The Complete Guide To Income Protection

Nobody wants to think about being unable to work due to illness or injury. However, it is important to protect your family’s income in the event of not being able to work.

Employer sick pay does not last indefinitely and social welfare payments are a safety net but would probably not pay for all of your bills and expenses. This is where income protection insurance comes in.

Who offers income protection insurance in Ireland

What is your most valuable asset?

Common answers for a person’s most valuable asset  may include the family home, pensions and/or personal investment portfolios. 

While the actual answer might differ from person to person, in many cases, it’s none of the aforementioned suggestions. Oftentimes, the most valuable asset that’s owned by an individual is their ability to earn an income

For example, take a newly qualified accountant working for one of the Big 4 financial services firms. He/she is likely around 25 years old. 

According to Morgan McKinley, newly qualified accountants from the Big 4 are the most in-demand workers within the accountancy and finance space. Such workers command a salary of between €60,000-€70,000 per annum in Dublin.

Over the course of their career, these workers will very likely have salaries in excess of €100,000 per annum for prolonged periods of time. 

If we assume that the individual will earn an average salary of €90,000 per annum over 35 years (i.e. to age 60) then he/she will earn €3,150,000 before tax over the course of their working life. 

Assuming an effective tax rate of 35%, we’re left with €2,047,500. We then need to account for the time value of money and arrive at the present value of the worker’s future cash flows. 

To do this, we need to assume a discount rate. There is much debate as to what’s an appropriate discount rate to use, but for argument’s sake, we’ll assume 3%. 

The present value of €2,047,500 over 35 years assuming a discount rate of 3% is €1,257,002. Therefore, we can value the workers ability to earn an income at €1,257,002 – quite a valuable asset indeed.

The value of our respective abilities to earn an income will depend on the income levels that we can command within our respective lines of work, years until retirement, taxation and the discount rate assumed. But clearly, our ability to earn money is incredibly valuable

If we were to lose our ability to earn money, say, due to an injury or serious illness, both our present and future financial stability could be placed into jeopardy. This is because a loss of household income upon sickness or disability can create what is known as an “income protection gap”.

According to Zurich, income protection gaps are not only damaging to households but also to businesses, governments and the economy as a whole. This is because income protection gaps have the capacity to undermine productivity within the workforce. 

This phenomenon (i.e. working while sick because you can’t afford to not work) is known as “presenteeism” and it costs U.S businesses an estimated $150bn per year!

One solution to the problem for all stakeholders is income protection insurance.

Did you know?

In the EU, you’re 15% more likely to face poverty and/or social exclusion with a medical disability.

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Income Protection

Overview

The basic premise of income protection is that it serves as a regular source of income for an individual should he/she suffer a loss of earnings by virtue of not being able to work due to sickness and/or disability. 

Income protection policies are attractive as claims under the policy, where eligible, can typically be made for a long period of time so long as the insurance premiums are paid and payouts remain eligible.

Why Doesn’t Everyone Have Income Protection?

If our ability to earn an income is so valuable then why doesn’t everyone have an income protection policy? 

One reason is because there are misconceptions about the cost of income protection.

Zurich reported that 52% of respondents without income protection insurance would consider buying it and that the main reason for not having it was a perceived high cost. Yet, when asked how much they’d be willing to pay for income protection insurance (~5% of monthly income), this figure was higher than the average cost of income protection insurance for most people. Thus, highlighting a knowledge gap.

There are also gender and household roles to consider. While men are more likely than women to have income protection insurance, the factor most likely to influence the income protection decision is being the primary household earner. 

Furthermore, Zurich finds that first-hand experience plays a greater role than financial literacy when influencing demand for income protection. 

This makes sense in the context of the old adage “hindsight is 20/20 but foresight is legally blind”

In this context, the value of income protection only tends to resonate with people after something bad has happened and an income protection gap has arisen (that’s when it’s too late!).

Income Protection Insurance Providers

Aviva - Home Insurance
Zurich - Home Insurance

Deferred Periods

Where an individual suffers a loss of earnings by virtue of not being able to work due to sickness and/or disability, payment under an income protection policy will only take effect in the event that the sickness and/or disability lasts for longer than the “deferred period” which is specified in the policy. 

Deferred periods can typically be 13, 26 or 52 weeks in duration. 

A shorter deferred period will result in a higher insurance premium given that the benefit becomes payable sooner. 

Depending on the policy terms, a deferred period may only have to be fulfilled once where future claims under the income protection policy arise from the same cause of the original loss of earnings (i.e. where the same sickness and/or disability causes recurring periods of loss of income).

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Income Protection Payouts

Similar to other insurance policies, certain restrictions may apply to income protection policies and payouts arising from such.

For example, where an individual engages in deliberate non-disclosure of material facts about their medical history and current health status. In their income protection underwriting guide Aviva highlight a number of medical conditions that would influence the underwriting process and would therefore need to be disclosed (this is not an exhaustive list):

  • Abnormal smears
  • Anxiety and depression
  • Asthma
  • Awaiting medical procedures
  • Back pain
  • Basal cell carcinoma
  • Blindness
  • Cancer
  • Crohn’s disease
  • Deafness
  • Diabetes
  • Epilepsy
  • Fibromyalgia
  • Gout
  • High blood pressure and high cholesterol
  • Irritable bowel syndrome
  • Kidney stones
  • Lumps and growths
  • Obesity
  • Ulcerative colitis
  • Ulcers

Furthermore, Aviva notes certain medical conditions which may make an application for income protection unacceptable. These include, but are not limited to:

  • Diabetes (under age 45)
  • Gross obesity
  • Heart attack
  • HIV/AIDS
  • Multiple sclerosis
  • Schizophrenia

However, where payouts are made under an income protection policy (i.e. where it is proven that the individual is unable to carry out the essential duties of their job or based on another metric), they will continue until the earlier of the following events:

  • The individual returns to work
  • The individual is deemed by the policy provider as being fit to return to work
  • The benefit cessation age is reached (maximum age 70)
  • The individual retires or ceases employment

Individuals who return to work either part-time or in a lower income role than they were in before the original claim may receive what’s known as a “rehab benefit”

In such a circumstance, the life insurance company would continue to pay part of the income benefit payable under the policy in addition to the individual’s new income. 

The rationale behind such a benefit is to encourage a partial return to work where medically possible.

In terms of how much cash is payable under an income protection policy, the maximum you can receive as per the CCPC is equal to 75% of pre-disability earnings less your State illness benefit entitlement and any sick pay you receive

As an example, say your salary was equal to €60,000 and you insured that income up to the maximum permissible limit of 75% (i.e. €45,000). 

If you received the maximum State illness benefit of €12,064, then the maximum benefit payable under the policy would be €32,936 per annum or €2,745 per month. 

how much of your income is covered

The reason why a cap of 75% is applied is because the life insurance companies will always want to make sure that there’s a financial incentive for the policyholder to return to work. The life insurance companies will typically restrict the maximum benefit that’s payable in any given year under the policy.

For example, in the case of Aviva, the maximum annual benefit that’s payable is €250,000 (per year) before indexation. 

The maximum benefit calculation can differ between company directors, self-employed persons, employees and homemakers/carers. Note that certain life insurance companies will permit employer contributions to the employee’s approved pension scheme to be covered.

Make no mistake about it, payouts from life insurance companies under income protection policies can and do happen. 

In 2022, Aviva paid out a record €48M to customers with income protection insurance. The primary causation for claims was psychological issues & mental health. 

According to their website, 56% of claims came from women to which the average annual payment was €34,500. The remaining 44% came from men to which the average annual payment was €51,000. 

Similarly, in 2022, Zurich handled claims from 360 claimants and are paying over €9M annually in claims. 

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Income Protection Premiums

Many individuals with income protection cover have obtained that cover through employer group schemes. In accordance with Revenue guidance, PAYE taxpayers can get tax relief on income protection premiums paid by way of deduction at source by their employer. 

Relief from income tax is afforded at the individual’s marginal rate up to an annual limit of 10% of total income. Note that USC and PRSI are still applicable. Your employer may also contribute money towards the payment of premiums and, where this occurs, only USC is payable on the contributions. Where the combined contributions of both the employee and employer exceed 10% of the employee’s income, income tax and PRSI will apply to the excess.

In return for the payment of a premium, an income protection policy will provide a fixed level of cover for the term of the policy. Similar to other policies, the policyholder may opt to include an “indexation option” whereby the level of cover is increased (irrespective of health status) in return for a higher premium.

How much tax relief is there on income protection insurance

How much premium you pay is largely dependent on the nature of your occupation. 

For example, premiums will typically be “banded” whereby low risk occupations pay the lowest premiums and high risk occupations pay the highest premiums. 

The occupational classifications are as follows:

  • Occupational Class 1: professional, managerial occupations, administration, clerical
  • Occupational Class 2: occupations involving occasional manual work
  • Occupational Class 3: skilled non-manual and manual occupations
  • Occupational Class 4: partly skilled and unskilled manual occupations
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Certain occupations may be too risky to insure, including occupations where the individual works:

  • At heights
  • Underground
  • Offshore
  • Underwater
  • With chemicals, explosives and/or machinery

Examples of denied occupations may include:

  • Armed forces
  • Commercial drivers
  • Professional sports persons
  • Security service personnel
  • Pilot
  • Fire brigade

Where the life insurance company feels that the risk is higher than what was accounted for by the actuaries in their regular premium pricing, an extra premium up to a specified percentage may be charged. This is referred to as “premium loading”

Where the risk is too great for premium loading, but is not so great that it can’t be covered, the life insurance company may offer coverage but with an exclusion that prevents a payout in the event of sickness and/or disability due to the identified risk.

Factors To Consider: Income Protection

  • Policy premiums may increase at a future date under reviewable policies
  • Maximum benefit clauses result in the insured individual not being able to fully claim the level of cover that they paid for
  • Claims may not be approved by the life insurance company following a review
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