Last month I wrote an article in support of agreed value income protection. In that article I listed various scenarios that might lead to a decline in a clients’ income over time and could result in a significantly reduced claim under an indemnity policy.
In this article I’ll cover off a few more reasons, which a client may wish to consider, why they should pay a bit extra to lock their cover up on an agreed value basis.
1. The risk of a dramatically-reduced second claim if a client has previously been on a long-term unrelated claim
I’ll start off with another risk of indemnity cover that many advisers would not have thought of – the risk of a second claim. To explain further I’ll use an example:
Your client is an employee with a very stable income history, earning $100K per annum over the last few years.
You recommend indemnity IP – the contract has a 36-month definition of pre-disability income so you feel that the extra premium charged for an agreed value policy isn’t worth it.
A year after the policy commenced your client unfortunately has a stroke… the claim is admitted and he remains on claim for three full years.
After this extended period out of the workforce the client finally returns to work (back to his $100K salary).
Only two months later this unlucky client is involved in a nasty car accident. Claim number two is lodged (it is not related to the previous claim so recurrent disability benefit isn’t applicable).
Here’s where it gets interesting: I’ve run this scenario via numerous claims managers and every one I spoke with suggested that this client would receive a massively-reduced monthly benefit if he went on claim after the car accident.
As the client’s pre-disability personal exertion income in the 36 months immediately preceding the accident would only have been $16,667 (i.e. what he earned in his two months back on the job), I was advised that the monthly benefit payable on his second claim would only be $1,042 (not the $6,250 he was expecting).
This might sound like a very unlikely scenario, but these types of things DO happen.
Imagine if the car accident led to this client being off work for a very long time. I guarantee that you’d be wishing you’d recommended an agreed value policy.
2. The indemnity risk for new university graduates, as well as clients who may be returning to the workforce after an extended period away (e.g. returning from long-term maternity or paternity leave)
Just as I highlighted in the above example, there are other similar scenarios where indemnity cover may leave your client exposed to a very poor claims experience.
Let’s look at an example of a client who has spent the last three years studying full-time and has therefore not earned any income in that time.
After recently graduating from uni, the client secures a job as an assistant marketing manager on a starting salary package including super of $50,000 per annum (so her total remuneration per month will be $4,167).
The IP monthly benefit she would be looking at applying for would be $3,125 (75 per cent of $50,000).
To save money the client opts for an indemnity contract.
Three months after the policy commencement date this client is very badly injured in a car accident and lodges a claim. Since starting in the role, she has earned a total income of only $12,500 (including super).
The claims outcome: Although it would be nice to think the insurer might pay the $3,125 monthly benefit in such a scenario, every claims manager I consulted confirmed that the claim would be based on the actual policy wording and therefore the claim benefit would only be $781 per month.
The client’s pre-disability income in the last 12, 24, or 36 months (depending on the insurer’s definition) would be assessed in every case as being $12,500 (which ‘letter of the law’ it would have been).
In such a scenario the only way to go (if you can get it) is agreed value, which would have paid a monthly benefit of $3,125.
3. CPI-linked increases under agreed value policies
Another very important benefit of agreed value policies over indemnity relates to the automatic sum insured increases linked to CPI.
Under an indemnity policy, if the monthly benefit has increased over time to a point where it actually exceeds the client’s actual pre-disability income the difference between the two figures would not be payable.
For example, if indexation of 5 per cent had applied each year to a $6,250 monthly benefit, by Year 5 the benefit amount would have increased to $7,597 (75 per cent of $126,876).
If at the time of claim the client was only earning $110,000 then all he would receive under an indemnity policy would be $6,875.
By comparison, the higher benefit of $7,597 is completely locked in under an agreed value contract and would be paid.
This situation no doubt happens quite frequently, and I’m sure when it does that most clients are not impressed. Given that a client would always wish to maximise their claim at a time of need this is another good reason to consider agreed value cover.
4. Indemnity policies often have stricter offset clauses
Other than the risk of declining income due to changes in a client’s circumstances, an indemnity contract may actually pay less than an agreed value due to how the insurer applies offset clauses.
Many insurers have different offset clauses for indemnity policies with their agreed value policies providing more generous outcomes with fewer restrictions.
5. Financially endorsed agreed value policies are so much easier for a client at claim time
If a client is unfortunately in a position where they have lodged a claim, the last thing they need at such an emotional and worrying time is the stress of having to dig up payslips, profit and loss statements and tax returns.
And it is the last thing the adviser needs as well! Stress when dealing with an indemnity claim can be magnified greatly if you are trying to secure a favourable outcome for your client by having the insurer assess a non-tax year ‘best 12 months’.
This is easier said than done, trust me – I’ve been there, done that! Last year I was personally involved in a very stressful indemnity claim for a self-employed business owner which did not have a happy outcome … this claim involved an assessment of income across two separate tax years and there were a lot of unknowns and inconsistencies in regards to how the insurer actually went about determining that ‘best 12 months’ of income.
For all of the reasons I’ve detailed above, as well as those listed in my previous article, I am a huge fan of agreed value income protection. The increased comfort, peace of mind and certainty these policies provide is worth the extra premium.
Richard Monroe, LFC Financial
Hey Jm, sorry I didn’t see this reply. Thanks for your insights. It’s clear there are a lot of assumptions here. I would think it’s really worth testing this assumption that people look to stay on claim. I hear it often but I never see it backed up. My (statistically insignificant) experience has been that the disabled despise their position and dependence and on a third party and look for ways to become independent. We should more time pricing products appropriately, providing intensive and easy assistance upfront to deliver “wow” moments and then supporting the fastest return to self reliance possible.
Hi Michael,
While there is not as much research available as we’d like, the research that is available does show very clearly that increasing the replacement ratio has a large impact on claims costs across the board. This is also consistent with the message I’ve heard when I talk with claims managers.
In my view there is no doubt that the cost crisis does reflect in part the adding of features without corresponding price increases. [The increasing reliance of rating houses over the last decade has certainly not helped in this regard, encouraging features may be hard to argue are in total in the best interests of clients.]. I suspect that the cost increase has been greater than expected due to the increasing incentives to claim or stay on claim from the new features. We need to reconsider the appropriateness of some of these features in context of their cost to the entire pool.
On the rehab question, I think that most life companies would admit they have under-resourced on this aspect, and I see a lot more action going into this area. Hopefully we’ll see some improvements over coming years.
Your last example is a good one of the complexities that can exist, and I’m not sure I see a perfect solution. Every time we try to do the right thing for a client like you explain, we end up letting many more take unfair advantage of it. My view is we have leaned too far, and some rebalancing is needed urgently.
Hello JM, nice reply. Do we have data to back up the assumption that people with an incentive to stay on claim do? Has that risk been demonstrated across the pool? Is this cost crisis simply a reflection of the fact that insurers have added feature after feature over a relatively short time period and failed to effectively price enhancements such as crisis benefits, specified injury benefits and partial payments? Have insurers adequately managed claimant rehabilitation? Many simply seek to limit payments to the agreed benefit rather than looking out of the box for solutions that reduce claim duration.
On the other side of the moral hazard relating to over payment is the consumers expectation of being paid a claim for the benefit they pay a premium for. I have seen in the past a person with early stages of mental illness reduce working hours or change occupations to improve their mental health only to collapse and go on claim a few years later. Would this person be over insured or simply on claim for an illness that reduced their income before it stole their ability to work?
Hi Richard,
thanks for your articles. Up-front, I am not a planner. I’m a
pricing actuary and would like to offer a different perspective,
especially to some of the issues raised in your first article. My
company, like most of the industry, is making losses on IP business.
Across the industry APRA quarterly statistics revealed the industry
reported losses on retail IP of almost $0.6b in 2014.
That’s pretty huge. Claims costs have been increasing for some time, and
the profitability situation appears to be getting worse. As you I read
through your articles on why you prefer agreed value, I saw quite a
few examples of moral hazard and examples of what I see are problems
with agreed value contracts. For example, if someone decides to change
career and earn less money, there is clearly a moral hazard if their IP
insurance continues at the previous career higher earning rate. If they
get ill, they are better off financially staying on claim than returning to
work. A number of your reasons had similar outcomes. From my
perspective, it doesn’t make sense to provide insurance on this
basis. On the one hand I can understand the sentiment that, as a
planner, you want to maximise claims for your clients. Yet, how do we
balance this with the fact when we pay too much (as happens in many of
your examples), we encourage people to stay on claim. In many cases
a better outcome would be to a return to work, as many studies have
shown. And of course, the more people we incentivise to stay on claim,
the higher the claims cost, and the higher the premiums for all
customers.
Hi Richard, thanks for your articles. Up-front, I am not a planner. I’m a pricing actuary. I would like to offer a different perspective to some of the issues raised (especially in your first article). My company, like most of the industry, is making losses on IP business. Across the industry APRA quarterly statistics revealed the industry reported losses on retail IP of almost $0.6b in 2014. That’s pretty huge. Claims costs have been increasing for some time, and the profitability situation appears to be getting worse. As I read through your articles on why you prefer agreed value, I saw quite a few examples of moral hazard and examples of what I consider are problems with agreed value contracts. For example, if someone decides to change career and earn less money, there is clearly a moral hazard if their IP insurance continues at the previous career higher earning rate. If they get ill, they are better off financially staying on claim than returning to work. A number of your noted benefits of agreed value contracts had similar outcomes. From my perspective, it doesn’t make sense to provide insurance on the basis of what is, effectively, over-insurance. On the one hand I can understand the sentiment that, as a planner, you want to maximise claims for your clients. Yet, how do we balance this with the fact when we pay too much (as happens in a number of your examples), we encourage people to stay on claim. In many cases a better outcome would be to a return to work, as many studies have shown. And of course, the more people incentivised to stay on claim, the higher the claims cost, and the higher the premiums for all customers.