How long you will be paid by the insurance policy depends on the policy length. There are two types of policy terms:

• Short term: You only get an income paid to you for a set term, such as 2 years or 5 years.
• Long term: You get an income paid to you for as long as the policy allows, usually up to age 65 (retirement age) or 70.

The longer the payment period, the more expensive the policy (all other factors being equal). Picking the right payment period is not easy, and it involves balancing risk vs cost. In a simple example of a 30-year-old office worker, we found that increasing the payment period from 2 years to 5 years meant a 20% higher policy cost. Taking the payment period to 65 years of age doubled the policy cost.

You can apply for an income protection insurance policy if:

• You work in full-time employment
• You work in part-time employment
• You are self-employed

If you have pre-existing medical conditions, you can still apply - insurers may charge you more, and/or exclude any cover and claims related to your existing condition (and possibly related conditions)..

According to a survey for the Financial Services Council NZ, 1 in 7 households in New Zealand have experienced a serious illness event over the past 5 years that resulted in an inability to work for 3 months or more and consequent loss of income.

If a serious illness event that resulted in the primary income earner being unable to work occurred, there is a significant effect on households’ ability to continue to pay their household expenses and maintain their lifestyle, once sick leave and annual leave ran out:

• 20% of households would only be able to continue to meet their expenses for 1 week. 
• Another 14% would be able to continue for 2 weeks.
• By 4 weeks after sick leave and annual leave ran out, an overall 55% of households would be unable to pay all their expenses and maintain their lifestyle.

The survey showed that only 20% of households would be able to cope for more than 12 months, indicating that 80% of New Zealand households would be unable to keep on top of their bills. 

Income protection insurance protects against this risk by paying up to 75% of a policyholder's income until they can return to work, so there is far less disruption to their personal finances.

If you work for forty years and earn an average of $50,000 per year, you have the potential to earn around two million dollars. This is likely to be more valuable than any property you own. As such, protecting yourself against the inability to earn an income may seem sensible, but the decision to do so will come down to your age, profession, financial commitments and family situation.

For example, a young mother and father of two children are probably more likely to consider income protection insurance than someone in their 50s with a mortgage-free home.

If you are ill or injured for a long period, an income protection policy will pay out for a set period of time. The cheaper the policy, the less the payout period will be (all other things being equal). It's important to know the differences, which we outline below. 

Short Term Income Protection (payable for 2 to 5 years)
Short term policies will pay an agreed amount of income for 2 to 5 years; the money received is put towards your general expenses such as mortgage or rent, bills and childcare costs. Once the period of payment ends, no further benefit is paid so if you are still ill or injured, your policy will no longer help. For these reasons, short term policies are cheaper than long term policies because the risk (and cost) to the insurer is much lower.
 
Long Term Income Protection (payable up to 65+ years of age)
Long term Income Protection income pays a regular income if you are unable to work due to illness or disability until you are well enough to return to work, or until you reach an agreed age, usually 65 or 70. 

Some insurers may offer it as an optional add-on; it's not standard with most if not all income protection policies. The triggers are illness or injury only, not redundancy or any other restructuring at a workplace. 

With two policies, you may be able to get up to 150% of your salary paid as a benefit, but the ongoing cost is likely to be expensive. If you want to eliminate the worry of recovering within the set payout period (i.e. 2 to 5 years), choosing a policy which has benefits paid up to retirement is a safer bet. 75% of an income is significant and should cover essential costs while the public health system, or private health insurance, takes care of your treatment and recovery. 

Some employers offer sick pay beyond the statutory requirement (5 days per year) and offer as much as 12 months at full pay. It's important to check with your employer what you're entitled to before choosing any insurance policy. Many policies won’t pay out if you’re still receiving a salary, so it's pointless insuring for to be paid out in 4 weeks if your company sick leave last up to 8 weeks. 

The longer you receive sick pay, the longer you can make your deferment period. This makes the policy cheaper as well.

Unlike employees, anyone who is self-employed doesn't have the luxury of falling back on sick pay or the opportunity to return to work when they recover. Self-employed individuals are the business, and a long-term absence can have devastating effects on the viability of the business. 

Income protection insurance can significantly reduce the amount of financial stress for anyone self-employed working by themselves without co-workers to fall back on. 

Financial stress is a major contributor to a range of illnesses. Buying insurance you can't afford could do you more harm than good. Many banks try and sell income protection insurance to their customers without considering the individual needs. We believe income protection insurance is a luxury and not a must-have.