Income protection insurance
INCOME PROTECTION
This guide about Income Protection (IP) Insurance is designed to help you decide if this is a suitable product for you. It aims to help by answering the following questions:
· What is income protection insurance?
· How does income protection insurance work?
· How can I decide whether I need income protection insurance?
· If I decide to buy, what decisions do I need to make?
· Should I get advice?
· What other kinds of health protection products are there?
WHAT IS INCOME PROTECTION INSURANCE?
It is a policy designed to give you a regular tax-free benefit if you are injured or too ill to work, resulting in a loss of earnings. There are three main types of product available:
· Those designed to replace a proportion of your lost earnings;
· Those which cover some of your living expenses – for example, your mortgage;
· Those which provide cover for housepersons.
A recent Government Report, “Pathways to Work”, found that in 2002 2.4 million people received incapacity benefits, and had been off work for more than six months, in the UK. Of these, 1 million had been unable to work for at least five years.
HOW DOES INCOME PROTECTION INSURANCE WORK?
Being too ill to work is likely to affect your earnings. What this effect may be, and how soon it will happen, will depend on your personal circumstances. Income protection insurance is designed to reduce the impact of this loss of earnings.
Under an income protection policy, you pay regular premiums to an insurance company and, in return, they agree that – subject to certain conditions – they will pay you a benefit if you are too ill to work.
At the heart of an income protection policy is the definition of incapacity. Which definition applies to you will be decided when you take out your policy. A number of different definitions of incapacity are used by insurance companies. You should check with your insurer what definitions they use, but the most common ones are:
· ‘own occupation’ – you will be able to claim if your incapacity is sufficient to prevent you from following your own occupation;
· ‘any suited occupation’ – you cannot claim unless you are too ill to carry out your own occupation, and any other occupation to which you are suited, as defined in your policy;
· ‘any occupation’ – you cannot claim unless you are too ill to carry out any job whatsoever;
· ‘activities of daily living’ – you can only claim if you are unable to carry out a selection of everyday tasks, such as washing and dressing yourself; and
· ‘activities of daily working’ – you can only claim if you are unable to carry out a selection of work-related tasks, such as walking, communicating and exercising manual dexterity.
Some of these definitions of incapacity may not be available for certain occupations. The definition that applies to you will have a significant effect on the amount you will have to pay.
There will usually be a period after the start of incapacity before your benefit is paid. This is called the ‘deferred period’.
There is no limit to the number of claims that you can make.
Insurance companies offering income protection will always limit your benefit to an amount less than your normal earnings. This is because income protection benefits are free of personal income tax, and insurers are keen to encourage you to return to work.
HOW CAN I DECIDE WHETHER I NEED INCOME PROTECTION INSURANCE?
You will need to consider what might happen to your income and your expenses if you were too ill to work.
First – calculate your income
Potential income sources will depend on your personal circumstances and a number of factors:
· If you are employed:
Your employer may continue to pay you for a limited time. Some employers will only pay Statutory Sick Pay. Others may be more generous. You should check what arrangements your employer has made.
· If you are self-employed or a member of a partnership:
Your income will almost certainly cease, although your business may continue to generate income for a short time if, for instance, payment is outstanding for work already completed.
· State benefits:
In the longer term you may receive Long Term
Incapacity Benefit and other State benefits. Some of these benefits are
means-tested, and in most cases there are conditions that have to be met, such
as your having paid sufficient National Insurance contributions. More details
can be obtained from your local Jobcentre Plus office or from their website
(www.jobcentreplus.gov.uk).
You should note that the amounts of, and eligibility conditions for, State
benefits may change in the future.
- Savings and investments:
If you have savings, these may produce income that will not be affected by your incapacity. Cashing in some investments earlier than planned may, however, result in a financial loss. Such savings may also affect your eligibility for some State benefits.
More details of the effect of savings on State benefits can be obtained from your local Jobcentre Plus office or from their website (www.jobcentreplus.gov.uk).
· Pension payments:
If you are receiving a pension from a previous job this is likely to continue despite your incapacity.
· Early retirement:
You may be able to start receiving an early retirement pension. This will depend on the rules of the pension scheme(s) to which you belong, and may also be at your employer’s discretion. Remember, any pension which starts early is likely to be significantly lower than if you had worked until normal retirement age.
· Alternative employment:
Even if you were unable to undertake your usual work, there might be alternative work that you could do. You could contact your local Jobcentre Plus office or the Department of Work and Pensions (www.dwp.gov.uk).
Second – calculate your expenses
If you are too ill to work for a long period of time, the way you spend your money may well alter. You need to consider how your expenses might change.
· Ongoing costs:
Some types of expenses will continue. These include mortgage, rent and other housing costs, council tax, gas and electricity bills, etc. Some expenses may be covered by specific insurances (although it is common for such cover to be limited, say, to a year from when you become too ill to work). You should check whether your mortgage, hire purchase, credit card or loan repayments or pension contributions are covered by this kind of insurance.
· Work-related costs:
Some expenses may reduce, or even be eliminated. These could, for instance, include the cost of travelling to and from your place of work.
· New costs:
Some expenses will increase, or will be incurred for the first time. These may include, for instance, the cost of heating your home all day if you do not go out to work, the higher cost of food if you have been using a subsidised staff canteen, and the cost of medicines and possibly nursing care.
· Other costs:
Some expenses are within your control, so you could economise if you wished to. These might include, for instance, holidays and entertainment.
When might I need income protection insurance?
Having considered the effect on your income and your expenses, do you think that you could cope with your changed circumstances if you were too ill to work? If so, for how long could you cope? If your calculations reveal a probable shortfall, you should seriously consider taking out income protection insurance.
When might I not need income protection insurance?
When:
· You have sufficient income from other sources:
If your calculations do not reveal a likely shortfall, or if you believe you could realistically adapt your lifestyle to a reduced income, then you may consider that income protection insurance is unnecessary. If you consider that you have adequate capital, savings or other resources to live on for however long you are too ill to work, then income protection insurance may be unnecessary.
- Your employer has comprehensive arrangements in place:
Income protection insurance is unnecessary if your employer has a satisfactory long-term sick-pay scheme (considering both the amount of any cover, and the length of time for which you would continue to receive an income). Any insurer will limit the amount they will pay you. If your employer’s scheme is adequate, this limit is likely to mean that you would receive very little – and possibly nothing at all – from any income protection insurance policy.
· You could live on State benefits:
If you compare your income with State benefits, and feel that these will meet your needs, then you will not need income protection insurance.
You should note that the Benefits Agency will use their own definition of incapacity when deciding whether you can receive State benefits. This definition may not be the same one your insurer would use.
IF I DECIDE TO BUY INCOME PROTECTION INSURANCE, WHAT DECISIONS DO I NEED TO MAKE?
Most insurance companies will offer a range of different policies. The overall cost of a policy is likely to be an important consideration. You should remember that, in general terms, the broader the scope of the cover, the greater the cost. For example, ‘own occupation’ cover is likely to be more expensive than ‘any occupation’ cover. The exact cost will depend on a number of factors, including your age, sex, occupation and medical history.
You also need to:
· Choose how long to wait before your benefit becomes payable:
You can usually choose from a range of possible deferred periods. You will probably wish to match this to your personal circumstances so that, for instance, if your employer will pay you for six months, the benefit from your income protection insurance policy starts after that time. You may consider that an interval, between when your employer stops paying you and when income from your income protection policy starts, would also be acceptable. The longer the deferred period, the cheaper your policy will be.
· Choose how long you wish your cover to last:
This will usually also be the maximum period for which benefit will be paid if you are too ill to work. It may be sensible to link this with your normal retirement age, but remember that the longer the term of your policy, the more expensive it is likely to be.
- Choose whether the premium you pay should be fixed or could change. You may be able to choose between:
Guaranteed rates – the amount you pay is fixed in advance. The amount you pay cannot be changed by your insurer, except in agreed circumstances (eg to rise in line with inflation).
Reviewable rates – your insurer can change the amount it charges you in the light of its costs, overall claims experience etc. This rate does not depend on any claims that you have made. Usually, no change can be made by your insurer during the early period of your policy.
Renewable rates – premiums are set for a fixed period. At the end of that time, you have the right to continue your plan, and your insurance company will set the premium level for a further fixed period, based on your age at that time.
The type of rate you choose will affect the amount you pay. Initially, guaranteed rates are likely to be the most expensive. But over a period of years, renewable rates may become more expensive, since they will increase as you grow older.
· Choose whether to increase the level of your benefit over time:
Some insurers will offer you the option of benefits which increase as inflation rises. Why? Because if the benefit which your policy provides remains at a constant level throughout its term, its real value is likely to diminish. The level of these increases will vary from insurer to insurer. Premiums will increase over the years as the level of cover provided rises.
SHOULD I GET ADVICE?
Talking to a financial adviser may be helpful. Most income protection insurers publish a wide range of information on their products, but all are required to issue a ‘Key Features Document’ to help you make comparisons between policies.
WHAT OTHER KINDS OF HEALTH PROTECTION PRODUCTS ARE THERE?
Insurance can give you the resources to cope when you encounter unexpected misfortune. Most people see good health as being very important, as it makes other aspects of life possible. The insurance industry can offer help in a number of ways to protect you and your family against the financial consequences of illness or injury. Insurers may combine different kinds of policy. However, the broader the cover the greater the cost.
The main categories of product on offer can be split into long-term products, sold for more than one year at a time, and general insurance products, which are renewed annually. The different types are:
A. Long-term insurance products:
Critical Illness
Critical illness insurance pays out a lump sum if you get any of the illnesses specified by your policy, provided you meet the definition of the illness in your policy and you have kept up your monthly premiums. This contrasts with income protection, which pays a regular monthly income if you are too ill to work regardless of the illness you suffer from. You can use the lump sum or the income however you wish, for example, to pay off or maintain repayments on your mortgage.
Private Medical Insurance
Private medical insurance is designed to cover the costs of private medical treatment for what are commonly known as acute conditions.
Long Term Care Insurance
The insurance is designed to finance long-term nursing and other dependent care. A claim is payable if your health prevents you from caring for yourself.
B. General insurance products:
Accident, sickness and unemployment cover
Accident, sickness and unemployment insurance typically provides benefit for a limited period. A common form of this type of insurance is Mortgage Payment Protection Insurance which usually covers your mortgage payments for a maximum of 12 or 24 months in the case of accident, sickness or redundancy. There is usually a waiting period before payments are made of either 30 or 60 days.
You will need to decide which of these risks concern you, and then select the product(s) which meet your needs.
Information on this page has been re-produced from the Association of British Insurers
Published November 2005
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