Episode Details

I wrote a blog in February 2020 highlighting the first phase of government mandated changes to income protection insurance products. The second phase of changes were implemented at the beginning of this month, and they are very significant. This blog discusses these important changes and how they may affect you.

Background

In December 2019, the insurance industry’s regulator (APRA), released a report outlining a number of compulsory changes that it mandated for income protection insurance products. Income protection insurance pays you a benefit if you cannot work due to accident or illness (it does not protect you from involuntary unemployment).

These changes were deemed necessary because insurance companies were losing literally billions of dollars on these products i.e. cost of paying benefits far exceeded premium revenue. However, no insurer wanted to make the first move to stem the losses. Fearing that insurance companies may eventually exit the Australian market (if no action was taken), the regulator stepped in and mandated changes to make products more sustainable.

There were two main issues that caused these products to be so unprofitable:

1. An inability for insurance companies to change terms to accommodate new risks. Mental health is a good example. Mental health claims were immaterial when policy terms were written 20 years ago. However, today, claims due to mental health are more substantial.

2. Long term benefits are very costly. If a 30-year-old claims on a policy and is never able to return to work, the insurer could be paying a benefit for the next 35 years. That is very costly. Therefore, it is important that policies only provide for genuine claims. Unfortunately, for the insurers, some policy terms are so generous that they sometimes act as a disincentive to cease being on-claim. This exacerbates losses.

Summary of the changes made this month

All insurers launched new product suites at the beginning of this month (existing products are no longer available). These new products reflected four important changes:

1. The amount of income that can be insured has reduced from 75% to 70% of your gross income. Replacing less of your pre-disability income gives you a greater incentive to return to employment as soon as possible.

2. The total benefit paid within the first 6 months of claim cannot exceed 90% of your pre-disability income. Many pre-October 2021 products offered ancillary benefits such as lump sum payments for specified conditions and rehabilitation benefits.

3. Pre-disability income is based on your actual personal exertion income received the 12 months prior to becoming incapacitated. Many older products used to allow you to select the highest 12-month period over the past 2 to 3 years (prior to incapacity).

4. Typically, you may be able to claim an income protection benefit if you are unable to perform the duties required in your ‘own occupation’ i.e. the occupation/role in which you are employed. However, the new products typically loosen the definition for any claims that last more than 2 years. In this case, the occupational definition is reduced to ‘any suited occupation’. The insurer will determine what is a suited occupation based on your skills, training, qualifications and experience. Some policies will pay a reduced benefit amount after 2 years if the insurer person is not “seriously disabled”.

An additional change expected

At the moment, many insurance contracts are non-cancellable which means as long as you keep paying the i