Income protection - one size doesn't fit all

Posted by: Tim von Dadelszen on 26 May 2007

As far as personal insurance goes, on a complexity scale you’ll find life insurance at one end and income protection at the other.

With income protection the array of choices available can present pitfalls for an unaccompanied traveller - one size certainly doesn’t fit all.

Along the road to finding an income protection policy that suits you, you’ll find: policy types, waiting periods, payment periods, split payments, disability definitions, taxation issues, and more. If we step over most of these for now, and just look at the first and possibly most important crossroad you’ll meet – what policy type to use?

There are a range of policy types - so let’s take a very quick look at them...

Indemnity
The benefit is usually calculated as a proportion of your income at the time you make a claim. An indemnity policy (generally) pays the lesser of the monthly insured benefit or 75% of the best 12 consecutive months income from the previous three years (this depends on the policy). The payment under this option is taxable, and the premiums are deductible.

Agreed value
A fixed level of cover is agreed at the time the income protection policy is set up - and this is the amount paid by the insurance company, regardless of your earnings at the time of the claim. The maximum amount you can insure is usually set at 55% of your gross income. While the tax treatment of this option is open to debate, with a plan that protects 55% the intention is that the payment won’t be taxed, and the premiums are not deductible.

Loss of Earnings
This type of policy is similar in many ways to an Indemnity policy - however the benefit is based on your actual income shortfall. Loss of Earnings (LOE) will look at your actual drop in income, and will then pay you 75% of this drop. In many cases this type of policy will pay more (so it’s often more expensive). Again, the payment under this option is taxable, and the premiums are deductible.

Loss of Earnings Plus
In the past it was difficult to choose between Agreed Value and LOE because it is hard to predict which policy would pay the client more at claim time (if the client’s income had dropped Agreed Value would be better, but if their income had increased LOE would pay more).  LOE Plus as a hybrid policy. It incorporates Agreed Value and Loss of Earnings – and if you need to make a claim you can choose the calculation that will result in the highest benefit.  In a nutshell, the advantage of this policy is that you’ll get paid the highest possible benefit.

So, how do you decide which path to take? As to which is of these policy types is best, that really does depend on the individual's situation. The choice will depend on a range of things, but one of the most influential is the predictability (or stability) of your income.

An Indemnity income protection policy is often a good solution if your income is going to remain stable – because with this type of policy your actual income at the time you go on claim is very important. This type of plan is usually price competitive and is often the type chosen by employees.

For people who have an unpredictable and fluctuating income (e.g. self-employed, contractors, etc) Indemnity policies probably aren't going to be the best option.  People in this situation need greater certainty at time of claim (especially where repeat claims are made), so it's best to consider an Agreed Value policy or a Loss of Earnings Plus policy.

That’s a quick look at the types of NZ income protection polices available - as you can see there’s a fair bit to consider. If you’re starting down the road to find an income protection plan, give us a bell and we’ll help you choose the right path.