When a serious illness or injury strikes, two financial problems usually arrive together: your treatment has costs, and your income stops while you recover. Different insurance products exist to answer each problem. Income protection and trauma cover are the two that protect you while you are still alive, and understanding the difference between them is largely the whole job of deciding what to buy.
Income protection: replacing your pay
Income protection pays you a regular amount, typically monthly, when you cannot work because of illness or injury. It does not pay the full amount you were earning. It replaces a portion of your usual income, which keeps the incentive to return to work and keeps premiums more affordable.
The two core settings on any income protection policy are the waiting period and the benefit period:
- Waiting period. The time between when you stop work and when payments begin, commonly a set number of weeks. You carry that early stretch of lost income yourself. A longer waiting period usually lowers the premium, because the insurer is on the hook for less of the early months.
- Benefit period. How long payments continue once they start, whether that is a set number of years or right through to a retirement age. A longer benefit period gives more protection but costs more, so it is a trade-off you have to price against your savings and other cover.
There is an important detail about the job income protection does alongside New Zealand's accident cover. ACC compensates many accidental injuries, but does not generally cover the everyday illnesses and conditions that keep people off work. Income protection is the product that steps in for the illness side and fills the gaps that ACC leaves. Many self employed people who do not have sick leave or employer cover are the most obvious candidates, but employees on a single income can be just as exposed if their sick leave runs out during a long illness.
Because income protection replaces a regular flow of money, benefits are usually taxable when they are paid. Unlike the lump sum from life cover, which is generally tax free, income protection payments are treated as ordinary income. An adviser or your provider can confirm how this lands for your circumstances, and it affects how much of the benefit you actually keep.
Trauma insurance: a lump sum for a serious event
Trauma insurance, sometimes called critical illness cover, pays a single lump sum if you are diagnosed with one of the specific serious conditions listed on the policy. The typical headline conditions are certain cancers, heart attack and stroke, though the actual list varies by provider. Crucially, the diagnosis is the trigger: you do not need to be permanently disabled to claim, and you do not have to be off work.
Because it pays a lump sum rather than a monthly amount, the money is for the many costs a serious diagnosis brings that income replacement does not cover. You can use it to fund treatment, pay the mortgage, take unpaid time off to recover, modify your home or car, cover childcare, or simply absorb the financial shock while you focus on getting well. There is no restriction on what the money is spent on.
The definition of each covered condition matters enormously in trauma cover. Providers differ in how strictly they define cancer, heart attack or stroke, and some events may not meet the policy's definition at all. Reading exactly which conditions are covered, and under what criteria, is the real work of choosing a trauma policy. A premium that looks similar across two providers can sit on top of very different definitions.
How the two fit together
These products are not alternatives. They pay on different triggers and serve different parts of the same problem:
- Income protection handles the ongoing loss: keeping a regular income coming in across months or years of being off work.
- Trauma cover handles the sudden shock: a lump sum for the immediate costs, treatment and financial decisions a serious diagnosis forces.
An injury is a good way to see the split in action. ACC may cover the medical treatment and a portion of lost earnings, while income protection fills a further part of the income gap for illnesses ACC does not touch. Meanwhile a cancer diagnosis, which ACC generally does not cover, is exactly where trauma cover pays its lump sum, alongside the income that income protection keeps flowing.
Income protection replaces part of your pay while you are off work, with waiting and benefit periods you set, and it is how self employed people and single income households survive a long illness. Trauma cover pays a lump sum on a specified serious diagnosis, with strict condition definitions you need to read carefully. Held together they protect both your income and your savings. Neither replaces life cover, which pays your family after you die, and life insurance works alongside them for a different loss. Health insurance, covered in our health insurance guide, pays for the treatment costs themselves.