By Jenée Tibshraeny
'It’s Thursday morning and I’m off to work… again. Lucky me!'
No, I’m not being sarcastic. This is what all us working people should be thinking as we hit the snooze button at the crack of dawn and battle the traffic to work.
Why? Because our income is our most valuable asset.
If you had to stop working due to an injury or sickness, the Government’s safety net would catch you, but only just.
ACC would reimburse you 80% of your income, if you were injured. But you might not be so lucky if you had to stop working due to illness.
If you’re a single person without any children and get cancer for example, you could be eligible for a Living Support Benefit of $262. You may also qualify for an Accommodation Supplement and a Disability Allowance.
While this may be just enough to get by day to day, it will be a struggle, especially if you’re servicing a mortgage.
Unless you have a very healthy savings account or enough assets that can be monetised when necessary, insurance is vital.
Something is better than nothing, right?
Income, trauma and mortgage/rent protection will all go some way to easing the pressure.
While trauma pays out a lump sum for you to use on whatever you wish if you suffer a major illness, income and mortgage/rent protection provide regular payments to help you get by.
Insurance companies are starting to launch cheaper and often weaker products that target the majority of New Zealanders without any form of life insurance. Something is better than nothing right?
Cigna for example has just this week launched a new mortgage/rent protection product.
Its Head of Product, Adam Rudland, says the company saw a need for a simple and affordable alternative to full income protection insurance. This was further reinforced by the recent financial results of the Cigna 360° Wellbeing Score research.
“While the research found that the cost of living is the top social concern for Kiwis, only 16% of us believe that we have financial security if we are unable to work. In fact almost half of Kiwis can’t pay the bills for more than a month if unable to work,” Rudland says.
“Some people are concerned about the additional cost of income protection insurance, particularly when they’re already struggling to make ends meet. But there are options available to protect just a part of your income - sometimes a little bit of insurance is all that’s needed to keep a roof over your head or food on your table if you can’t work.”
The questions are, how much money are you saving by opting for mortgage/rent protection over income protection, and is this saving worth it?
How much dearer is income protection compared to mortgage/rent protection?
Income protection is around 50% more expensive than mortgage/rent protection (according to an Interest.co.nz study).
This is what a 35-year-old teacher, earning a gross salary of $70,000 a year, would pay for mortgage versus income protection each month.
|How much more income protection costs compared to mortgage/rent protection (%)|
|Quotes sourced from LifeDirect and Cigna as at May 18, 2016 and are subject to change.|
As an aside, it's worth noting premium prices are fairly similar across different insurers in each product category, which highlights the importance of focussing on the quality of cover when selecting an insurer.
We can assume the person in this exercise has a $480,000 mortgage, which she’s paying off over 30 years, at an interest rate of 4.75%. Her mortgage repayments accordingly cost her $2,504 a month (not all insurers quoted above will cover her for this full amount).
Under her income protection policy, we can assume she receives cover for 75% of her income, which equates to $4,375 a month.
She has selected a wait period of 4 weeks on both policies, and will be covered for the two years after she stops working.
How much are you sacrificing in terms of cover, opting for mortgage/rent over income protection?
While a robust comparison between the two types of insurance is a job for a financial adviser rather than a financial journalist, this table details some of the differences between the two types of cover.
Lighter weight cover = cheaper premiums.
Heavier weight cover = more costly premiums.
You get a regular payment to cover your rent/mortgage if you can’t work due to illness or injury.
You can sometimes get limited cover if you’re made redundant, but you often have to pay for this as an add-on.
Some insurers also allow you choose the level of cover you’d like. AIA for example lets you can choose to get cover equivalent to 45% of your income or 115% of your rent or mortgage repayments.
You get a regular payment if you can’t work due to illness or injury. Some policies allow you to add on cover for redundancy. You can choose from two variations of income protection:
Indemnity value: A value calculated based on the income you can prove you were earning just before becoming disabled. This is usually calculated as up to 75% of your gross annual income.
Agreed value: A set amount you agree on with your insurer, which isn’t assessed again at claims time. The agreed value can vary depending on your income.
Fidelity Life for example will cover you for up to 62.5% of your gross income if you earn less than $70k, up to 60% if you earn between $70k and $100K, and up to 55% if you earn more than $100k.
You will still receive cover, even if you receive payments from ACC for the injury that’s stopped you from working.
Any ACC payments or sick leave you’re paid in relation to your injury will be deducted from your cover. Your income protection will be worthless if you have an accident and ACC covers 80% of your income. ACC does not however provide cover for if you get sick.
You don’t have to pay tax on the insurance cover you receive.
Generally, you have to pay tax if the cover you receive is an indemnity value. The premiums you pay are accordingly tax deductible. Agreed value policies are often exempt from tax payments and deductions.
An Authorised Financial Adviser for Goldsworthy Financial Solutions, Jeff Goldsworthy, acknowledges affordability is a key consideration when weighing up the options. Generally speaking he says:
“If you’ve got a one income household, the financial impact of disablement is going to be much higher, therefore you want to have the maximum benefit [ie income protection].
“Where the mortgage repayment coverage can kick in is where you’ve got a two-income household. Generally the mortgage is the single biggest expense, so if you can cover the mortgage, and still rely on one income, generally you can balance it. The downside to that is if you get a major health condition.”
He points out that for some people mortgage/rent protection could be advantageous as it doesn’t usually take your income into consideration.
Cigna is a little different in this regard, as it will only pay an amount equivalent to 40% of your income, if your income isn’t at least 2.5 times larger than your mortgage repayment/rent.
In other words, you’d need a gross annual income of at least $75k if you’d like your insurer to cover the full $2504 monthly mortgage repayment in the case study used above. If you were servicing that mortgage on an income of $70k, you’d only receive cover of $2333 a month, which leaves a shortfall of $171.
What are the other ifs and buts to consider?
It is worth nothing the claim period you can select - the length of time the insurer will cover you for after you have to stop working - varies between insurers. Most insurers give you an option of two years, five years or to age 65. However some insurers have more extensive offerings, while others are more limited.
Cigna for example caps its claim period at two years, meaning if you have to stop working at age 45, you will only be covered by your insurance until age 47.
Goldsworthy says he usually advises his clients to opt for a claims period of five years. He says 81% of disability claims are settled within two years, while 96% are settled within five years.
By industry standards, the average period of disability is between 14 and 16 months.
The wait period you can select - the length of time before your cover kicks in following you stopping work - also varies between insurers, with the minimum usually being four weeks.
In the case of both mortgage/rent and income protection, the cover you receive will often be reduced in the case of redundancy, and payments may stop after a certain period of time.
Redundancy cover may also not kick in until after the redundancy package from your employer runs out.
Goldsworthy suggests his clients should therefore think hard about whether redundancy cover is worth their while.
Indemnity or agreed value?
If you go down the income protection path, Goldsworthy admits the difficulty is deciding whether to opt for an indemnity or agreed value policy.
While the indemnity value could be higher (ie 75% of gross income) and the premiums are tax deductible, he says it provides less certainty at claims time.
Because it considers your income directly before you suffered the condition that’s made you stop work, you risk ending up having no cover if you have to stop work a few months after returning to work, having just had time off due to sickness.
For example, one of Goldsworthy’s clients was covered under his indemnity policy when he stopped working for a year due to suffering from severe stress. After returning to work after three months, he relapsed and had to stop again. Given he had hardly worked over the previous year, the indemnity value of his insurance was worthless.
While this might not be the case with every policy, as many look at your income over the past three years, Goldsworthy says opting for an agreed value policy can provide more certainty.
No matter which policy you opt for, he says it’s essential to be honest and upfront when filling out the application form. Your insurer may not pay out your claim if you don’t disclose all the right information about yourself.