The top tip for income protection is to get the balance right

Many advisers implement lump sum pay-out solutions as a default for permanent disability events. They do so because their clients – in many cases incorrectly – believe that a large amount of capital will cover their immediate post-event expenses.

Brad Toerien, CEO at income protection specialists FMI, cautions against this approach. He warns that lump sum solutions do not take into account the short-term stress of efficiently managing a large and sudden capital pay-out. They also cannot fully compensate for the long-term implications of lost income on the client’s financial wellbeing.

Toerien points out that "Income Protection” is so named for a reason: "The best way to protect your client’s income – assuming that is your primary goal – is to invest in a policy that pays out in monthly instalments for the rest of your client’s working life”.

Although Lump Sum products have a role to play in holistic permanent disability solutions, it is crucial that the lump sum payment is utilised for its intended purpose, namely settling outstanding debts, business assurance, making partial contributions towards an investment, and preparing for major lifestyle changes as a result of disability.

The cash from a Lump Sum disability benefit should not be used to replace future income. The major problem with providing future income cover using a fixed Lump Sum benefit is uncertainty. "Lump Sum Disability cover is inflexible and clients will need to make key assumptions about the potential disability period until their retirement, the effect of inflation on their claim pay-outs, and the expected return on initial lump sum investments made,” says Toerien.

"Obviously clients are unable to predict if or when they will become disabled and it is therefore difficult to know what period of time would need to be covered until retirement. This might lead to the client being over-insured when investing in a Lump Sum policy when there are other investments options available that might be more suitable, beneficial, and affordable”.

Clients are better served with a holistic income protection plan that includes Temporary Income Protection – for temporary disability – and a combination of Lump Sum Disability and Permanent Income Protection for permanent disability.

Permanent Income Protection pays out monthly income replacement benefits and can be used to cover both permanent and longer duration ‘temporary’ disabilities. It is specifically designed to match the client’s income over time and offers an option to increase pay-outs in line with inflation.

Permanent Income Protection offers numerous advantages over Lump sum Disability cover. It can be customised to sustain your client’s lifestyle and meet his or her unique cash flow requirements while coming in cheaper than Lump Sum in the long run. An added ‘kicker’ is that Permanent Income Protection premiums are tax deductible.

Temporary Income Protection is important because statistics show that far more clients experience temporary disability (which could seriously impact on a self-employed person’s income) than permanent disability. In the event your client becomes permanently disabled they will still require bridging income while the disability is being verified as permanent (the waiting period).

"It is important to understand that Lump Sum Disability and Permanent Income Protection are different products with different functions and that they should be used in conjunction in a holistic solution rather than as replacements for one another,” concludes Toerien.

To ensure comprehensive cover for disability, FMI advocates a holistic approach that combines Temporary Income Protection, Permanent Income Protection, and Lump Sum Disability – drawing on the strength of each product to ensure comprehensive cover for disability.