By 1 October 2021, insurers will be required to make further changes to their IP policies, including:
1. Income at risk – for clients with predominantly stable income, income should be based on annual earnings at the time of the claim event, not older than 12 months. This means that current indemnity IP policies that base benefits on the highest 12 months’ earnings in the two or three years prior to claim will no longer be available.
However, for clients with income that is variable (e.g. Self-employed or business owner clients), income should be based on the average annual earnings over a period of time (can be longer than 12 months) that is appropriate for the occupation of the client and reflective of future earnings lost because of the disability. This flexibility may also benefit clients whose income fluctuates due to reasons such as unpaid parental leave or contract workers.
Adviser tip – ensure you have reviewed a client’s income over several years to determine if the income is stable or variable, and that this will be the case in the future. If possible, ask the client to provide you with their tax returns over the last 3-5 years to support your recommendation. Also, frequently review your clients’ coverage amount as part of a structured review or process and emphasise the importance of the clients notifying you of any significant changes to their salary or employment.
2. Income replacement ratio – income replacement will be capped to a maximum of 90% of earnings in the first six months of claim and then 70% of earnings thereafter.
APRA’s reason for change is that existing IP products have features and ancillary benefits (e.g. advance payments, rehabilitation benefits, etc) that may cause the insurance benefit to exceed 100% of earnings at claim and therefore reduce incentives for the claimant to return to work.
On the positive side, indexation of benefit payments at the level of CPI is permitted and there is no cap on monthly benefits. Further, where a client’s insured income excludes superannuation guarantee contributions (SGC), insurance benefits related to SGC can be paid in addition to the 90% / 70% income replacement limits (otherwise the caps apply to income inclusive of SGC). In all instances, insurance benefits related to SGC should be paid into a superannuation fund and not to the client/claimant.
Adviser tip – consider how you are currently recommending IP and review your insurance philosophy to manage the reduction in the percentages covered. It may be worthwhile utilising other insurance benefits to protect the IP claim payment (discussed later) and/or consider a self-funding strategy such as using leave entitlements or dipping into cash reserves to cover any shortfall in income for the client.
3. Policy contract term – IP policy terms must not exceed five years. After the five-year period, a new policy must be entered into that reflects the terms and conditions that apply to new contracts then on offer by the life company. If a client enters a new contract after the initial five years, medical underwriting is not required however any changes to the client’s occupation, financial circumstances and dangerous pastimes must be updated and reflected in the new policy.
Whilst the detail of this particular part of the new product construct is still being discussed between the industry groups and APRA, this may mean that, for example, if a client’s occupation changes to one which carries a higher level of risk (e.g. changing from white collar to blue collar work), the cost of cover could increase. Further, the policy could also be cancelled if the client is employed in an occupation the insurer is no longer willing to insure. Similarly, if a client’s income reduces due to a reduction in work hours (e.g. due to study, parental leave, injury, sickness, etc), their cover may also be reduced.
Insurers are unable to extend a current policy even if the client’s circumstances are the same. A new policy agreement must be entered into.
Adviser tip – educate your client about the five-year contract term and encourage a structured review to be undertaken at this time if they have not already sought advice from you within the five years.
4. Benefit period – life companies must ensure effective controls are in place to manage the risks associated with longer IP benefit periods. There are various ways that insurers can control long-term claims including tiered or stricter disability definition, tiered income replacement ratios, or lower maximum termination ages.
Adviser tip – ensure that you have the most current PDS of the insurers who you regularly utilise with your clients and seek support from the insurer to understand regular product updates.