Income Protection – Definition of Disability

There are many features of a quality Income Protection policy that are required to be moulded around your situation. Waiting period, benefit period and type of contract are some of the more obvious however the definition of disability is a feature that varies from policy to policy and can make the difference as to whether a claim is paid or not.

Australian Income Protection policies commonly use three distinct definitions to assess degrees of disability:

-          Duties based – where you are unable to perform important duties of your occupation. This is the most common basis (especially for older policies).

-          Hours based – where your working hours are reduced in your occupation.

-          Income based – where you suffer a loss of income due to disability.

Policy Definition	What it means….
Duties Based	You will be paid a full benefit if you are unable to perform income producing duties of your occupation and due to this you are not working. A reduced Income Protection benefit will be payable if you continue to be in paid work.
Hours based	You will be paid a full benefit in the event that you can not work in your own occupation for more than 10 hours per week. You will be paid a reduced Income Protection benefit if you work in your own or any occupation for more than 10 hours.
Income based	You will be judged as disabled if, due to illness or injury, you suffer a reduction in earned income of 20% or greater. If you continue to work and earn income, the income protection benefit that you receive will be reduced.

The majority of Income Protection policies use the duties based definition however there are now policies that include all three definitions and enable the client to choose which definition they are best suited to at claim time.

Most new policies include all three definitions which obviously provide the widest opportunity of claiming. If you have an older policy it may be worth gaining a pre-assessment to see if you can qualify (both financially and medically) to upgrade your policy.

Beware simple Income Protection policies

We are sometimes come across advertisements stating things like “protect your income from only $2 per week!” or “Instant protection – just answer 5 simple questions” and I always shudder. I was reading a comment on the Choice website recently about a lady who applied for one of these direct policies and when it came to claim time the insurance company didn’t pay the claim as after they pulled the client’s Medicare records, they found out that she had an abnormal blood test almost five years ago. The policy had a blanket exclusion for all pre-existing conditions and this, it seems, was enough for them to deny the Income Protection claim.

Insurance companies gained a bad name for themselves in the 80s and 90s as they did not complete their due diligence at the time of application and substituted the “pre-existing condition” clause into the policy. This meant that they investigated the client’s health at the time of claim and often rejected claims after many years of the client paying their premiums and believing that they were covered.

After this insurance companies built into their application process an in depth medical questionnaire and sometimes automatic medicals (including blood tests, blood pressure readings, urinalysis….) that ensure a certain peace of mind for the client who can, with confidence, know that as long as they have disclosed everything to the insurance company that they are covered. They can then start to pay their premiums with this in mind. It also provides the Income Protection client and their adviser a chance to debate the terms of the contract to ensure that this will be the case in specific conditions.

Apart from gaining health clearance for any pre-existing conditions, we find that these policies contain particular exclusions that should not be present in an Income Protection policy. They are more often than not more expensive that a quality Income Protection policy available through an unbiased adviser.

I guess it is human nature to try and get things done as quickly and painlessly as possible, however there are some things that are simply not worth it. Income Protection is one of these. 

Income Protection and Tax

Income Protection is tax deductible. It is a type of insurance that will provide an income at the time of claim (which is taxable) and therefore you should be able to claim a deduction for all premiums paid. Like any financial investment which has the purpose of generating future income, there are tax benefits associated with the payments.

There has been a push recently by industry superannuation funds for members to hold Income Protection within the superannuation environment however it is important to note the after tax position when making your decision.

Income Protection is tax deductible to the fund when held within superannuation (just as it is tax deductible to the individual when self-owned). The superannuation environment is concessionally taxed at 15% as opposed to outside where personal tax rates are up to 45%. Therefore less of a deduction is possible when held inside super. Most funds do not enable tax returns at individual account level and therefore the deductible amount is passed on as premium savings to the policy holders in the fund.

Based upon simply the after tax cost of the insurance, it will always be better to hold your Income Protection outside of the superannuation environment. Obviously as premiums are deducted from your superannuation savings, this will deteriorate your retirement balance quite dramatically if you are not making additional contributions to your fund.

There are some optional benefits available with Income Protection such as a TPD option that will render your policy not deductible to an extent. For example Tower Australia offers a Critical Illness option that will pay a non-taxable lump sum in the event of the life insured suffering a traumatic illness. This option when applied to your policy renders your Income Protection premium 93% deductible.

It is important to note that benefits when payable will be taxable and therefore when thinking about reducing your monthly benefit you will need to take this into consideration. You will receive the whole benefit from the insurance company in the form of a monthly direct transfer or cheque and then you will need to put money aside to cover the tax payable.