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INSURANCE
INSURANCE By Steve Wright
The benefits of short payments
Short benefit payment terms under Income or Mortgage Protection can be useful but do you know how they work?
Short benefit payment
periods (how long your income protection or mortgage protection cover will pay monthly benefits on disablement) can be very useful, especially for clients with very limited budgets. The cheaper premium that comes with a short benefit payment term on income protection and mortgage repayment insurance, such as 2 or 5 years, can be tempting and often necessary for clients with limited budgets who need short waiting periods but it is important that clients understand the downside.
The downside is naturally that for those clients disabled (totally or partially disabled) forever or a very long period, their benefit payments may end before their disability ends. If you recommend insurance with a 2 year payment term and the client is disabled forever, 24 monthly benefit payments is the most the client will get, leaving clients exposed to the financial risk associated with long term disability.
‘BUT DON’T BENEFIT TERMS RESET FOR EACH DISABILITY’!
Good policies will reset short term benefit payment terms following a return to work after disability but clients have got to
recover sufficiently to be back at work
full time before that can happen (i.e. they
are no longer totally or partially disabled). If they are disabled again because of the same underlying cause then typically their return to work must be for a minimum period (usually 12 months) before their benefit payment terms reset. If a client is once again unable to work because of a recurrence of the original condition which left them disabled and they have not been back at work for the required period, only the balance of the original payment term is available for benefit payments a second time around (and nothing is payable if the previous benefits ended because the payment term ended!).
DO SEPARATE BENEFIT PAYMENT TERMS APPLY FOR EACH CAUSE OF DISABLEMENT?
No! Typical disability policies, like income protection and mortgage prepayment insurance, pay benefits on disability irrespective of the cause of disability.
Benefit payment terms apply to periods of disability not individual causes of
disability. Clients with a 2 year payment term do not get two years of benefits for each individual cause of disability. Unlike trauma cover, which pays on cause not effect, income and mortgage protection insurance pay on effect (the cause is generally irrelevant). This means, for example, a client (with only a two year benefit payment term) initially disabled due to a distressing and painful medical condition, requiring unpleasant treatments and who, after 18 months, then also becomes sufficiently depressed to be unable to work, will still only be entitled to benefit payments to the end of the current payment term; a maximum of 24 monthly payments! A new payment term does not begin when the second event, the depression, first prevents the ability to return to work.
It is true that many, even most, disabilities are of relatively short duration, less than 2 years, but there are some that last a lot longer and some last forever. If your client wants protection against longer term disability, you may want to recommend benefit payment terms which pay benefits ‘to age 65’ or ‘to age 70’. If the higher premium that goes with a
longer benefit payment term is a problem, a longer waiting period or split waiting periods, can reduce premiums. Increasing the waiting period usually imposes a small and manageable risk the client can carry themselves. Each additional month added to the waiting period only adds the value of another months’ benefit to the risk the client takes themselves. The additional risk of a longer waiting period is literally a few thousand dollars and good policies will waive the waiting period for recurrent disability occurring within 12 months anyway. Taking a fixed payment term of 2 or even 5 years, leaves clients with very large risk, no income or benefits for the remainder of their working lives, possibly decades! This loss could easily amount to millions of dollars, risks they may not be able to take themselves.
‘SHORT PAYMENT TERMS PLUS LUMP-SUM TOTAL AND PERMANENT DISABILITY COVER WORK FINE FOR LONG TERM DISABILITY’!
Because most disabilities end within 2 years, many advisers favour a 2 year income protection benefit payment term and top-off the longer term disability risk with additional TPD lump-sum cover. The theory being that, someone disabled for two years is more likely
to be permanently disabled and premiums can be reduced. Unfortunately there are a couple of issues to consider with this strategy: ▶ There is no certainty that the client’s disability will actually pan out this way and every likelihood the disabled client will not be totally and permanently disabled at the end of the payment term; and ▶ In order to achieve a meaningful premium reduction, it is my suspicion that proponents of this strategy recommend a couple of hundred thousand dollars of TPD Cover, not the big TPD sums insured large enough to cover the value of the lost income cover or mortgage repayment cover monthly benefits to age 65 or 70. For a 35 year old on a modest salary, say $6,000 per month (with a monthly benefit of $4,500 and a two year benefit payment term) the value of this monthly benefit lost if they are totally and permanently disabled is 336 payments (28 years’ worth of benefits). This is at least $1,512,000 without any inflation indexing and at only 1% inflation it is $1,735,000. At these levels of TPD cover, the total premium payable by the client (TPD and mortgage repayment cover) will be close to the cost of income protection or mortgage repayment cover with a ‘to age 65’ payment term.
Getting the client’s disability risks adequately covered requires careful consideration of the client’s needs and wants and a good understanding of what the products you recommend will actually do come claim time. Multiple benefits and options are likely to be necessary in combination and the various options will all have their pros and cons. As usual, stress testing your initial thoughts about a recommendation by asking ‘how might this solution fail and if that happened what would be the consequences?’ can be very valuable. ✚
Steve Wright has qualifications in Law, Economics, Tax and Financial Planning and is General Manager Product at Partners Life. This article is for information purposes only. Its content is intended to be of a general nature, does not take into account your financial situation or goals, and is not a personalised financial adviser service under the Financial Advisers Act 2008. It is recommended you seek advice from a financial adviser which takes into account your individual circumstances before you acquire a financial product.
