I've spent 24 years in financial services, during which time I've worked on a significant number of difficult income protection claims. I still don't understand why the indemnity-first approach for income protection still prevails with the majority of advisers in today's environment.

Well, I do. It's not the client-first approach we'd all like to expect. Advisers have to do less and get paid more, but that's another story.

The following was the explanation from a client's former adviser on the differences between indemnity and agreed value.

While some of it is correct and some of it is justified on the surface. It's not the level of understanding you as the consumer need from your adviser

The previous advisers' assertions;

The main differences between an agreed value and an indemnity value policy:

1. An agreed value/loss of earnings policy has a maximum insured benefit of 55% of income at application time whereas an indemnity value cover has an insured benefit of up to 75%
2. In the event of a claim, (subject to the policy terms), an agreed value policy would pay the insured benefit amount irrespective of what the insured’s income was prior to the claim whereas an indemnity value policy would pay the lessor of the insured benefit amount and 75% of income prior to claim using the best consecutive 12 months in the three years prior to the claim
3. Any benefit received from an agreed value policy would not be subject to income tax whereas the benefit from an indemnity value cover is subject to income tax
4. The premium payments for an indemnity value policy are an allowable tax deductible expense whereas those for an agreed are not
5. Essentially, an agreed value policy is more suitable for a self-employed person and/or one with a fluctuating income because it provides more certainty at claim time as to the benefit received.
6. Any ‘other’ ongoing income (including ACC) may be offset in the event of a claim. (at the other end, ACC also asks the question ‘Are you receiving any other income in respect of this claim so the insurance benefit made be offset from any ACC benefit

Let's have a closer look at each of these statements

Replacement Ratio

1. An agreed value/loss of earnings policy has a maximum insured benefit of 55% of income at application time whereas an indemnity value cover has an insured benefit of up to 75%

• Yes, this was true at the time; now, we can insure up to 62.5% on the agreed value.
  • • What needs to be understood is that the difference in cover amounts accounts for the different tax treatments.
    • The 75% cover is tax assessable, but the agreed value is not.
    • The perception is you can get more cover on indemnity.
  • The reality is that after tax is in your hand, the agreed value will almost always pay you more.

Claim Calculation

2. In the event of a claim, (subject to the policy terms), an agreed value policy would pay the insured benefit amount irrespective of what the insured’s income was prior to the claim whereas an indemnity value policy would pay the lessor of the insured benefit amount and 75% of income prior to claim using the best consecutive 12 months in the three years prior to the claim

• The point here is lessor. Agreed is agreed, that’s the level you pay for and the level you get paid. With CPI or indexation operating on the policy, it will grow in claimable value over time. 
• With Agreed, the agreed value amount is what is paid; the indemnity cover would pay 75% of what you could prove or the sum insured, whichever is lower. If your income dropped or your pay increases didn’t keep up with inflation, then on the indemnity policy, you will be overinsured for what you could claim.

Tax Treatment

3. Any benefit received from an agreed value policy would not be subject to income tax whereas the benefit from an indemnity value cover is subject to income tax

• Correct, this is a key point to understand what you are actually covered for.

Tax Assessability

4. The premium payments for an indemnity value policy are an allowable tax deductible expense whereas those for an agreed are not

• Correct. Keeping in mind the 55/75% ratio from point one, the agreed policy would have 20% fewer dollars in cover amount, and this would come at a relatively lower premium. 
• Once the tax deduction was claimed on the 75% policy, you typically ended up in much the same place premium-wise.
• The ‘sales’ technique, "buy this one, you can claim the deduction," is just that—a sales technique.
  • This sales technique results in you having less secure cover for a higher perceived value that’s actually not there.

Certain Occupations Better Aligned?

5. Essentially, an agreed value policy is more suitable for a self-employed person and/or one with a fluctuating income because it provides more certainty at claim time as to the benefit received.

• I flatly disagree.
• If your income fluctuated as a self-employed person, the insurance company generally wouldn’t offer agreed value but only indemnity value.
• Real estate agents are a great example; most of the time, we can generally only get indemnity coverage for Real Estate Agents and commission salespeople as their income fluctuates with the market.
• It's often not stable enough for the insurance company to offer an agreed risk. 

Agreed value provides certainty for everyone and should be the preferred cover in all cases.

• In my client's case, we can protect their high salary earnings now, and if they do go contracting or self-employed, then this is locked away regardless of what they earn from there.
• If their income ends up being higher, then we review and increase as required.
• In all cases locking away the ability to claim the benefit, you are paying for.

Degenerative Claims

Statement 5 also demonstrates a lack of understanding of a degenerative claim.

• Take multiple sclerosis; this condition affects people over a long period of time.
• If it takes eight years to go from good health to disabled health, then the indemnity policy will fall short. 

The earnings at the beginning are likely to be the highest, with the last three years before disability being the lowest.

•  The agreed value policy will pay the agreed amount from way back at the beginning, plus CPI increases since it was taken.
• The indemnity policy is going to pay 75% of the best 12 months of the 36 months directly preceding the date of disability, which is eight years after the diagnosis.
  • Potentially, the indemnity policy is going to be almost worthless at this point.

Other Income or Earnings

6. Any ‘other’ ongoing income (including ACC) may be offset in the event of a claim. (At the other end, ACC also asks the question ‘Are you receiving any other income in respect of this claim?' so the insurance benefit may be offset by any ACC benefit.)

• Yes, this applies equally to agreed-value and indemnity covers.
• Typically, ACC pays, and then the income protection pays a top-up if there’s still a shortfall.
• I've yet to see ACC offset a claim because an insurance policy was paying, as they are legally obliged to pay for accident-related disability.
• The key difference with offsets is that the Agreed-Value policies offset the life assured’s exertion-based earnings, while indemnity typically offsets all earnings. Some insurers have recently added exertion earnings criteria to claim calculations. 

Other workers

If you put another person into your business to run it and they maintain the profit, your indemnity policy often wouldn’t pay a claim.

• In the same situation, with an agreed-value policy; the profit comes from the business because someone else made it, not the insured person's exertion, and an agreed-value claim gets paid. (if your indemnity or loss of earnings policy has exertion criteria added, then this also applies.)

To mitigate the offset of ACC, we would also look at mortgage repayment protection, which has no offsets, where a mortgage payment can be insured.

The answers for you:

If you want cheap cover, any adviser can find you a cheap policy, if you want an effective income protection cover have a chat with us, so you get it right at claim time.

Often, our approach results in a similar or lower premium with the security of the claim and without additional hassles.

You pay good money to be covered. If you never expect to claim, why do you pay a premium? If you're paying a premium, make sure you're covered with the right coverage.

Get in touch with us for a free review to assess your needs