As the name suggests, an agreed value income protection policy is one that will pay an agreed value to the holder if the insured event – the illness or injury which prevents the client from working – occurs. The amount insured is typically based on the client’s income at the time the policy is taken out, and is subject to various limits. In contrast, an indemnity policy will pay a percentage of the client’s income at the time that the insured event occurs. Again, this is subject to various limits.
Everything else being equal, indemnity policies typically offer lower premiums. This is largely because there is much less administration required on the insurer’s part when an indemnity policy is taken out. With an indemnity policy, the work of determining the client’s level of income is delayed until the client makes a claim. In an agreed value policy, the insurer completes this administrative task at the time the policy commences. Because most clients do not ever make a claim, this means that the insurer faces less administration overall for clients who take indemnity policies.
In most cases where an adviser is recommending income protection insurance, the adviser is also recommending whether the client make use of an agreed value or an indemnity policy. As a result, the adviser needs to be clear as to why one or the other type of policy has been recommended.
Indemnity policies typically suit clients with stable employment situations where their income is not likely to fluctuate, and certainly not likely to fall over time. People in secure employment where longevity is the base for income levels, such as public servants, are often suited to indemnity policies. SOAs that recommended indemnity policies need to state why that type of policy is suitable, and include a caution about the fact that this cover may not remain suitable if the client loses or resigns from their job, or faces some other situation in which the basis of their income changes.
Agreed value policies typically suit clients with less stable income situations. This might include self-employed people or people employed in less stable or enduring employment. Employees on fixed term contracts, for example, are often better suited to agreed value policies. As agreed value policies attract higher premiums than indemnity policies, effective SOAs need to spell out why the agreed value option has been recommended.
The point is this: as with most areas of financial planning that involve choice, there can be good reasons for making a particular choice. The SOA should make these reasons clear to the client – and to anyone else who might read the SOA at some future time.