Many clients understand the importance of ensuring a continuity of their personal exertion income in the event of a temporary illness and thus recognise the importance of income protection (IP) cover.
When it comes to structuring IP cover, advisers will rightfully prefer IP to be personally owned. The client personally pays the premiums each year, which in turn gives rise to a personal tax deduction at their marginal rate of tax.
Traditionally, most IP policies have been structured with terms that replace a proportion of their income right through to their 65th birthday. This is despite the underlying need that is typically identified, which is to protect against an unforeseen illness or injury that temporarily prevents the client from engaging in gainful employment.
Looking ahead, with household budgets expected to come under pressure from cost-of-living increases and the prospect of further interest rates hikes, a more cost-effective premium on the IP policy may be warranted for some clients.
One way to secure a sharper premium on IP cover is to structure it on terms that cover a proportion of the client’s income should they become temporarily ill for a period of 5 years, rather than through to their 65th birthday. When the IP is subsequently bundled alongside Permanent Disablement cover, which is usually housed inside super and funded from retirement savings, we’re in a position where we can provide clients with not only cost-effective IP cover (see illustration below), but also safeguards in the form of TPD cover that would seek to protect the client in the event that the initial temporary illness evolves into more of an enduring, or permanent, disablement.
This is where claim statistics come into consideration. APRA data indicates that the retail IP claims frequency ratio is 1.19% pa (as at October 2021).
In AIA Australia’s (AIAA) experience, what we’ve seen is that of this small cohort of policyholders that actually go on to claim on their IP cover, around 85% come off claim within the first 24 months, usually with a successful return to work. Intuitively, you’d expect that, given the purpose of the cover is to protect against temporary illnesses.
We then tracked the remaining 15% or so of the original claimants remaining on claim at the 24-month mark and traced them to identify what proportion still remained on claim after 5 years. Of those still on claim after 5 years, back testing indicates that on average 7 out of 10 of these claimants are deemed unable to ever return to work in their own occupation. So, if that client also had the TPD cover in place, then that could provide the seed and investable capital for a long term income stream going forward.
The illustration below shows that an AIAA IP CORE policy with a 5-year benefit period provides a $1,600, or a 55% saving, in Year 1 when compared with the alternative of an AIAA IP CORE policy ‘To Age 65’ Benefit Period. Those savings likewise accrue over a cumulative 10 year period.
This provides meaningful insurance premium savings for clients experiencing cash flow pressures, and indeed may be the only option, and ultimately the difference between having comprehensive IP cover or not, in the current inflationary environment.
