Total and permanent disablement: a little misunderstood

No other risk insurance product currently available is more maligned and perhaps more misunderstood than total and permanent disablement (TPD). Is it a rip-off product under which benefit payments are never made? Has it been made redundant by trauma insurance? Or is it a product that has a crucial part to play and, as such, should be seriously considered within an adviser’s suite of risk insurance solutions?

The following is by no means a definitive analysis of TPD; it is simply looking at the relative merit or otherwise of the product.

The definition

For a benefit payment to be made, the definition of TPD within a policy must be met, in addition to any other claim requirements.

The definition of TPD can be broken down into three parts.

(i) Inability to work

An indicative definition may say something like: ‘The life insured, due solely to a sickness or injury, must be absent from their occupation for at least three consecutive months and then be unlikely ever to work again …’

Within this definition there are, in turn, three sub-sections. One requires that the insured be unable to work in their own occupation, a second requires that the insured be unable to work in any occupation for which the insured is reasonably suited by training, education or experience, and a third requires that the insured be unable to work in any occupation at all.

There is no directly equivalent cover within trauma insurance.

(ii) Loss of …

The second part of the TPD definition enables a benefit payment:

‘If the insured loses:

— both feet, hands, or sight in both eyes; or

— a combination of two hands, a foot, or sight in an eye.’

‘Loss’ can be defined as either ‘loss of the use of' or, in some older policies, ‘loss by severance’.

Similarly, ‘loss of sight’ is generally a loss below 6/60, whereas older policies may require ‘total blindness’.

The above cover may well overlap two other areas of risk insurance coverage:

— the ‘loss of limbs’ and ‘blindness’ insured events within trauma insurance; and

— the scheduled injury benefit, which usually pays between six and 24 months benefit, within income protection insurance.

(iii) Activities of daily living

The third section of the definition deems the insured to be total and permanently disabled ‘if the insured is unable to perform at least two of the five activities of daily living without the assistance of another person’.

Again, it is not unusual to find equivalent cover within trauma insurance under the ‘loss of independent existence’ insured event.

The presence of these overlaps with trauma insurance has led some people to suggest that TPD is redundant and, therefore, they do not consider it within their risk insurance recommendations.

Is this a reasonable position to take?

TPD v trauma insurance

While it is true that someone could suffer an insured event under a trauma insurance policy that will leave them totally and permanently disabled, when considering the need for soundly-based ‘advice’, it is necessary to have something more factual upon which to base a recommendation.

One way of gaining a better understanding of the synergy between TPD and trauma insurance is to consider the premium rates for each.

To illustrate, for a non-smoking male aged 35:

— the TPD rate may be $70.00 per $100,000 of cover; whereas

— the trauma insurance rate may be $265.00 per $100,000 of cover.

If there was no overlap of coverage for each, you would expect the premium rate for both TPD and trauma insurance to be $70.00 + $265.00 = $335.00.

In fact, in this example the combined coverage would cost $295.00 per $100,000.

In other words, combined cover can be obtained by an 11 per cent increase in the trauma insurance premium ($265.00 to $295.00), which is indicative of an 11 per cent gap in cover, at that age, if TPD is not included with trauma insurance.

However, while the numeric logic appears to show a gap in cover if TPD is not recommended, is there a way to further reinforce this? What are some examples of sicknesses and injuries not covered under all trauma insurance policies that may render the life insured eligible for a TPD benefit?

— central nervous system;

— chronic brain syndromes;

— emotional disorders: psychoses, depression and post traumatic stress;

— cardiovascular disorders: hypertension, congenital heart problems and peripheral vascular disorders;

— musculoskeletal disorders: osteoarthritis, rheumatoid arthritis and chronic overuse syndrome;

— ear and eye disorders: labyrinthitis and retinal detachment;

— gastrointestinal disorders: ulcerative colitis;

— endocrine disorders: diabetes;

— respiratory disorders; and

— pulmonary fibrosis and emphysema.

Additionally, an important distinction between TPD and trauma insurance is that the first section of the TPD definition is assessed against the ability to perform an occupation. Trauma insurance, on the other hand, requires the satisfaction of a definition.

It is absolutely the case that not only are there conditions that would render someone totally and permanently disabled which are not covered under trauma insurance, there are also insured events under trauma insurance that would render someone unable to work in their own occupation or even an occupation for which they are reasonably suited well before they would satisfy the particular trauma insurance definition.

To fail to recognise this is to immediately increase the risk of a client having a gap in their risk insurance protection which, in turn, immediately increases the risk to the adviser of being found to have provided inappropriate advice.

Unfortunately, however, sometimes the impediment to TPD is not so much a lack of belief on the part of the adviser but a lack of premium dollars on the part of the client.

Is there a way to reduce the overall TPD cost without sacrificing appropriateness of cover?

Revenue TPD

The purpose of a TPD benefit payment is to:

— pay one-off capital expenses; and

— create a revenue stream to meet ongoing revenue expenses,

associated with being severely disabled and unable to work.

Typical capital expenses might include:

— home and car modifications;

— a new, more suitable, home or car;

— debt reduction; and

— one-off medical and rehabilitation expenses.

The risk insurance solution is the provision of a lump sum TPD payment.

Typical ongoing revenue expenses might include:

— regular medical and rehabilitation expenses; and

— maintenance expenses to pay for those things the insured is no longer capable of doing.

The risk insurance solution is usually the provision of an additional lump sum TPD payment that is invested such that ongoing revenue expenses can be paid from the interest earned.

The problem associated with the latter solution is that while ongoing expenses, at best, remain static, but generally tend to increase, interest earned from an invested lump sum will fluctuate as interest rates change.

The graph illustrates the monthly interest earned as a result of changes in interest rates between 2000 and 2009.

There is an alternative solution — a revenue TPD vehicle (eg, the disability plus optional benefit under TOWER’s income protection plan).

This enables the insured to cover up to 50 per cent of their earnings in addition to the 75 per cent generally insured under their income protection policy. This additional amount is payable if the insured is permanently unable to perform at least two activities of daily living (ie, equivalent to the third section of the TPD benefit).

These payments can be indexed in line with inflation, which covers off the issues associated with increasing maintenance costs.

Another advantage is cost. A $1 million TPD invested at 5 per cent would generate $4,000 a month interest. The table below shows the comparative costs between taking $1 million TPD coverage or a $4,000 a month disability plus.

Naturally, an advantage of TPD is that the insured retains the capital amount; however, if traditional TPD cover is not appropriate or is too expensive, a revenue TPD vehicle may be worth considering.

Summary

Is TPD a rip-off product, under which insurers rarely make a payment?

No — the logic behind TPD benefit payments is quite compelling and, contrary to popular opinion, some insurers have a higher proportion of TPD claims paid than trauma.

As a proportion of claims lodged, TPD benefit payments would typically run at around 75 per cent or more.

Is TPD redundant because trauma insurance covers the need?

No — facts and figures clearly show there is a material gap in cover.

Is TPD therefore a valid product that should potentially form part of an adviser’s suite of risk product solutions?

In many cases the answer will be a resounding ‘yes’ and, in fact, the inclusion of revenue TPD insurance only serves to expand the possible applications of TPD cover.

The above logic clearly demonstrates why advisers are so critical within the risk insurance advice process — they are the best qualified to obtain the facts, analyse the needs and recommend the solution. If this due diligence process is followed, TPD should be a serious consideration when the recommendation is made.