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What is income protection insurance?
Income protection insurance is an essential insurance for most individuals, but few people realise this until it is too late. Even Oscar Wilde, who boasted no great knowledge of financial planning, was astute enough to observe: “It is better to have a permanent income than to be fascinating.” But, unfortunately, in those days anyone who agreed with such sentiments was unable to insure against the possibility of losing their income.
Nowadays, on the other hand, most people are able to take out income protection insurance, which will pay out a regular tax-free income if they are unable to work as a result of long-term sickness or disability. Financial planning experts commonly argue that this should be a cornerstone of most people’s financial planning.Use our: Current accounts A-Z | UK Credit Cards Top 10 | Back to Top
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, however much attention they pay to diet and exercise. Indeed, research by Munich Re has shown 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 from being deducted from your bank account, so going without income protection insurance could be tempting fate.
Those in very good jobs will usually receive generous sickness benefits through the workplace and these may extend right up until the date upon which they had intended to retire. The majority of employees with long-term health problems will, on the other hand, find themselves having to rely on the state, which is likely to prove hard.
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 situation, but you can be sure that it will never allow you to do anything more than to subsist.
Income protection insurance, however, can enable you to receive benefit payments of up to around half your income if you are unable to work due to long-term health problems. 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.
But comprehension of income protection insurance is not helped by the fact that it is also commonly referred to under other names, most notably “income replacement insurance” and “permanent health insurance (PHI).”
These titles are entirely interchangeable with income protection insurance but, just to complicate matters further, the product is also commonly confused with a significantly different one called payment protection insurance.Use our: Household insurance top 10 | Professional indemnity guide | Back to Top
Payment protection insurance
Payment protection insurance, covers unemployment as well as poor health, 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.
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, when it is used to protect a policyholder’s general lifestyle.
It is essential not to confuse any forms of payment protection insurance 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.Use our: Savings accounts top 10 | Guide to saving accounts | Back to Top
How does income protection insurance work?
Income protection insurance is frequently better value than any kind of payment protection insurance, 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 outset.
Applicants must answer 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 initial process can take several weeks.
This detailed underwriting can also mean that you have exclusions imposed for medical conditions that you have already suffered from. If you have a history of back pain or stress-related disorders is, in particular, likely to find that these are excluded.Use our: Banks listings | Offshore banking | Back to Top
The individual underwriting also means that applicants can find that the premiums you are eventually quoted can come to considerably more than the prices you originally saw advertised. Factors that can have a major impact on premiums include your age, gender, smoking habits and - most importantly of all - occupation.
Underwriters know that those in some jobs are far more likely to claim than those in others. Roofers may, for example, 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.Use our: Mortgage Lenders | Guide to Remortgaging | Back to Top
Premiums will also be affected by the amount of monthly cover you choose, the length of the cover period, and by the length of the initial “deferred period,” which is the amount of time that elapses between when your claim occurs and when the benefit payments actually start.
The shorter the deferred period the greater the cost. It can be possible to have a deferred period of anything between one month and one year, but in practice most people opt for either six months or three months.
Exactly which insurance company you select will also have a major bearing on prices, because some offer much better value for income protection insurance than others. The key message to take on board is that the company with the cheapest premiums is not necessarily the best value.Use our: Current accounts A-Z | UK Credit Cards Top 10 | Back to Top
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:
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- 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 basis of cover that remains flat throughout the term, whilst others quote for escalating cover that keeps up with inflation.
- Some quotes will refer to premiums that remain ‘fixed’ 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, so it is usually advisable to go for a ‘fixed’ premium.
- Watch out for whether the insurer will pay out if you are unable to do your “own occupation” or “any occupation.” The best ones will pay if you are unable to do your “own” occupation, but some only pay if you are unable to satisfy particular functions of daily living, and others only pay if you are unable to do “any occupation” to which you are suited by means of experience, education and training.
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, meaning that their services effectively cost the consumer nothing - because insurers will not normally refund this commission element to consumers, even if you deal with the insurer directly.
Indeed IFAs can actually save you money by shopping around 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 assess what length of deferred period you should choose, you will also need to provide them with details of your company’s short-term sick pay scheme.Use our: Savings accounts top 10 | Guide to saving accounts | Back to Top
In addition to paying attention to the finer details of cover, IFAs will consider how insurers compare when it comes to paying 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 help themselves get back to work as soon as possible.
For these reasons, IFAs may prefer specialist income protection players like Unum, Liverpool Victoria, Friends Provident and Bright Grey than better known brand names with rock-bottom headline pricing.
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. In some such cases, a niche player such as Pioneer Friendly Society could well prove the best option, or the IFA may even consider it necessary to recommend payment protection insurance instead of income protection insurance.
Although payment protection insurance 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 it better value than income protection insurance for individuals that income protection insurers will not cover at standard rates.Use our: Banks listings | Offshore banking | Back to Top
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 brought out.
Even the standard income protection insurance format could undergo a major overhaul in the near future, as a result of significant work currently being carried out by two major industry working parties.
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 always likely to prove the most cost-effective and safe route.Use our: Mortgage Lenders | Guide to Remortgaging | Back to Top
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- Just because you are ill or made redundant, the bills will still keep coming.
- State benefits will not enable you to do more than subsist.
- The cheapest income protection policy is not necessarily the best value.
- Don’t confuse income protection insurance with payment protection insurance.
- Make sure you buy income protection insurance via an IFA.