Agreed Value Income Protection Insurance
Income protection insurance is a financial safeguard, offering policy holders a safety net when they are unable to work due to sickness or injury. There are two main types of cover that have traditionally been available: agreed value and indemnity value. However, as of 2020, agreed value policies are no longer offered to new clients, leading us to question what made these policies so valuable and why the industry shifted away from them.
This blog will provide an overview of agreed value income protection policies, their benefits, downsides, and the implications of their unavailability for new clients.
What is an Agreed Value Income Protection Policy
An agreed value income protection policy is a type of insurance that pays an agreed monthly benefit if you are unable to work due to sickness or injury. The monthly benefit is based on your income at the time of taking out the policy, rather than at the time of claim.
In summary, you and the insurer agree on how much your income protection benefit will be, and that amount remains fixed, regardless of any changes to your income over time.
In comparison, an indemnity value policy pays a benefit based on your income at the time of the claim. This means that if your income has decreased since you took out the policy, your payout will be lower, which can cause a financial impact if your income significantly drops before the time of your claim.
The Benefits of Agreed Value Policies
Agreed value policies were often the preferred choice for income protection policies. Below are some of the key benefits of agreed value policies:
1) Certainty and Security
One of the most significant advantages of agreed value policies was the certainty they offered. When the policy started, the cover amount was set based on your income at the time, and that amount remained fixed throughout the life of the policy. Even if your income dropped due to personal circumstances, career change, the benefit would stay the same. This was particularly important for people whose income could vary from year to year, as it provided peace of mind knowing their protection would remain consistent.
2) Self-Employed
People with inconsistent income, such as consultants or small business owners, often found agreed value policies to be ideal. Unlike employees on a regular salary, self-employed individuals may experience significant shifts in income. With an agreed value policy, they could lock in a benefit based on a good earning year, avoiding the risk of receiving a lower benefit if they had a bad few financial years right before a claim.
3) Avoiding Documentation Issues at Claim Time
With an agreed value policy, the cover amount was calculated at the start of the policy. The insurer would generally request evidence of income such as pay slips or tax returns. Meaning at the time of claim there was generally no need to provide any proof of income. This can result in a simple and quicker claims process. In comparison, indemnity policies require proof of income at the time of claim, which can sometimes be time consuming and stressful, especially if you are dealing with an illness or injury at the same time and the uncertainty of how much you will be paid.
The Downsides of Agreed Value Policies
While agreed value policies had clear advantages, they also had some drawbacks. Some of the disadvantages included:
1) Higher Premiums
The certainty and flexibility by agreed value policies resulted in a higher cost. In general, premiums for agreed value policies were higher than indemnity policies. This was due to the insurer taking on more risk by guaranteeing a set payment, regardless of changes in income.
2) Over insurance Risk
If you took out an agreed value policy based on higher income but later moved to a lower-paying job, you could be receiving more in benefits than you would have earned while working. While this might sound like a bonus, over insurance can create issues. Over time, insurers and regulators began to view over insurance as a potential problem that could result in rising premiums for all policyholders and needing to be addressed.
The Phase-Out of Agreed Value Policies
In 2020, following recommendations from the Australian Prudential Regulation Authority (APRA), agreed value income protection policies were discontinued for new clients. The decision was part of a broader regulatory effort to ensure the long-term sustainability of income protection insurance, which had been experiencing significant losses due to rising claims.
APRA identified several issues with income protection insurance:
Over Insurance: As noted earlier, agreed value policies can lead to policyholders being overinsured, resulting in higher claims costs for insurers which leads to rising premiums for policy holders
Unsustainable Premiums: The cost of income protection insurance, particularly agreed value policies, had been increasing due to rising claims costs. Insurers were struggling to maintain profitability in this market, leading to concerns that if premiums continued to rise, income protection could become unaffordable, and those who held insurance would be unable to retain it.
Moral Hazard: As agreed value policies locked in a cover amount this created the potential for a moral hazard. Policyholders could be incentivised to claim on their policy even when they might have been able to return to work or accept a lower-paying role, knowing that their insurance benefit would exceed their current employment income.
What This Means for Policyholders
While agreed value policies are no longer available to new clients, those who already held cover before the changes are generally able to retain their cover, provided they continue paying their premiums. Below are some important considerations for existing policyholders:
Rising Premiums: As the income protection insurance market continues to adjust to regulatory changes and rising claims costs, many existing policyholders are seeing their premiums increase significantly. If you are holding an agreed value policy, it’s important to review the policy regularly to ensure it still meets your needs, whilst also remembering they are highly comprehensive compared to the new products available.
Seek Professional Advice: If you are unsure if your policy still meets your needs or are finding the premium increases difficult to sustain, it can be worth speaking to a financial advisor. We are able to review your policy and discuss your options.
The Future of Income Protection Insurance
The removal of new agreed value policies marked a significant shift in the insurance market. As the industry adjusts to these changes, it’s important to carefully consider your income protection needs and ensure you have the right level of cover in place. For those with existing policies, it’s important to understand your policy in detail before making any changes. By seeking professional advice, you will have help to navigate these changes and ensure you’re still getting the protection you need.
After working as an advisor for a decade, Joel founded Unified Wealth.
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