Indemnity: new blood for life insurance

Income protection has had its fair share of trouble in the past five years as life insurance groups have scrambled to fix loss-making books of business. One major trend rearing is the emergence of indemnity style products. Louie Dimovski explains the genesis of these products and how they affect your clients.

Income protection has had its fair share of trouble in the past five years as life insurance groups have scrambled to fix loss-making books of business. One major trend rearing is the emergence of indemnity style products. Louie Dimovski explains the genesis of these products and how they affect your clients.

Income protection has long been a traditional staple of the life insurance market. It has proven popular with customers because of its ability to provide a financial safety net in times of trouble.

But indications are that the goalposts are slowly moving as re-insurers respond to concerns about the bottom line of the income protection market. Pressure is slowly building on product providers - few of whom are prepared to provide life products without the backing of the re-insurers — to shift the focus away from agreed value policies, which are currently the most common product on the market, to more flexible indemnity-style products.

These developments will gradually impact on distribution networks but, in the meantime, it is important that advisers continue to attend to the basics to achieve the best results for themselves and their clients.

When shopping around for income protection cover, it is imperative to look for a policy that combines affordability with relatively flexible policy conditions. You should also consider what level of benefits would be payable should your client be totally disabled and unable to work.

There are also a number of definitions and features to take into consideration before determining the most appropriate type of cover. In doing so, it is essential that the policy addresses each person’s individual needs to avoid paying for unnecessary additional cover. On the other hand, you also need to ensure that the disability benefits that may ultimately become payable are sufficient to maintain the lifestyle to which the policy holder is accustomed.

It is also important to note that, with the push to return to indemnity style benefit payments at the expense of agreed value contracts, this may have a significant impact upon the level of benefit - depending on the stability of earnings - should a claim ever be made for total disablement.

To gain a better understanding of likely developments in the disability market, it is useful to look at the types of products currently available. There are at least four types of benefit payment methods currently available —

1. Agreed Value — This is currently the most common benefit style available in the Australian disability market. Agreed value contracts provide a benefit that is equal to the benefit insured amount less offsets. Offsets are earnings that are received or, in some cases, receivable from other sources while on claim (eg part-time or casual work, interest or dividend payments, rental from investment properties).

The main advantage of agreed value contracts is that they provide the greatest degree of contractual certainty since the benefit is agreed upon at the commencement of the policy. No matter what level your earnings are at the time of total disablement, you are entitled to the agreed amount less offsets. This level of certainty, however, comes with a price. Agreed value contracts are generally more expensive than the other benefit style contracts.

2. Indemnity (Loss of Earnings) — As agreed value policies are phased out, loss of earnings indemnity contracts will take over as the preferred product choice in the disability market. Loss of earnings indemnity contracts provide a benefit that is equal to the lesser of the:

? benefit insured amount; and

? 75 per cent of pre-disability earnings less offsets.

These policies are more suitable to employed people with a stable income that is likely to consistently increase over time. In this case, you would generally receive a benefit that is equal to or, at times, greater than an agreed value benefit (see Fig. 3). Given that loss of earnings indemnity policies are less expensive than agreed value contracts, it is worthwhile looking at this type of cover should you be employed and have a steady income.

On the other hand, if you are a self-employed person with a fluctuating income, you may be well advised to stay away from any loss of earnings indemnity style contract. If your business suffers a downturn in turnover in the two or three years prior to total disablement (pre-disability earnings), you will find that the this style of contract will provide a benefit much less than that provided under agreed value cover.

3. Indemnity (Basic) — This style of indemnity contract provides a benefit that is equal to the lesser of the:

? benefit insured amount; and

? 75 per cent of pre-disability earnings.

This benefit is then subject to offset reductions.

While the two types of indemnity style products are similar, each treats offsets differently, which can make a considerable difference to the benefit amount that is payable. Under loss of earnings indemnity contracts, offsets are only taken into consideration when determining the insured’s loss of pre-disability earnings. On the other hand, basic indemnity style contracts use offsets to reduce either the benefit insured amount or the loss of pre-disability earnings, which results in a benefit payable amount that is either equal to or lower, but never greater, than other benefit style contracts.

Once again, if you are employed with a steady income, you may well consider this cheaper form of income protection cover, however, self-employed people with fluctuating income may be well advised to stay clear of these types of contracts for the same reasons mentioned above.

4. Loss of Earnings — A small number of Australian life companies provide this type of benefit contract. Under loss of earnings, the benefit equals:

Pre-disability Earnings less Post Disability Earnings X Monthly Benefit

Pre-Disability Earnings

While relatively scarce, the loss of earnings style contract provides the most realistic replacement cover of income because it recognises the actual loss you suffer by treating offsets as post disability earnings. Instead of deducting offsets directly from the benefit amount, the loss of earnings style benefit uses offsets to determine the percentage amount of income that is lost due to disablement. This percentage is then multiplied with the monthly benefit amount insured to give a benefit payable amount.

Where there are no offsets, there is no difference in the benefit payable when compared with agreed value benefits. However, where pre-disability earnings remain the same or increase and offsets apply, the loss of earnings style benefit will generally produce a benefit greater than that provided by an agreed value policy. If pre-disability earnings decrease and you are in receipt of other income while on claim then the agreed value benefit will generally be greater.

Once again, this style of benefit payment is suitable for employed people with steady incomes. However, anyone that is self-employed and has a fluctuating income may also want to consider this style of contract as it would need a very significant drop in pre-disability earnings for a benefit under a loss of earnings contract to result in a lower benefit when compared to an agreed value contract (see Fig. 5)

As can be seen from the tables, there are instances where benefits currently payable under indemnity style policies equal or exceed those provided by agreed value policies. As new indemnity products are launched into the market in the months to come -with older agreed value policies taking more of a back seat - it will continue to pay to keep an eye on the detail of each policy and shop around to ensure you get what you need.

Louie Dimovski is a senior researcher with independent research and software development company, PlanTech Consulting

Fig. 1: Pre-Disability Earnings remain the same. Nil offsets.

Agreed Value Indemnity (LOE) Indemnity (