Defaqto

Who needs income protection insurance?

No-one can guarantee that they will not be the victim of an unfortunate accident or be diagnosed with a serious illness.

Research by Munich Re shows that there is at least a one in four chance of needing to claim on an income protection insurance policy during one’s working life.

The fact that you are down on your luck will not stop the bills from arriving or the mortgage payments being deducted from your bank account, so going without income protection insurance could be unwise..

If you with generous employers may be entitled to sickness benefits which can, in certain circumstances, extend right up when you retire.

But the majority of employees with long-term illness will find themselves having to rely on the state for support after three months of sickness or disability.

The exact amount of state help that will be available will vary according to factors such as your age, savings levels, number of dependants and housing needs, but you can be sure that it will never allow you to do anything more than subsist.

Income protection insurance, however, can enable you to receive benefit payments of up to around half your income while you are unable to work.

These payments will continue until you recover or, if you fail to do so, until the end of the policy term - which is typically your intended retirement date.

Widespread confusion

There is considerable confusion among consumers about income protection – possibly because of the various names used to refer to it. These include ‘income replacement insurance’ and ‘permanent health insurance (PHI).

Payment protection insurance

However, the above should not be confused with ‘payment protection insurance’ (PPI) which is sold when you take out a mortgage, credit cards and personal loans. PPI is expensive and typically lasts for only one year and is usually only suitable for people who are employed.

PPI covers you if you can’t work due to accident, sickness, or unemployment, but its great drawback is that it only pays out for a maximum of 12 months – or 24 months in a small minority of cases.

Someone with a long-term illness or injury could therefore still find themselves without an income for many years. Also  most PPI policies won’t pay out if you are unemployed, self employed or a temporary or contract worker.

Payment protection insurance is also commonly called:

• accident sickness and unemployment insurance or ASU
•  loan protection insurance, when it is used specifically to protect a loan.
•  mortgage payment protection insurance or MPPI, when it is used specifically to protect a mortgage.
•  income payment protection insurance, or IPPI when it is used to protect a policyholder’s general lifestyle.

It is essential not to confuse any form of PPI with income protection insurance. In this respect, it is especially important to be aware that income payment protection insurance is often incorrectly called income protection insurance – which can be very misleading.

How does income protection insurance work?

Income protection insurance is frequently better value than any kind of PPI, although its main downsides are that it is more complex to understand and can take longer to arrange.

This is because those who apply for income protection insurance have to be underwritten individually at the outset.

You have to complete a detailed health questionnaire and, if the underwriter requires further information, it may write to your GP or ask you to undergo an independent medical examination with a doctor in your area. In some cases, therefore, the whole process can take several weeks.

Rating factors

Individual underwriting means you can find that the premiums you are eventually quoted are considerably higher than the prices you originally saw advertised.

Factors that can have a major impact on premiums include your age, gender, smoking habits, obesity and - most importantly of all - occupation.

Underwriters know that those in some jobs are far more likely to claim than others. Roofers, for example, may be required to pay four times the standard headline rate to reflect the fact they are exposed to a greater than average personal injury risk.

Even teachers may be charged at least twice the standard rate to reflect the fact that their profession is unusually susceptible to stress.

Cover Issues

Premiums will also be affected by level of cover chosen, the  period of cover, and the length of the initial ‘deferred period’ - the amount of time that must elapse between when your claim occurs and when benefit payments commence.

The shorter the deferred period the greater the cost. It is possible to have a deferred period of anything between one month and one year, but in practice most people opt for either three or six months.

If you have some income protection insurance through your employement as an employee benefit, it is important that you tell your adviser this and arrange for the policy to dovetail with your work cover.

Premiums vary considerably across the different insurers, but remember that cheapest is not necessarily the best value.

The small print

Different providers can have significant differences in their small print conditions, and if you are not aware of these, it will be like comparing apples with pears. Areas to watch out for include the fact that:

• Some policies have lower than average maximum benefit limits;
• Some insurers insist on making significant deductions for other income you receive whilst making a claim;
• Some insurers quote on a fixed amount of cover throughout the term, whilst others quote for escalating cover that keeps up with inflation;
• Some quotes will refer to premiums that remain ‘fixed’ or 'guaranteed' throughout the term, whilst others will be for premiums that are subject to regular pricing reviews to ensure that they are reflecting the insurer’s overall claims experience.

The latter may cost slightly less, but this saving could prove a false economy if premiums soar at the review stages.

Watch out for whether the insurer will only pay out if you are unable to do your “own occupation” or “any occupation.”

The importance of advice

Because this field can be extremely complex, there is much to be said for ensuring that you end up with a suitable policy by seeking professional advice from an independent Financial Adviser (IFA).

Most IFAs earn their remuneration from commission paid by insurers, but some will work on a fee basis, or commission offset against fees.

IFAs can actually save you money as they are obliged to scan the entire the market to ensure that you get the best value deal.

Before you consult an IFA, however, you will need to establish exactly what cover you already have to protect against ill health, and this may involve having to contact your HR department.

You will need to find out whether you are already a member of a group income protection scheme and, in order to help the IFA dovetail the policy with your work cover, you will need to provide them with details of your company’s short-term sick pay scheme.

Specialist insurers

IFAs will  also consider how insurers compare when it comes to paying out on claims. Some of the more specialist insurers are likely to give policyholders the greatest benefit of the doubt in the case of borderline claims and provide more comprehensive rehabilitation facilities for claimants who wish to get back to work as soon as possible.

A good IFA will also be aware of which insurers are likely to grant the most lenient terms for those with poor medical histories and risky occupations.

Although PPI typically only pays out for one year, it charges all policyholders the same flat rate, regardless of age, gender, occupation and smoking habits.

This can therefore sometimes make PPI better value than income protection insurance for individuals whom income protection insurers will not cover at standard rates.

Constantly changing market

A little knowledge can certainly be a dangerous thing with income protection insurance and even those who pride themselves on being clued up should be aware that this market is subject to constant change in terms of the innovative new products that are being developed.

In view of the amount of initial and ongoing research that needs to be conducted to select a suitable policy, buying via an IFA is likely to be the safest route, providing a means for help and redress if things go wrong.

Key points

• Just because you are ill or made redundant, the bills will still have to be paid
• State benefits will not enable you to do more than subsist
•  The cheapest policy is not necessarily the best value
•  Don’t confuse income protection insurance with payment protection insurance (PPI) 
• Make sure you buy income protection insurance via an IFA.