Tax break for disability claimants may result in behavioural changes

According to an Association for Savings and Investment South Africa (Asisa) study, South Africans are underinsured by about 60% for disability. Amendments to the Income Tax Act, which take effect on 1 March 2015, will alter the tax treatment of income disability and contribute to closing the current disability insurance gap in South Africa.

Brice Salence, Head of Insurance Pricing and Reinsurance for Group Risk at Momentum Employee Benefits, explains the tax change: “Currently, premiums on income protection policies are tax-deductible, but income at claim stage is taxed. Following the amendment, premiums will no longer be tax-deductible, but income received will be tax-free; meaning claimants can expect a larger payout”.

The root of insufficient disability benefits lies with the method employers use to determine contributions. Most calculate pensionable salary at 80% of total cost to company (TCT) salary. Working on the standard disability benefit of 75% of pensionable salary (i.e. 75% of 80% of your TCT), most employees end up with a 60% of TCT benefit; in other words, a 60% replacement ratio. This is generally insufficient to meet disabled claimants’ needs.

“Claimants with higher marginal tax rates will benefit the most from the amendment as tax-free income payments will align them more closely to their monthly income. Although individuals in lower and middle-income brackets will not benefit as much, some may already benefit from government grants,” explains Salence.

Salence cautions that increased replacement ratios will force insurers to raise the costs of income replacement policies.

“Costs are derived through two main components: the likelihood of a policyholder becoming disabled and the expected duration that the claimant will receive income until they recover, die or retire,” explains Salence.

“Higher replacement ratios may reduce the incentive for disability claimants to return to work. We expect an increase in claims submitted and consequently more claims approved,” she explains. “We also anticipate that the duration of income claims will increase particularly for claim causes where the diagnosis of health and recovery is less objective. These include some leading claim causes such as psychiatry, spine and certain symptoms relating to musculoskeletal conditions.

“Employers should partner with insurers that have an effective claims and incapacity management team in place. A dynamic relationship between employers, employees, brokers and insurers can facilitate early notifications and appropriate claims. It creates a co-operative environment that supports rehabilitation and encourages claimants to return to work. This will help to manage risk and prevent fraudulent claims. Collaborating with a provider that understands these risks and how to manage them is essential.

“The tax change presents an opportunity to somewhat close the insurance gap next year if clients accept price increases and do not reduce their cover. This will ensure that their insurance needs are met and thereby increasing their financial wellness,” concludes Salence.