Monthly paying disability payments. It can be great cover. It can also be a minefield. What is agreed value? What does indemnity mean? And why is ACC in the title??
Key Points:
- Purpose of disability insurance
- Indemnity versus Agreed Value
- ACC, yes it is an insurance firm
Purpose of disability insurance
What is your biggest asset? Your income earning ability. If you cannot work for an extended period, is your income at risk? If so, you probably need financial protection. The title ‘disability cover’ doesn’t do the product category justice. Products like Income Protection and Mortgage Repayment Insurance will cover much more than disability.
Whether because of accident or illness, if you are unable to work, these products can replace part of your income. They will not replace 100% of your income. Even our national insurer, ACC, will only cover to 80% of your gross earnings. The most you can get from private insurance is 75%. Sometimes even that maximum may not be available.
These monthly paying benefits are some of the most complex within the personal insurance suite of products. The underwriting requirements are far more stringent and the components for the cover can be quite intricate.
That said, having some form of income replacement can be exceptionally helpful. Imagine if you were one of the nine men with prostate cancer, or one of the nine women with breast cancer, diagnosed every day in New Zealand. You’d need time off for treatment and recovery. This might take up to two years. Even if your medical costs are covered by health insurance, chances are you will need to step back from work for a period to undergo treatment and recover.
Indemnity versus Agreed Value
Let’s start with Agreed Value. As it says, the amount you can expect to get at claim time is agreed up front. This is done during the policy application right at the start. Typically, if you are taking out a mortgage repayment product, it will be Agreed Value. Many companies will insure 110-115% of your mortgage repayments (the extra allows for interest rate changes).
Confusingly, companies will also let you use their Mortgage Repayment product to insure up to 40-45% of your gross income. As these benefits are usually not off-set by other income (like ACC or other income replacement products), it can be an effective strategy. Being Agreed Value, you have some certainty around what you can expect should you need to claim.
Broadly, Indemnity products are financially assessed at claim time. This means that they will ask you for your financial returns right at the time that you are sick and off work.
These are the products that will typically cover up to 75% of your Gross income. If you are a salaried or wage earner, with consistent earnings, this can be a very effective product to replace a good chunk of your income. Remember you will still be taxed on this.
Just because this is insurance, and some things are never straight-forward, there are Indemnity products that can also be Agreed Value. You may see these labelled as Loss of Earnings Agreed Value. Essentially, they allow you to insure up to 75% of your income, but using the Agreed Value function.
For self-employed people, there are additional challenges with proving their income, normally over a 2-3 year period. Insurance companies will do what they can to help self-employed people get cover, within their risk-assessment mandates. Often, they will look at what expenses can be added back into the income, such as depreciation.
Note: COVID-19 has made Agreed Value products harder to get for self-employed people. Not impossible, but due to so much disruption around incomes, or those who survived on wage subsidies, the risks are harder to assess.
ACC, yes it is an insurance firm
Living in New Zealand it can be easy to forget that ACC runs as an insurance firm. The part of the firm that deals with replacing income due to accident is where we see the greatest similarity to private insurers.
If you are an employee, are unlucky enough to have an accident, and require time off work, ACC will pay up to 80% of your gross earnings. Remember you will still be taxed on this. Your employer is paying your insurance premium via your salary deduction to ACC every pay cycle.
If you are self-employed, you have two options available to you. CoverPlus (Indemnity) and CoverPlusExtra (Agreed Value). By default, you are on CoverPlus if you are registered as self-employed. Normally your accountant will work out an amount that you need to pay ACC at the end of your tax year. Unfortunately, many accountants stop there.
On CoverPlus, ACC will pay you up to 80% of your declared taxable income. If you have a good accountant, they have probably reduced your taxable income quite considerably, using all the legal tax methods. Great. Except for when you have an accident. You will only get 80% of that low income amount. [By the way if you die, the death benefit that your family gets from the Government is also calculated on this lower income amount]. The other thing with ACC CoverPlus is that the maximum income they will use is $130,911.
On CoverPlusExtra, ACC will pay you the amount that you specify. This gives you certainty of income during an uncertain time. However, here too the maximum income they recognise is $130,911, so if your income is more than this, you may want to top it up with other products.
There are some good tactical methods that can be used, combining CoverPlusExtra with private insurance to give you maximum financial protection. Creating some certainty is what personal and financial risk management is all about. Speak with your adviser if you want to know more.