At a glance:

  • Policies for benefit payments differ in how they determine income.
  • Indemnity value policies are the most common type of policy and typically pay out a percentage of your pre-disability income.
  • The benefit percentage represents the portion of your eligible income that you will receive as a benefit payment in the event of a claim.



Are you aware of the monetary benefits that income protection insurance can provide during uncertain times? Do you know how these benefits are calculated and what factors might affect the amount you receive?


Understanding income protection insurance benefits is crucial in safeguarding your financial well-being when facing challenges due to injury or illness.


Policies for benefit payments differ in how they determine income. Most insurers calculate benefits by averaging monthly income over a specific period, usually 12 months before the disability. This average income, known as “pre-disability income,” determines the benefit amount. However, this approach poses difficulties for individuals who work in a reduced capacity after injury or illness.


For example, Susan, a 45-year-old employee, gradually reduced work hours due to a back injury. Her income was significantly lower due to reduced hours and time away from work. When Susan claimed on her insurance, her benefit payment was reduced because the policy didn’t account for her reduced income before the total disability.


An income protection insurance policy is designed to provide you with income replacement if an injury or illness impacts your capacity to work. However, income protection claims are successful only if there is sufficient evidence of injury or illness causing disablement.


Understanding how income protection insurance benefits are calculated is vital in ensuring that you have a safety net in place during challenging times. Aspect, for instance, offers benefits of up to 85% of your pre-disability income, providing a substantial financial cushion to support you when you need it the most.


Even if it’s a short period of time, many people suffer the long-term consequences of being out of work without coverage. There is the unfortunate possibility of having to sell the family home, delay retirement plans, send children to a different school and take out high-interest loans to pay off urgent bills – not to mention bankruptcy. This can result in a lengthy return to stability for you and your loved ones.


In this article, we aim to shed light on the calculation of income protection insurance benefits, taking into account factors that may affect the amount you receive. By the end, you will be empowered with actionable insights that will enable you to make informed decisions about your income protection insurance coverage.



Factors Influencing Benefit Calculation



Indemnity vs. Agreed Value


Under an indemnity value policy, the benefit you receive is based on a percentage of your income before you cease work due to illness or disability, known as your pre-disability income. This means that the benefit payment takes into account the income you were earning at the time you made a claim. Indemnity value policies are the most common type of policy and typically pay out a percentage of your pre-disability income.


On the other hand, with an agreed-value policy, the benefit amount is predetermined and agreed upon between you and your insurer when you purchase the policy. This agreed amount remains fixed, regardless of any changes in your income at the time of making a claim.


Agreed value policies provide certainty and assurance that you will receive the predetermined benefit amount, even if your current income is lower than when the policy was initially taken out.


It’s important to note that for some agreed value policies, in order to receive benefits at the agreed rate, you may still need to provide evidence or verify your income.


This verification ensures that you were earning the insured amount at the time of policy purchase or at some point during the years since. In contrast, under an indemnity policy, the calculation can be more complex and takes into account your pre-disability income.



Eligible Income


The definition of eligible income varies among insurance policies, but it typically includes various sources of income such as:


• Salary: Your regular earnings from employment.

• Bonuses: Additional payments received based on performance or other criteria.

• Commissions: Compensation earned as a percentage of sales or business generated.

• Other regular income: This may include rental income, dividends, or other consistent sources of revenue.


It’s important to review your policy documentation or consult with your insurer to understand the specific inclusions under eligible income. Each policy may have its own definitions and provisions.



Exclusions or Limitations on certain types of income.


While most income sources are considered for benefit calculation, certain types of income may have exclusions or limitations. For example:


  • Non-regular or sporadic income might not be covered by certain policies, excluding windfalls or large commission payments.
  • Investment income, particularly from investments alone, such as capital gains or savings account interest, may not be included.
  • Certain types of unearned income, like passive rental property income or royalties, could be excluded under some policies.



Benefit Percentage


The benefit percentage represents the portion of your eligible income that you will receive as a benefit payment in the event of a claim. For example, if your benefit percentage is set at 60% and your pre-disability income is $5,000 per month, you would receive $3,000 as your benefit payment.


The significance of the benefit percentage lies in its direct impact on the financial support you receive during periods of illness or disability. A higher benefit percentage translates to a greater portion of your income being replaced, providing a more substantial safety net to help maintain your financial obligations and lifestyle.



Common Range of Benefit Percentages Offered


The range of benefit percentages offered by insurance providers can vary. Generally, benefit percentages can range from 50% to 85% of your pre-disability income. It’s important to note that different insurance providers may have different options within this range, allowing you to select a benefit percentage that aligns with your specific needs and circumstances.


Factors that May Affect the Benefit Percentage


Several factors can influence the benefit percentage offered by insurance providers. These factors may include:


• Occupation: Some occupations may have higher or lower benefit percentage options based on associated risks or income levels.

• Policy Terms: The specific terms and conditions of your policy may dictate the available benefit percentage options. Certain policies may have a predetermined benefit percentage, while others may allow for customisation within a given range.

• Underwriting Factors: Insurance providers assess various underwriting factors, such as age, health, and lifestyle, which may impact the available benefit percentage options or premiums associated with them.



Waiting Period


The waiting period is the specified period of time that you must endure after becoming disabled before you can start receiving income protection benefits. It is essentially a waiting period during which you will need to rely on other sources of income or financial resources to meet your needs.


Role of the Waiting Period in Benefit Calculation


The waiting period directly impacts the benefit calculation and the timing of your benefit payments. Generally, income protection payments are made monthly in arrears. This means that if you have a waiting period of, for example, 30 days, your first benefit payment would be made 60 days after you first became disabled.



Impact of Choosing Different Waiting Periods on the Benefit Amount


Here’s how different waiting periods can affect your benefit:


Shorter Waiting Period:


Opting for a shorter waiting period, such as 30 days, means that you become eligible to receive benefits sooner after your disability. This may result in a higher benefit amount paid out over a shorter period of time.


Longer Waiting Period:


Choosing a longer waiting period, such as 90 days, means that you must endure a longer period without income protection benefits. However, selecting a longer waiting period can often result in lower insurance premiums since the insurer assumes a lesser risk due to the longer waiting period.


When deciding on the waiting period, it’s essential to consider your financial circumstances and needs.


Factors to consider include:


Availability of Sick Leave or Annual Leave: If you have access to paid leave or have substantial savings, you may be able to afford a longer waiting period, reducing the premium costs.


Job Security and Savings: Casual employees, business owners, or individuals with low savings may opt for a shorter waiting period to ensure prompt financial support in the event of a disability.



Policy Terms and Conditions


Importance of Understanding Policy Terms and Conditions:


• Clarity and Transparency:

Familiarising yourself with the policy terms and conditions helps you understand the scope of coverage, limitations, and requirements associated with your income protection insurance. It enables you to have clear expectations and make informed choices regarding your financial protection.


• Compliance and Eligibility:

Understanding the policy terms ensures that you meet the requirements for eligibility and maintain compliance throughout the coverage period. This includes factors such as payment of premiums, and reporting changes in circumstances, and adhering to policy conditions.



Examples of Policy Provisions Affecting Benefit Calculation:


Benefit Indexation:

Some income protection policies offer benefit indexation, which adjusts the benefit amount over time to account for inflation. This provision helps ensure that the benefit keeps pace with the rising cost of living.


Pre-existing Conditions:

Policies may include exclusions or waiting periods for pre-existing medical conditions. It is essential to understand how these provisions impact your eligibility for benefits related to specific conditions that existed before the policy’s commencement.


Benefit Calculation Method:

Policies may employ different methods to calculate the benefit amount. For example, the policy might determine the benefit based on a percentage of your pre-disability income or use a predetermined sum insured.


Benefit Waiting Period:

The waiting period is the time you must wait before becoming eligible to receive benefits after a disability. The length of the waiting period can affect the benefit amount and may vary depending on the policy. Common waiting period options include 30 days, 60 days, and 90 days.


Benefit Duration:

Policies may specify a maximum duration for benefit payments. For instance, benefits might be payable for a specific period, such as two years, or until a certain age, such as retirement age.



How Policy Terms Can Influence Benefit Amounts Over Time?



Policy Updates and Amendments


Policy terms can change over time due to updates or amendments made by the insurance provider. Modifications to policy provisions, such as the maximum income replacement payment or occupational definitions, can affect the benefit calculation. It is important to stay informed about any modifications and understand how they may impact the benefit calculation or eligibility criteria.



Changes in Benefit Indexation


If your policy includes benefit indexation, the benefit amount may increase periodically to account for inflation. This ensures that your coverage remains relevant and aligns with the increasing cost of living.



Do I need to purchase income protection insurance?


The thing to keep in mind when considering income protection insurance is that it can make more sense for some people based on their specific circumstances. Income protection may be a suitable product if you fall into any of the following categories:


  • Full-time, part-time, or casual employees may face uncertainties.
  • If you’re self-employed or own a small business, sick leave or holidays aren’t guaranteed.
  • Your income supports dependents.
  • Mortgage and other debts demand repayment.


You can calculate the income you would receive month-to-month by multiplying your personal annual income by 85% and then dividing that total by 12 months. People can get up to 85% of their income with Aspect (other insurers only offer up to 75%).


Your income protection premium may decrease or increase depending on a variety of policy options and personal details. A longer waiting period and shorter benefit period will make your insurance policy more affordable. You just need to ensure that it is still appropriate to your specific needs.



How is Income Protection Benefit is Calculated



Example 1: Basic benefit calculation


Assumptions and scenario description:

Let’s consider a scenario where the income protection insurance policy provides a benefit of 75% of the insured person’s pre-tax income. The waiting period is 30 days, and the benefit is paid monthly in arrears.


Step-by-step calculation of the benefit amount:


• Determine the insured person’s pre-tax income: Let’s assume their pre-tax income is $5,000 per month.

• Calculate the benefit amount: Multiply the pre-tax income by the benefit percentage. In this case, it would be $5,000 x 0.75 = $3,750.

• Apply the waiting period: Since the waiting period is 30 days, the insured person would need to wait for 30 days from the date their doctor confirms their disability before becoming eligible for the benefit.

• Commencement of benefit payments: After the waiting period is fulfilled, the insured person will start receiving the benefit amount of $3,750 monthly in arrears.



Example 2: Benefit calculation with varying factors


Let’s consider a scenario where the income protection policy offers a higher benefit percentage of 85% and a shorter waiting period of 14 days.


Step-by-step calculation of the benefit amount:


• Determine the insured person’s pre-tax income: Let’s assume their pre-tax income is $6,000 per month.

• Calculate the benefit amount: Multiply the pre-tax income by the benefit percentage. In this case, it would be $6,000 x 0.85 = $5,100.

• Apply the waiting period: Since the waiting period is 14 days, the insured person would need to wait for 14 days from the date their doctor confirms their disability before becoming eligible for the benefit.

• Commencement of benefit payments: After the waiting period is fulfilled, the insured person would start receiving the benefit amount of $5,100 monthly in arrears.


Consideration for calculating income protection insurance


To calculate your income protection insurance, insurers also consider a wide variety of factors in assessing your risk level. Some of these factors include:


Age:  As a person gets older, the likelihood of falling ill increases. As a result, insurance premiums rise as a person ages. In contrast, purchasing a policy when you’re young will result in lower monthly premiums because the risk of a claim is lower.


Health: In the event of having a medical history that increases your risk of filing a claim, the insurer may add a loading to your policy, resulting in a higher premium.


Occupation: Obviously, some jobs come with greater risks than others. Your premiums will depend on the level of risk involved in your occupation and the actual duties you perform. For example, If you’re a firefighter, your premiums may increase because insurers see firefighting as a high-risk occupation.


Waiting Period: The higher the premium, the shorter the waiting period.


Benefit Amount: The longer the duration of your benefit, the more you will be charged.


Smoking Status: Smokers tend to be at higher risk of developing certain diseases, and therefore pay higher premiums. You will pay more for income protection if you smoke. If you give up, you can change your status to that of a non-smoker.



Additional Considerations


Tax Implications: 


Income protection insurance benefits are generally considered taxable income. This means that the benefit payments you receive may be subject to income tax. However, if you personally pay the premiums for the policy, the benefit payments may be tax-free. It’s important to consult with a tax advisor or accountant to understand the specific tax implications based on your individual circumstances.


Policy Exclusions and Limitations:


Income protection policies often have specific exclusions and limitations that may affect your coverage. Common exclusions can include pre-existing medical conditions, self-inflicted injuries, and injuries sustained during illegal activities. It’s crucial to thoroughly review and understand these exclusions and limitations to ensure you have a clear understanding of what is covered and what is not.


Regular Policy Review:


It’s important to regularly review and update your income protection policy to ensure it aligns with your current needs and circumstances. Life events such as marriage, divorce, changes in employment, or significant changes in income may require adjustments to your coverage. Regularly reviewing your policy with your financial advisor or insurance provider can help ensure that your coverage adequately protects you in case of illness or injury.


Benefit Duration and Payment Period:


Income protection policies have specific benefit durations and payment periods. Benefit duration refers to the maximum period for which you can receive benefit payments, such as two years, five years, or until retirement age. Payment periods refer to the frequency of benefit payments, such as monthly or quarterly. Understanding these durations and periods is important in assessing the adequacy of your coverage.


Policy Renewal and Premiums:


Income protection policies typically require regular premium payments to maintain coverage. It’s important to understand the terms of policy renewal and any potential premium increases over time. As mentioned earlier, insurance providers may adjust premiums periodically to ensure the sustainability of the product. Regularly reviewing the affordability of premiums and exploring options with your financial advisor can help you manage the costs of your policy.


Occupation and Benefit Definitions:


Income protection policies often define disability or incapacity based on your ability to perform your “own occupation” or “any occupation.” The definitions may vary, and it’s crucial to understand the specific criteria used to determine your eligibility for benefits. If you have a specialised or high-risk occupation, it’s important to ensure that your policy provides adequate coverage and aligns with your occupation’s specific requirements.


Policy Bundling and Additional Riders:


Some insurance providers offer the option to bundle income protection with other types of insurance, such as life insurance or total and permanent disability (TPD) insurance. Additionally, you may have the option to add additional riders or options to your policy, such as an indexation of benefits to account for inflation or a rehabilitation benefit to support your return to work. Assessing these options and considering their relevance to your needs can provide comprehensive coverage.



Understanding income protection insurance is crucial for securing your financial future. At Aspect Underwriting, our experienced team can guide you through registration and tailor a policy to your needs. With over 40 years of combined experience, we offer industry-leading advice.


Consider factors like indexation and pre-existing conditions when planning your coverage. Seek guidance from financial advisors to understand policy terms and benefit calculations. Regular reviews and consideration of tax implications are essential. Ensure adequate coverage for challenging times by understanding income protection insurance.

Mike Wallis

Mike has over 25 years experience, having spent his first seven years working as a Broker at Jardine Lloyd Thomson in Melbourne and in 2002 was transferred to JLT’s Accident and Health Department in London. For four years (2002 – 2005) Mike was a specialist A&H Lloyd’s Broker and during this time developed excellent relationships with the Lloyd’s A&H underwriting fraternity. In 2006 he returned to Australia in a senior broking position with overall responsibility for Placement Strategy, including the implementation of underwriting facilities and the various authorities granted by Lloyd’s. Mike was the underwriter at two specialist Underwriting Agencies prior to founding Aspect Underwriting in 2016.