Income protection policies have not yet gained a significant amount of traction, with lump-sum based capital disability products still dominating the disability insurance market in South Africa.
According to a Swiss Re survey, 73% of the disability insurance sold in South Africa is lump-sum cover. These products are perceived to provide greater certainty.
The reason for this could be ascribed to the fact that most income protection policies lock in on benefit structures without meeting the policyholder’s individual needs, leading to a questionable value proposition. In addition to this, having capital in hand at claim stage provides more certainty and options and the claims definitions with income protection policies often include an aggregation against active income.
An increasing amount of insurers are offering flexible income protection options, which may help increase the popularity of these products in the market. An example of this would be the fact that some insurers now offer income pay-outs for death benefits.
Income protection policies pay a recurring income in the event of permanent disability or temporary disability, whereas lump-sum disability policies cover permanent disability through a once off lump sum pay-out. In our opinion, the main purpose of income protection products and lump-sum disability cover is essentially the same in the sense both products are aimed at protecting future income. The choice of product should suit the policyholder’s circumstances and needs at claim-stage, something which, in our opinion, is impossible to foresee at point of sale.
Lump sum products are not always appropriate to the client’s actual needs.
With a lump-sum, where a client is disabled without any impact on their life expectancy, they are at risk of outliving their income. Future changes in economic factors such as inflation, interest rates and investment returns could erode the value of the client’s cover by negatively impacting their ability to buy an annuity that matches their income needs. Lump-sum cover also typically contains significant premium waste, as the shape of the lump sum over time does not track the client’s need and income – resulting in inevitable cover reviews, the reduction of cover that’s not needed later on in life, and premiums that have now been wasted paying for cover that’s never going to be in force at retirement.
On the other hand, where clients have a poor prognosis, if they had chosen an income protection product that pays out a monthly income amount they would receive far less value. A significant proportion of clients who are permanently disabled have a severely impaired life expectancy, meaning they would receive far fewer monthly income protection pay-outs. Other than BrightRock, providers of income protection products never show the capitalised value of the recurring income they’re providing. And their clients are never offered the option to be paid the lump-sum instead. Nor can they offer clients this annuity rate on guaranteed terms at each point into the future.
In our opinion the current strict delineation between income-based and lump-sum-based disability cover is failing to fully meet client needs. That’s why we decided to offer clients, if they choose lump-sum cover for their permanent illness and injury needs, the ability to change this choice to a recurring pay-out at claim-stage. In other words, they only have to decide which option best suits them when they have an insight into how long they’re likely to live and what the current economic conditions are. For example, a client diagnosed with stage four cancer with a very poor prognosis who has not been given long to live may take the lump sum, while a client who loses a hand may opt for recurring pay-outs to retirement, growing at CPI+1% to replace lost income.
Where clients pick the lump-sum option, we automatically offer them the choice at claim-stage of a recurring pay-out on guaranteed terms, to protect them against the impact of longevity and future adverse market conditions and to give them significantly more pay-out value, through the best of both worlds choice. The option also exists to take a combination of the lump sum and recurring pay-outs to better meet your needs. In terms of tax-treatment, both structures are income tax neutral. In other words, should clients opt for the recurring pay-out at claim-stage, then no income tax will be deducted. So if a client’s income need is R30 000 and this is the monthly pay-out they’ve selected, then they will receive the full R30 000.
Remember that most income protection policies are designed to assist policyholders in the event of serious, unpredictable health events. Some income protection policies have different criteria based on the initial capital/ recurring selection, for example a client who is paralysed but goes back to work may receive their entire capital benefit pay out, but recurring pay-outs cease on returning to the workforce. In the market, the focus on occupational criteria and the practice of aggregation in claim of benefit payments against active income means that clients may have their pay-out reduced or halted even though they remain severely ill or injured and continue to meet the clinical criteria for a disabling illness or injury. This causes uncertainty for clients.
BrightRock uses the same clinical definition set for permanent income and capital disability pay-outs and, once a claim is approved, we do not reassess or reduce pay-outs against any active income the client is able to earn despite their disability, which optimises certainty for clients.