Insuring your pay keeps a drain at bay

Think peace of mind comes with income insurance? There's good news and bad for business owners, workers and the self-employed. At a time of low unemployment, employers are offering benefits such as company-provided income protection insurance to attract and keep staff. But there are concerns about the quality of some "group" insurance and whether it lulls people into a false sense of security.

Worst of all, some people may find themselves in no man's land when they change jobs - older and no longer with a pristine medical history - and the group insurance doesn't include a "continuance" option. David Evans, head of individual risk for MLC, says handling group insurance well is challenging.

People frequently overestimate the amount and misunderstand the nature of the income protection they have through work or their superannuation fund, says Elke Richardson, a risk insurance adviser at Centric Wealth. "In many cases, clients don't know what they have with their employer," she says, or they just take the employer's assurance that they have good cover.

Richardson sends them away with a checklist so their employer can note in writing precisely what cover they have.

"They come back with a whole different perception," she says.

They may think they have the maximum cover - that is, they'll be paid 75 per cent of their income in the event of illness or injury - when in fact it's much less. There may be a long waiting period before payouts begin, or they may discover that in the event of chronic illness or becoming disabled, payouts cut out after two years.

Many group policies pay only if you cannot work in any occupation. So if you cannot keep working in your job because of illness or injury, but other jobs are possible, it is no payout for you, she says. Her preferred "own occupation" policies mean you are covered if you cannot work in the job you are trained to do, even if you could find other work.

KEY CONDITIONS Advisers suggest an ideal contract, if money were no object, would have:

* A short waiting period (30 days, rather than, say, 90 days).

* A long benefit period (to age 65, rather than two years or five years).

* An "own occupation" definition, rather than "any occupation".

* An agreed value, rather than indemnity.

* Level, rather than stepped, premiums.

With an agreed-value policy, the insurer agrees to cover the income specified at the time the contract is taken out, regardless of whether your income declines later. Indemnity cover is cheaper, but the insurer would base any payout on your earnings at the time of the claim, by which time they could be lower. Mark Kachor, managing director of insurance industry researcher DEXX&R, says self-employed people with fluctuating incomes would be better off with an agreed-value contract.

Level premiums are determined by your age at the time you take out income protection and essentially stay the same for the life of the policy. Stepped premiums are cheaper to begin with - and for that reason most of MLC's non-super clients take this option - but they increase with age, so can become quite expensive at a time when people are trying to focus on maximising their retirement savings. Last year MLC began allowing clients to mix stepped and level premiums to improve affordability.

Evans says people should consider a level premium seriously if they are going to have insurance for some time. "It's not just about 'day-one' affordability; it's about long-term affordability," he says.

If you are trying to bring your premium down, you are probably better off choosing a longer waiting period, he says.

"Generally, there are some trade-offs that need to be made. In most cases, people would extend the waiting period and maintain the benefit period."

OVERLAPPING COVER Richardson says employees should be clear about exactly who is paying for workplace insurance cover. "Do you pay for it, somehow, out of your salary?" she asks.

"If you're paying for it, I maintain you can get a better contract outside. Sure, it's not as cheap [as group insurance], but it's always better to get the superior product and know exactly what you're getting, rather than have complications down the track when circumstances change."

Richardson says it is vital to check whether a group policy has a continuation option. This is a clause that says you have the right to take over the insurance contract if you leave your job, as long as you exercise that option within the specified period, usually 30 days.

If there is no continuation option, the concern is that some years on, when you are older and perhaps less healthy, you will be thrown back onto the insurance market and face much higher premiums than if you had bought and stuck with income protection when you were younger and healthier.

An insurer may ask an older applicant to provide a more detailed medical history, or to undergo a medical examination, before offering cover. Depending on what shows up, the insurer may add a "loading" on top of the standard premium they charge for a person of that age and gender, or write in "exclusions" - for instance, declining to cover time off work related to an existing condition, such as a bad back.

Potentially - though this is reasonably rare, says the Investment and Financial Services Association - you may not be able to obtain insurance cover at all.

Of course, you should consider whether the quality of the group insurance is such that you would want to continue it, Richardson says.

POTENTIAL TRAPS One option is to put your own insurance in place and leave it there, regardless of any benefit a new employer offers. "It's something to think about," Evans says. "It's important that you put cover in place, when you're young and healthy, that you can retain for the long term.

"If there's any risk around leaving your employer, you may think it's better to take out an individual contract."

But take care to ensure all your insurers know about each other. Another trap with income protection is the potential for people to end up with overlapping policies - through super, employer and private arrangements.

Evans says it is important that people disclose all the insurance they already have when arranging another contract. If they have overlooked workplace or super-based insurance, they should make their personal insurer aware of it as soon as they realise.

This allows the insurers to adjust the policies, so together they do not breach the limit of 75 per cent of income.

Kachor gives the example of someone earning $10,000 a month, whose maximum cover would be $7500.

They may have $3000 cover through their super fund, so the most they could cover with another insurer would be $4500.

"If you don't disclose the amount payable by the other insurer, that becomes a real issue about who's going to pay and you don't really want to be in that situation because that can delay payment," he says.

You may end up only getting the outstanding $4500 even though you have paid the second insurer premiums for $7500 of cover, or one insurer might refuse to pay at all on the grounds you were not truthful.

Evans says there is no black-and-white answer to how an insurer would respond and it depends on what is involved in each policy.

SOLUTIONS One answer is to dovetail your policies, advisers say. Your workplace or super-based insurance may have a benefit period of two years, so you could take out a private policy that has a two-year waiting period but a benefit period to age 65. That way you now have long-term cover but there is no point in time where two insurance claims might collide.

A financial planner, Kevin Bailey, managing director of The Money Managers, says it can get complicated, but do not be tempted to avoid income-protection insurance.

"The premiums are ugly and you want to get your assets up to the point where you're self-insured, but it's a stop-gap measure you have to have," he says. "Yes, it's horrible, but it's not as bad as the alternative - not having any, and being out of work because of illness or injury.

"You ought not to take on any debt for a home or investment without having income protection, until such time as your assets are enough to protect you."

However, a survey of industry super fund members recently found that only 31 per cent had income protection.

The joint Australian Institute of Superannuation Trustees and Industry Funds Forum survey also found that the average level of income protection cover was $2700, when the average required was $3750. It estimated that 45 per cent of people were underinsured by at least $1000 a month for income protection. At the other end of the scale 12 per cent were over-insured by at least $1000.