Money: Price tag on pay cheques

By PHILIP MACALISTER

If someone asks you what your most valuable asset is, you probably say your house. But, unless you are retired or close to it, you are almost certainly wrong. The biggest asset you have is your ability to earn income.

The best way to illustrate the size of this asset is to look at the potential earning capacity of a 40-year-old on $65,000 a year. This person can expect to earn $1.63 million (in 2000 dollars) in the 25 years to retirement.

Odds are this big asset is unprotected. With other big assets, such as your house and car, you will more than likely have them insured. It is far less likely your future income streams are insured against accident or disability which may force you out of work for lengthy periods.

Income protection, or disability income insurance, has been a strong growth market in recent years, yet fewer than 100,000 people are covered.

There are 21 standalone guaranteed renewable income protection contracts on the market in New Zealand. Being guaranteed, renewable contracts insurance companies cannot cancel individual policies and cannot single you out for a premium rise. Instead, the contracts have to be treated as a group.

The basic philosophy behind income protection is that the life office will pay you a portion of your wage or salary if you have to stop work because of accident or injury.

This insurance has traditionally been bought by the self-employed, whether they run a small landscaping business or manage a medium-size manufacturing business. But the case is growing for wage and salary earners to consider buying a policy.

The reality is the Accident Compensation Corporation will not pay out in all situations, and pays less than in the past.

For instance, if you are forced out of work for an extended period due to, say, a health-related condition such as hepatitis or a stroke, then you will not have any income unless you have insurance.

Likewise, ACC is not likely to cover you for stress or depression.

Tower Health managing director Jim Minto says more than 50 per cent of claims against income protection contracts are for these types of non-medical events. For these reasons income protection is "a core element" of any financial plan.

The simple appearance of income protection insurance belies its complexity. American International Assurance general manager David Whyte says: "Price is only one factor and it is not the determining factor."

Picking the right policy is about getting certain elements right: the type of policy, the definitions used in the policy document including what is a total disability and what is a partial disability, the track record of the insurer and finally the premium price.

This type of insurance comes in two forms: indemnity and agreed value policies.

With an indemnity option the insurer will pay you 75 per cent of your pre-disability income. With an agreed value policy the payout is determined by you and your insurer at the time you pay for the cover. The catch is that the payout cannot be more than two-thirds of your pre-disability income.

While most people do not bother reading the fine print of policy documents, it is well worth doing with income protection.

You will find that insurance companies use different definitions of what is a disability and whether it is partial or total.

It can have a significant bearing on the payments made if you have to claim.

Further issues arise in the way the company may treat other income earned while you are off work and the calculation of this may impact on the level of payouts.

Given the complexity, Mr Whyte says: "It is unlikely that the average consumer is going to be able to make a useful comparison without the help of a qualified adviser."

The other big warning is what is likely to happen to premiums in the future.

Many life companies are taking a bath on income protection insurance. Consequently, premiums are likely to skyrocket.

In some cases in the past year, increases have been double-digit.

The primary reasons are poor past underwriting practices and longer-than-expected claim periods.

Companies in Australia and the United States have also been struggling with these problems. AXA, in the 12 months to September 1999, lost $A22 million on income protection in Australia. Life companies are tightening up their claims management and trying to get people back to work as soon as possible.

They may start to make it much harder for people to have extended lengths of time on a claim.

In the United States, for instance, it is now difficult to buy a policy which has a waiting period of less than 60 days. That is, you have to be off work for 60 days before receiving a payment from the insurer. Also, benefit periods are reducing and many occupations have been moved into categories with higher premiums.

Some US companies have withdrawn from this market totally, and others have removed the bells and whistles in their policies to bring down costs.

Mr Whyte says the key lessons out of these changes are that you should know the track record of a life company's premium history before signing on the dotted line.

He contends that if a company has been increasing its rates significantly, it is likely to continue doing so. "Advisers need to look for [life] offices with a stable price and benefits history."

A final point people should consider when looking at buying an income protection (or any sort of life policy) is the claims paying ability of the company.

At present, it is mandatory for non-life companies to get an independent rating from an agency such as Standard & Poor's. While it is not required of life insurers, some have gone through the ratings process as it gives customers a better feel for the strength of the company.

After all, with a life policy you want to know if the company is likely to be around in the future if you need to make a claim.

* Philip Macalister is the editor of online money management magazine Good Returns. Good Returns provides news on managed funds, mortgages, insurance, superannuation and financial planning.