these changes, APRA has announced that contracts issued after 1 October 2021* will be for a term not exceeding 5 years, and for you as a policyholder, you will have the right to renew your policy after 5 years based on the prevailing terms and conditions at the time of each renewal.

You won't have to be medically underwritten again however this renewal will look at any changes to your occupation, financial circumstances, and dangerous pastimes.

*This change has been pushed back to October 2022

What this means for you:

Initially, I was really worried about this change but after thinking about this for longer, I can see how this makes sense. My belief is that we need to work towards "fair" and this means on both sides.

My only concern is that when "fair" is not documented, it allows room for contracts to be relied upon and claims not to be paid. I would like to think that we are all on the same side where we want valid claims to be paid as opposed to lawyers for these insurance companies getting involved to reduce the number of claims paid.

Within reason, I think that some of this change makes sense. For example, a smoker pays almost double the premiums of a non-smoker. If a smoker stops smoking for 12 months, they can change their policy to a non-smoker and get the premium savings. They can then take up smoking again and their premiums will be the lower non-smoker rates for life.

Let's take an example, I am a financial adviser, if I leave the industry and become a fireman, logically, should my income protection policy remain the same? The risk has now increased (in fact Fireman struggle to get income protection at all). If in 5 years' time, the insurance company decided they could offer me the policy anymore is this fair?

Insurance relies on us as a whole (ie everyone who has insurance) to continue paying our premiums. This is where the money for claims comes from. If insurance is going to be fair for everyone and not just me, then we might need to accept that changes like this are necessary and we can no longer rely on how things have always been.

Would it be annoying for me as the adviser who becomes a firefighter, yes! I could then look at other policy options (ie topping up my Trauma or TPD etc) to compensate for this lost Income Protection.

This issue I see that hasn't been considered is that if your health has also changed in this period and you would now not be able to get the other covers this would be a problem.

To combat this, the insurance companies could medically assess you based on the time of your original application however again this would require a fundamental change to how things are done.

If we are moving towards fairness, I think this would be fair for the insurance companies.

#4 - Long Term Benefit Controls:

APRA's concern is that long-term benefits periods (ie how long you will be paid should you need to claim) have an adverse impact on claim duration meaning that they encourage longer than necessary claims.

From 1st October 2021, APRA has announced that:

• Policies with longer benefit periods should have effective controls to manage the risks associated including specific design features"
• These could include such things as requirements or incentives for people on claims to follow medical advice, participate in rehab or retraining activities.

Again, as we are not 100% sure what these products will look like, some of the possibilities that are being considered are:

• Stopping to age 70 benefit period
• Looking at a change in occupation definition from Own to Any Occupation after 2 years - this is a major concern
• Moving from a three-tiered definition of disability (hours, duties, income) to one tiered definition based solely on important duties
• Dropping the replacement ratio as mentioned earlier after a specific time

What this means for you:

As per the last change, this is the second of the changes that will have the biggest impact on you and one that you should carefully consider.

Part of these changes I believe will be accepted by you reasonably (capping the benefit period at age 60 or 65) as these are things you can plan for.

Alternatively, the change from an own to any occupation definition after a period of time for me is something that you cannot plan for.

Own Occupation as the name suggests looks at your inability to do your current role or the role you have been accepted for when you applied. Any occupation looks at your inability to work in any role that you are qualified for by education, training, or experience. As I call this when I talk about it, can you go back and work at Maccas?

The reason this change concerns me is that whilst we all hope we don't ever need to claim on these policies, we want to know that should we do, we continue to receive the benefits we need. If at a later date the insurance company decides that I can go back and pack shelves at a supermarket (which I did when I was 17), I don't want my payments from the insurance company to reduce if I would not be able to go back to my regular job.

So what can you do from here?

If you have income protection in place currently, I'd suggest it would be a good time to get a good understanding of what you have in place and why you have this.

As of the 1st October 2021 insurance policies will start to be pooled together for example:

• Agreed Policies before 1st April 2020 - "Pool A"
• Indemnity Contracts prior to 1 October 2021 - "Pool B"
• Income Protection policies post 1 October 2021 - "Pool C"

What we are already seeing is that depending on which pool you fall into, the pricing will be altered based on the "perceived" sustainability of this pool. Some of the recent pricing changes to existing income protection policies have already been big (mid-teens to over 100% with some industry super funds).

What the insurance companies would be hoping to do by increasing the price on the policies that are more in your favour as a customer, you will be forced to either cancel or alter these policies or consider switching across to the new income protection policies.

I hate this behaviour and I have been pushing for alternate options (such as being able to give up some features of your existing policy as opposed to an all or nothing approach).

Whilst we are still not 100% sure what this will look like, having a plan for this is critical so look at your policy and get in touch with your adviser if you have any questions.

If you are thinking about income protection now, look at the changes I have outlined above. If any of these are a concern to you make sure you take action ahead of the 1 October 2021 deadline.

If you want an in-depth recap of how Income Protection works, check out my complete guide to Income Protection here.