Creating your safety net

Income protection insurance can help fill the coffers when fate steps in — but it pays to choose the right policy

It’s an obvious question but one that’s easy to ignore: who will pay the bills if illness or an accident leaves you unable to work?

For doctors, the issue is particularly pressing. Typically they have high financial obligations, which means a stint without cash can pack a bigger punch.

Chris Wren, of Highland Financial, says doctors tend to need to service a debt that requires a high cash flow. If they have no income, they can’t meet the repayments on their loans, he says.

Mr James Gerrard, a financial adviser at PSK Financial Service, agrees. “There’s such a large amount of money at risk if something happens and a doctor is unable to work”, he says.

Mr Gerrard estimates, however, that only half of Australian doctors have income insurance.

Medical Benevolent Association of NSW social worker, Ms Meredith McVey, says a lack of income protection insurance leads many doctors to the Association’s door seeking financial assistance.

Even if a doctor has income protection insurance, it’s often not enough to cover their obligations and there can be long waiting periods before payments kick in, she says.

Income protection insurance is not cheap. This type of insurance will set you back between $800 and $12 000 a year, depending on your age and income, although premiums are tax deductible.

The statistics show the need for income protection insurance, Mr Wren says. Men have a one-in-four chance of claiming for a major health event, such as heart attack, stroke or cancer, during their working life, while women have a one-in-three chance.

There are many different policies, so what should you look for? Financial advisers point to some of the key differentiators and offer their tips choosing a policy that suits your needs.

Waiting period

When you make a claim, a waiting period must be served before payments start. The longer the waiting period, the cheaper the premium.

Many policies have a 30-day waiting period, but if you can survive without an income for 3 months, the policy will be around 40% cheaper, Mr Gerrard says.

“The 90-day waiting period offers the best value of money, but you need to make sure have sufficient cash reserves to get by before the policy kicks in”,
he says.

One option is an offset facility on your mortgage to draw down on for a couple of months.

Terry McMaster, of McMasters’ Accounting, Financial Planning and Legal, says many companies try to sell a policy with a 30-day waiting period, but premiums are much less with a 90-day waiting period. “Very few doctors would be wiped out if they weren’t paid for 60 days”, he says.

Policy type

There are two types of premiums: stepped and level. With a stepped premium, the cost of the policy goes up as you age, in line with the rising statistical risk of making a claim.

Mr Gerrard says stepped premiums go up substantially for people in their 40s and mid 50s. “Because of this, doctors often stop or cut back their policies, yet statistically that’s when they are most likely to make a claim.”

The alternative is to choose level-premium insurance, which allows you to lock in your premium at the outset. You pay more initially, Mr Gerrard says, but you will pay less over the longer term.

“For the first 8 years, a stepped policy will be cheaper than a level policy but in year 8, the stepped premium should equal the level policy in overall cost. After 13 years, you’ll see a net benefit from a level policy”, Mr Gerrard says.

You can also index the sum for which you’re insured every year to ensure it doesn’t diminish with inflation, he says.

Benefit period

Once you’ve served your waiting period, you get a monthly benefit for a set period, with the duration varying from policy to policy.

Mr McMaster says sometimes doctors are sold cheap “useless” policies that only pay out for 2 years.

“We want income to kick in on the 90th day, to be indexed to inflation and to go to your 65th birthday”, he says.

Mr Gerrard agrees. “The benefit period could be 6 months, 2 years or 5 years, but the most comprehensive policies go to age 65 or 70, so I always choose those for health professionals.”

The longer the benefit period, the higher the premiums, but you can balance this a little by tweaking the policy and making trade-offs, such as extending your waiting period, he says.

Income upfront

Guaranteed income (otherwise known as agreed value) means that you and your insurance company agree on your income up-front. If you make a claim, they will pay you accordingly — even if your income has fallen.

Indemnity cover, which means that you are paid according to your income at the time of the claim, tends to be 15% cheaper.

According to Mr Wren, when you’re flat on your back, it’s not an ideal time to try to prove what you earn. “We always advise you get guaranteed income”, he says.

Mark Morcos, head of Wealth Journey, says the insurer will ask for your past 2 years’ of tax returns to verify your income up-front.

“You want to know how much you are being insured for”, he says. “You definitely want to go for an agreed-value policy.”

Premium vehicle

Some people pay their policy personally as premiums — and these are tax deductible — while others pay through their super fund, through salary sacrifice.

Mr Gerrard says the tax advantage is about the same. While some consider the superannuation option to be more convenient, it is a less favourable option for those who are trying to maximise their super contributions, he says.

Also, when the insurance policy is held in a super fund, if you do make a claim, it can be trickier to get your money, Mr Morcos says. As well as proving you are unable to do your normal job, you have to meet the Superannuation Industry (Supervision) Act 1993 definition of incapacity.

Mr McMaster agrees. “Because there are rules about getting the money out, it can get locked up in your super policy, so it’s not something we recommend”, he says.

Proportion covered

Once you do make a claim, most policies will cover around 75% of your income. Mr McMaster says it’s important to be insured for an appropriate, but not excessive, amount, to minimise premiums.

“This may not represent a bonanza if you happen to get sick”, he says. “For instance 50% of doctors are married to other doctors or high-income earners and they provide a natural hedge to each other.”

Doctors need to decide if they really need to earn $420 000 a year if they are unable to work when, for a quarter of the price, they could still get $120 000 a year through an income protection policy, he says.

Mr McMaster also advises doctors who think they are in better-than-average health to consider cutting back on their cover once they get older and their premiums start to skyrocket.

“Income protection insurance is a bet and the probabilities are that you will lose the bet: you will pay your premiums and not get ill”, he says.

“While young doctors with all their financial commitments can’t afford to not to make the bet, it’s different for older doctors with grown-up kids, super and who own their home. In those circumstances we say cut back, often to the screams of insurance advisers.”