APRA proposes to shake up Income Protection as we know it

18 February 2020

Australia Prudential Regulation Authority (APRA) have proposed to end ‘Agreed Value’ Income Protection policies from 31st March 2020. This comes as Disability Income Insurance (Income Protection), recorded a $3.4 Billion loss over the last 5 years in Australia.

What is an ‘Agreed Value’ policy?

In short, an agreed value policy is the life insured providing proof of income at application stage. As a result, the insurer ‘agrees’ upon the sum insured at this point, regardless of the income earnt immediately prior to claim.

Why is this an issue?

Picture this, you’re currently earning $160K per annum. You speak with your Financial Planner to protect your long-term ability to earn an income. You provide proof of income and obtain an agreed value Income Protection (IP) policy of $10,000 per month.

Fast forward 10 years, due to personal factors outside of work, you decide to change roles to an occupation that carries less stress and responsibility. As such, your earnings fall to $100K per annum.

Fast forward another 5 years, now 15 years since the policy began, and you wish to claim. Under an agreed value contract, you would be eligible to receive $10K per month ($120K per annum), which is greater than your current earnings.

If you were receiving Income Protection claim proceeds greater than your current salary, what incentive do you have to return to work?

APRA believe that features such as this “provide a financial disincentive for policyholders to return to work,” impacting on the sustainability of Income Protection.

Left unchanged and given the recorded losses over the past 5 years, we may see Life offices withdraw from offering Income Protection all together. APRA Executive Board Manager, Mr Geoff Summerhayes agreed “Disability income insurance plays a vital role in providing replacement income to policyholders when they are unable to work due to illness or injury.” Unchanged, prices may increase to a point of unaffordability or insurers could withdraw altogether, potentially causing catastrophic financial consequences to the public’s financial future.

What if I already have an ‘Agreed Value’ policy?

The changes proposed by APRA only affect new policies issued from 31st March 2020 onwards. Therefore, if you have an existing ‘Agreed Value’ policy, in terms of its definition, it will remain unchanged. The question is, will this cause premiums to drastically increase in an attempt to make the existing policies ‘sustainable’ (or should I say profitable)?

Other potential changes coming…

In addition to the removal of ‘Agreed Value’ policies, from 1 July 2021 APRA is also proposing to introduce:

  • A sum insured cap of $30,000 per month;
  • Policy terms of 5 years: At year 5, the life insured will need to provide updated occupational information;
  • For individuals with Benefit Period greater than 5 years, inferior disability definitions to apply from year 5 onwards.

Summary

As much as we don’t like to admit it, Life Offices need to operate at a profit. The current model operating at a loss, I feel is unsustainable. Consequently, something needs to change in order for Life Offices to continue offering Income Protection policies into the future.

Whether you have an ‘Agreed Value’ Income Protection policy or not, these changes may affect you through inferior definitions, or future price increases. Through times of change, it becomes vital to speak with a trusted professional to receive personal advice that is tailored for you and your individual needs.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the thought or position of Findex Advice Services Pty Ltd.

Resources:

APRA intervenes to improve sustainability of individual disability income insurance , https://www.apra.gov.au/news-and-publications/apra-intervenes-to-improve-sustainability-of-individual-disability-income