By Elna van Wyk - National Head of Underwriting & Disability Management for Momentum Employee Benefits.
From March 2015, an amendment to the Income Tax Act will standardise the tax treatment of insurance policies that offer protection against death and disability.
Currently, premiums on policies that pay out a lump sum on disability are not tax-deductible, but lump sums paid are tax-free. However, premiums on income-protection policies are tax-deductible, but monthly income on payout is taxed.
The amendment removes the current tax deduction for premiums on income-protection insurance, and makes monthly income received tax-free; meaning claimants can expect a larger payout.
The risk is that the amendment may encourage a reduction in cover as current premiums provide a pre-tax income rather than a tax-free income. It could also discourage the uptake of income-protection cover as individuals may value reduced taxes today more than potential future tax-free proceeds, particularly as chances are they may never claim on the policy.
A study commissioned by the Association for Savings and Investment South Africa (Asisa) calculated the gap between death and disability insurance needed and actual cover taken by SA income earners. The overall death insurance gap was R7.3 trillion, while disability was shown to be R11.1 trillion, meaning South Africans are underinsured by about 62% for death and 60% for disability. Thus reducing current benefits is inadvisable.
The root of insufficient disability benefits lies with the method employers use to determine contributions. Most calculate pensionable or risk salary at 80% of total cost to company (TCT) salary. Working on the standard disability benefit of 75% of risk salary (i.e. 75% of 80% of your TCT), most employees end up with a 60% of TCT benefit. Thus, despite tax-free disability benefits, members will remain underinsured.
The Asisa study shows that the highest earners have the most inadequate cover, considering more cover is required to maintain their living standards. However, an individual paying 40% income tax stands to benefit most from the amendment as tax-free income payments will align them more closely to their current take-home pay.
Although individuals in the lower and middle-income brackets receive better cover, in the event of disability their income needs are often higher as they may not have medical aid and are unlikely to have built a savings buffer. Coupled with high levels of debt, disability often means financial ruin for these families often for generations to come.
Yet disability insurance is treated as expendable, with individuals lapsing policies during financial difficulties. Consumer education is vital to change this behaviour and ensure current premiums are maintained.
It is increasingly necessary for employers to ensure they have an effective claims and incapacity management team in place to establish an integrated health approach that will ensure early intervention, while prohibiting fraud.
Currently, the leading causes of disability across all income groups are musculoskeletal, neurological, psychiatric and cancer. Thus most claims have a longer-term nature, making cost over time a serious consideration.
In the UK, psychiatric claims already make up 20% of all claims. The WHO states that depression will be biggest cause of disability by 2020. In these circumstances, an integrated approach between the employer, insurer and medical scheme will be invaluable. The ability of the insurer to engage directly with employees as soon as a risk is identified is key for effective intervention and the optimal management of risk, claims and potential fraud.
The upcoming tax amendment provides an opportunity for employers and trustees to reconsider the adequacy and appropriateness of disability benefits. Collaborating with a provider that has a deeper understanding of the needs and risks, including the management of those risks is paramount.