The Value of Income Protection  25th June 2009

Matt is a 35-year old self employed electrical contractor living in Melbourne’s outer suburbs. He is in a business partnership with his wife, Jenny, aged 30, and they have two young children, aged six and four. Matt generates the income whilst Jenny organises Matt’s work appointments and keeps the books for the business. Matt generates an income of $110,000 after expenses. The couple have a $300,000 home mortgage, for which they pay $2,105 monthly, and a car lease for Matt’s work van, with repayments of $500 per month.

On the weekend, Matt plays baseball with his former schoolmates. One Saturday, whilst sliding into home base, Matt severely twisted his knee. He was taken to hospital, where it was determined that he needed a full knee reconstruction. The prognosis was good, but the doctors instructed Matt to take four months off work to recuperate.

Matt’s private health insurance covered most of his medical costs. However, what about the income that Matt would lose as a result of his inability to work for the four months? Fortunately for the young family, about a year ago, Matt had taken out an income protection policy, covering 75% of his after expenses earnings, with a 30 day waiting period. This included the full $110,000 generated through his personal exertion and amounted to a monthly income (benefit) of $6,875.

As suggested by his financial adviser, Matt also took out an accident option, which meant the insurer would pay him 1/30th of his benefit for each day that Matt was totally disabled (if he were disabled for at least three days in a row during his waiting period). Since Matt satisfied this definition, he was able to receive the full $6,875 after the first month of total disability, and a total of $27,500 for the four months he was off work. The real value of this to Matt would be the ability to pay his mortgage and lease payments, and to maintain the family’s lifestyle while he was disabled. Matt was also able to insure his business expenses while he was disabled.

Now consider this: If Matt were permanently disabled due to illness or injury, his lost income until the age of 65 (assuming an inflation factor of 3% p.a.) would be just under $3.5 million. The amount of income protection that could be paid to Matt in the same period is just over $2.5 million. This amount would be paid over and above any other insurances he had for total and permanent disability or critical illness.

If Matt took a guaranteed agreed-value policy, his income protection benefit, if he were totally disabled would be payable regardless of a change in occupation, a reduction in income, a change in sporting activities or pastimes or in fact periods of leave or unemployment. In addition, Matt’s income protection premiums would be tax deductible based on his marginal tax rate.

Is it expensive?
In Matt’s case, his after-tax annual premium would be less than 2% of his gross income after business expenses. This premium would be at blue-collar occupation rates, and would be significantly less for a white-collar professional. In addition, Matt could save money by taking cover at level premium rates (premiums do not increase with age) rather than stepped premium rates (premiums do increase with age), which would initially be more expensive, but would provide considerable cost savings in the long-term.

(Courtesy of Comminsure)

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