Income protection for the self-employed

28 July 2017

Money & Life team

Money & Life contributors draw on their diverse range of experience to present you with insights and guidance that will help you manage your financial wellbeing, achieve your lifestyle goals and plan for your financial future.

This article considers the specific needs of the self-employed and the policy definition considerations for planners when making insurance recommendations to this group of clients.

This article is for educational purposes only and is no longer available for CPD hours.

Income Protection (IP) can be considered the most universal of insurances when it comes to the different type of people who need it. Rather than considering whether the individual has debts and dependents, or the cost of medical and final expenses, IP needs calculations are quite simple – if you have an earned income, you should protect it.

Self-employed people can be considered among the most vulnerable when it comes to sickness and injury. This vulnerability stems from three main areas: having little or no access to paid leave; experiencing capital and income losses in the event their business value is impacted; and extreme difficulty accessing government benefits due to the complexity of their financial circumstances and record-keeping.

In this article, we’ll consider the specific needs of the self-employed and the policy definition considerations for advisers when making insurance recommendations to this group of clients.

Special risks

Everyone’s circumstances are different, but in many cases the self-employed can be the most exposed when it comes to sickness and injury.

In most cases, there isn’t any sick or annual leave entitlements to rely on and/or the business cannot operate without the business owner. This means that in the event of sickness or injury, the individual is less inclined to cease work, either in whole or in part. This can worsen their sickness or injury and/or result in financial and reputational damage to their business, while they continue to soldier on.

In the event they lose the ability to work entirely, this can affect their income as well as impact the value of their business.

The self-employed also face a high level of difficulty accessing government benefits if forced to rely upon them. Those who have, or had, a business, face the burden of completing additional paperwork to apply for the Disability Support Pension or Newstart allowance, should they find themselves temporarily or permanently disabled. The assessment can then take significantly longer than usual, requiring a complex assessor to consider the application. Current wait times for a complex assessment is approximately three months.

Consider the following case studies.

Case study 1: Stewart

Stewart, aged 39, is an electrician. He works for himself, with his wife assisting with paperwork, and an apprentice working with him at each job.

Over the weekend, he injures his back playing with his kids. His injury means he’s unable to twist, bend and move, making him unable to get into roofs and under floors, and perform his day-to-day duties. His doctor and physiotherapist recommend that he ceases physical work for 6-8 weeks to allow the injury to heal.

Without the ability to work, Stewart will be without income. He is limited to working on his backlog of book-keeping, and taking on certain jobs where he can observe and instruct the apprentice. But for the most part, Stewart is unable to work, and therefore his income reduces significantly. He is uninsured.

Case study 2: John

John, aged 49, is a franchisee. He operates a regional franchise of a large company and his business begins to experience financial problems. At the same time, John is suffering from anxiety and depression, exacerbated by marital issues.

Over the next year, John’s functioning level deteriorates and he has less focus on his business, as his personal problems escalate. John doesn’t feel he can take any time away from the business for his health, as there is no one else to manage the depot. When his marriage comes to an end, John is unable to cope and is hospitalised for five days.

John’s mental health state is severe and he will be unable to return to the business in the foreseeable future. The business has to be sold quickly and returns a ‘fire sale’ price. He’s left with ongoing debts and no income.

John seeks assistance from Centrelink but is not eligible for the Disability Support Pension, as his disability has not yet stabilised and become permanent. Although he is disabled and unable to work, his only option is to apply for the Newstart allowance ($535 a fortnight).

As a prior business owner, operating out of a trust, John is required to complete over 100 pages of paperwork for Centrelink, and requires a complex assessor for his application. The current wait time for this type of assessment is three months.

These case studies illustrate some of the difficulties faced by the self-employed, ranging from needing a policy, which allows them to work and make a claim at the same time, right through to demonstrating how difficult it is to access government safety nets.

If you ask anyone involved in insurance advice about the elements of IP policies that are important for self-employed people, invariably the first suggestion made is that the policy needs to be an Agreed Value contract. This is a good start, but just as much care and consideration needs to be given to the definitions of the policy.

Consideration 1: The definition of total disability

While the additional benefits and features of insurance policies are highly valuable, the ability to easily claim for the core purpose of cover is absolutely critical. The definition of total disability is the main game here – and it is the policy benefit which has the highest percentage of premium attached. A generous Total Disability definition will include a number of ways that an insured person can qualify for their full monthly benefit under an IP policy.

Some retail, and most group, IP policies will only offer a definition based on the insured person’s inability to perform one or more important income producing duties in their usual occupation, and not working in any occupation. This definition should be considered the most basic total disability definition, and advisers should expect these policies to be priced accordingly.

The definition is more restrictive, as there is no ability to satisfy a full claim if the insured undertakes any work. This means many claims which could be full benefit claims under a different policy, will be reduced to partial disability claims.

An important income producing duty can be defined in different ways, such as a duty that would reasonably be considered primarily essential to producing the client’s income, or a duty that generates at least 20 per cent of the client’s income.

A few group insurance arrangements are more restrictive in that they require that the insured person to be unable to perform all important income producing duties of their usual occupation – making it much harder to qualify for a Total Disability payment.

Example: One duty definition

Veronica, 56, is diagnosed with early stage breast cancer. She has surgery and then begins radiation therapy. Although she isn’t able to work full-time, she can work two half days per week, totalling eight hours. She continues to do this for the course of her treatment and then slowly begins to build back up to full-time hours.

Veronica’s eight hours per week means she is earning 21 per cent of her pre-disability earnings. Her policy only has a ‘one duty’ definition, which means that this amount will be offset, reducing her claim to a partial disability claim. Her monthly benefit is $10,000 and income is $2,400. Under the partial disability calculation, her claim payment is reduced to $8,200.

Most retail insurers will offer a range of alternative methods to meet the Total Disability definition, however, they may not offer this on all of their IP cover options.

Generous insurers will offer a three tier definition on all of their IP policies – standard, comprehensive, super or non-super. The other two tiers, offered in addition to the ‘one duty’ tier, are the ‘10 hours’ and ‘loss of income’ criteria.

Alternative definitions to ‘one duty’ give the insured flexibility to work, within limits, at the time of disability without penalty. These definitions result in higher claim payouts, and ensure the insured is encouraged, rather than penalised, for attempting to work part-time if they can. They are particularly useful for self-employed individuals.

The 10 hours tier allows an insured person to return to their usual occupation for up to 10 hours per week, but be unable to perform the important income producing duties of that role for more than 10 hours per week. Any income earned by working up to 10 hours per week will not be offset against the benefit payment (excluding policies with modified terms).

Advisers should be wary of policies with 10 hour definitions which also say “and not working” or limit the amount of income that can be earned (for example, 20 per cent). A 10-hour definition, which requires the individual to be “not working”, adds no benefit to a policy and is somewhat misleading.

Example continued

Had Veronica’s policy contained a three tier definition, including a true 10-hour definition, her claim would have been different. As she was working less than 10 hours per week, she would still qualify for a full claim payment, even though she was working eight hours per week, and the claim payment is $10,000 (the full insured monthly benefit).

The loss of income tier is the third tier and is generally the most useful for self-employed people. It means that the insured person is either working in their usual occupation at a reduced capacity, or they are in another role, and their earnings after the disability are less than or equal to 20 per cent of their pre-disability income.

Adviser’s should be careful to avoid definitions which require the individual to be “not working” in order to claim under this definition. If this is the case, it adds no benefit to the policy.

Example

Simon is a self-employed plumber. He injures himself at work and can’t do any physical work for eight weeks. He is well behind on his paperwork and utilises the time to attend to his book-keeping, complete his BAS, and work on his advertising and marketing.

Over this time, he works around 20 hours per week, but earns very little income. Although he is working 20 hours per week, losing his ability to do his income producing duty has meant his income is down to just 10 per cent. With an income-based definition that allows him to work, Simon qualifies for a full claim. He’s able to remain productive and utilise the time, without penalty for his claim.

Multiple definitions of total disability provide important flexibility to policy holders at claim time. They allow the insured to do some work without penalty, or continue to manage their business to ensure that it doesn’t deteriorate further.

Advisers should be cautious when seeking a three tier definition to ensure the hours and income tiers are not impeded by a restriction on working.

Consideration 2: Waiting period requirements

The ‘waiting period’ is the amount of time from when the insured person becomes disabled to the date when benefits start to accrue. Waiting period requirements do not refer to the length of the waiting period, but rather, how disabled the insured person needs to be during this period.

Examples include:

  • Totally disabled for the entire waiting period;
  • Totally disabled for the first 14 days of the waiting period, and totally or partially disabled for the remainder;
  • Totally disabled for seven of 12 days during the waiting period, and totally or partially disabled for the remainder;
  • Totally or partially disabled for the entire waiting period.

A general rule of thumb is that the higher the number of days that total disability is required, the more restrictive the policy. Policies that require the full waiting period of total disability, or policies which require the insured person to be totally disabled for a number of days at the start of the waiting period, can be difficult to satisfy for people with degenerative diseases or conditions which are episodic in nature.

A ‘day one partial’ allowance exists where the insured person does not have to be totally disabled for any days during the waiting period to qualify for payment. With ‘day one partial’, the waiting period will continue under any of the following situations:

  • Partially disabled during the whole waiting period;
  • Partially disabled during the first half of the waiting period and totally disabled during the second half;
  • Totally disabled during the first half of the waiting period and partially disabled during the second half;
  • Totally disabled during the whole waiting period; or
  • Any other combination of Total and Partial disability during the waiting period.

Under any of the above scenarios, the insured person can fulfil their waiting period requirements to enable payment from the end of the waiting period. This is particularly useful for self-employed clients who need to be working in some capacity, if they have the ability to do so.

In fact, the Financial Ombudsman Service pointed out in the 2011-12 annual review that policies which require periods of total disability during the waiting period are not considered appropriate policies for those who are self-employed.

Example

Milana, an accountant, has an IP policy, with a waiting period of 30 days. She suffers a rock-climbing accident on the weekend and, as a result, can’t work full-time. However, she can work for five hours during the first week after the accident. Despite her good intentions, even working that much during the first week was too much and therefore, she needs to rest at home the following week. She is able to work for eight hours in the third week and then 15 hours in the fourth week.

As Milana has a policy with ‘day one partial’, it doesn’t matter whether (or when) she is partially disabled or totally disabled in the waiting period for it to continue. Therefore, even when the number of hours per week vary during her waiting period, she is still able to fulfil her waiting period obligations to be eligible for payment and to receive it at the normal time.

Note that the actual payment made will depend on the level of work during the benefit period. The amount of work the person is able to do during the waiting period has no bearing on the amount received.

The ‘day one partial’ arrangement is only relevant to the eligibility of the insured person to receive payment and when it will be paid.

Consideration 3: Day one benefits

Given most self-employed people do not have any leave entitlements, waiting periods can be a greater hardship than for employees able to rely on sick and annual leave entitlements. Therefore, after considering the definitions of total disability and waiting period requirements, attention can turn to the type of benefits that can be paid almost immediately after the sickness or injury.

Nursing care/Bed confinement

Different insurers have different names, but this benefit is generally very similar across policies. If the insured is confined to bed for more than three days, the policy will begin paying a daily benefit for every day the insured was confined to bed, including the first three. This bed confinement is likely to mean the client is in hospital but can also apply to home bed rest. This benefit means that in the case where your client finds themselves seriously ill, financial assistance will be received straight away.

Specified injury

This benefit is at the other end of the scale to nursing care, as it doesn’t require any level of disability. A benefit is payable under a Specified Injury benefit based upon the insured suffering a certain listed injury, usually a fracture, such as a leg or collarbone. Even if the insured has no time off work, the benefit is paid, assisting with additional transportation and medical costs that they may be facing.

Crisis benefit

The crisis benefit is sometimes called Critical Conditions or Trauma Advancement. Essentially, it means if the insured meets the definition of one of the full payment trauma events, they are entitled to an immediate claim, usually equal to six times the monthly benefit. This can allow your client to plan for expenses, undertake the process of recovery and return to work, knowing that their income is maintained.

Conclusion

Making recommendations for self-employed clients can be tricky when it comes to insurance, it can be hard to calculate benefits and the financial underwriting is sometimes challenging. But as a client group, the need for cover couldn’t be greater.

The benefits of being self-employed, such as the levels of flexibility, can mask a vulnerable financial situation that can deteriorate quickly in circumstances of difficulty. Therefore, advisers should pay particular care to the policies being considered and recommended to these clients, as the definitions can make an enormous difference when it counts, at claim time.

You may also be interested in