Diana Clement: Earnings insurance for difficult times

It's amazing what a year can do in the psyche of investors. At the beginning of 2007 a good chunk of us thought ourselves invincible. But by midyear, many were scrambling to take out insurance cover for income.

Unlike in some countries, unemployment insurance is thin on the ground here. Some insurance brokers will even say that you can't get redundancy cover at all.

Laurence Louw, financial services general manager at insurance broker Crombie Lockwood, says insurers are not keen to provide comprehensive unemployment cover.

"There is a lack of incentive for that [unemployed] person to rehabilitate and potentially find another job."

Try, however, to pay a $300,000 mortgage on the state unemployment benefit and it pretty soon becomes apparent why cover may be needed.

In Britain and US it's possible to buy redundancy cover that pays a percentage of your income for a number of months or years if you lose your job.

Tasman Pacific Insurance offered such cover here until two years ago. But, says claims manager Joe Evans, although popular, it wasn't economically viable for the company.

Evans isn't aware of any other companies in New Zealand that offer such policies.

In the absence of the type of full redundancy cover available overseas, some people choose just to cover their mortgage or other debt against loss of income.

Even this cover is usually limited to life, illness and accident cover and only for the property you live in.

Such policies don't cover redundancy or any rental properties you may own.

Redundancy cover is offered by a small number of insurers as an extension to their mortgage protection policies, says Peter Lewis, of Quicksmart Mortgages & Insurance.

Those insurers include AIG Life, AMP and Sovereign.

People who take out home loans rarely think they may be made redundant.

Some also fail to factor in the cost of insuring their mortgage payments, thinking they'll do it later, but often not doing so because of the cost, or through apathy.

It becomes even more important for property investors. Mortgage broker Jonathan Michell, also of Quicksmart, says it's not unusual for property investors to spend $50 to $80 a fortnight topping up their mortgages as well as paying their own home loan.

If those people lose their jobs or are incapacitated, they stand to lose a lot.

Although a godsend for some people, redundancy cover for mortgage repayments is not cheap. For example AIG Life's mortgage protection cover for $2000 a month, including redundancy, costs about $83 a month for a non-smoking 40-year-old male and $139 for a female of the same age.

The cover has a 30-day stand-down period before you can claim.

AMP's home loan redundancy cover has a similar stand-down period.

Interestingly cover under these policies isn't just limited to the actual mortgage payment.

AMP, for example, covers up to 160 per cent of monthly mortgage repayments.

More than a few people who have taken out redundancy cover in the past year have found themselves having to claim.

So much so that insurer Sovereign has just introduced a six-month stand-down period for anyone taking out a new policy from this month.

Sovereign, which launched its redundancy cover extension to its freehold mortgage protection plan in May 2007, wrote in a letter to industry professionals last week:

"Sovereign needs to take measures to minimise the exposure to customers who take a redundancy policy knowing they will be made redundant."

Some insurers are also expecting an upswing in fraudulent claims.

Certainly it's not unusual for claims to happen shortly after the insurance is taken out.

In one case considered by the insurance ombudsman a person took out redundancy cover despite having had discussions and a letter suggesting that his job was insecure.

In the proposal form he answered "no" to the question: "Are you aware of any pending redundancy or liquidation at your place of permanent employment or have you been advised that you may be made redundant?"

The ombudsman agreed with the insurer that the customer must have been aware, or could reasonably have been expected to be aware, that he may be made redundant before signing up for the policy thanks to the letter he had received from his employer discussing his future employment prospects.

Even if you don't take the more expensive redundancy cover offered by some insurers, it can be worthwhile taking out a policy or policies that cover you in the event of illness or disablement. The most common policies are:

Life.

Trauma.

Total permanent disablement.

Every insurer's cover is different. This can be tricky for someone trying to choose his or her own policy.

For example, about 30 different conditions are covered by insurers, says Louw. But not all cover every condition and definitions vary.

Louw adds that total permanent disablement policies are becoming increasingly expensive.

They pay out a percentage of your income if you're unable to work through sickness or injury. Instead, he often recommends trauma cover to people, which mostly provides a payment - usually a lump sum - if they suffer a specified critical condition, such as heart attack, stroke and most cancers.

From the insurer's perspective it may be cheaper to pay out a fixed amount rather than a percentage of income for an undefined period.

Interestingly, says Louw, his company has seen an increase in inquiries about health and income protection-style policies over the past 18 months, in part, he believes, through people's rising debt and also the economic situation.

"People are recognising their greatest asset is their own ability to earn an income," he says.

While it's possible to get all sorts of accident, sickness and unemployment insurance to cover personal loans, hire purchase debts and credit card balances, not all may be necessary.

The Consumer's Institute advises against getting credit card repayment insurance - which it says costs around 15 per cent of the credit card balance each month. Instead it suggests having a rainy day fund.

Likewise it recommends against taking out accidental death insurance.

"This insurance only covers accidents. Die from heart disease or cancer - the leading causes of death by a long way - and it won't pay out."

Instead it recommends people consider taking out term life insurance.

There are other ways of self-insuring as well. At the simplest level that may mean building up a rainy day fund of living expenses to last for three to six months.

Few people realise that they can call on their KiwiSaver investment when they are in financial hardship through unemployment or sickness.

Or, for that matter, that it's possible to live off equity in your home for a while - assuming you have some.

The catch here is that your lender may not let you extend your home loan if you're unemployed, says Lewis.

One way around this is to set up a portion of the mortgage in a revolving credit account that you can borrow against should you lose your job. Lenders sometimes offer mortgage holidays as well.

It's worth reading the fine print of any of the policies mentioned in this article carefully. Some have very nasty stings in their tails.