In the May/June issue of our Smart Money Magazine, we explore the topic of income protection insurance, a product that has been the focus for many over the last few months. It prompts us to ask the question: How will you pay the bills if you were sick or injured and couldn’t work?
There is a growing unease about the economic fallout of coronavirus (COVID-19), with many businesses laying off contractors and putting staff on extended leave, as well as natural worries about contacting the disease.
What this crisis has shown is that being unable to work can quickly turn our world upside down. No one likes to think that something bad will happen to them, but if you can’t work due to a serious illness, how would you manage financially? Could you survive on savings or sick pay from work? If not, you may need some other way to keep paying the bills – and income protection insurance is an option to consider.
You might think this may not happen to you, and of course we hope it doesn’t, but it’s important to recognise that no one is immune to the risk of illness and accidents. No one can guarantee that they will not be the victim of an unfortunate accident or be diagnosed with a serious illness. This won’t stop the bills arriving or the mortgage payments from being deducted from your bank account, so forgoing income protection insurance could be tempting fate.
Cover monthly payments
Income protection insurance is a long-term insurance policy that provides a monthly payment if you can’t work because you’re ill or injured, and typically pays out until you can start working again, or until you retire, die or the end of the policy term – whichever is sooner.
Keep your finances healthy as you recover from illness or injury:
Income protection insurance replaces part of your income if you become ill or disabled
It pays out until you can start working again, or until you retire, die or the end of the policy term – whichever is sooner
There’s a waiting period before the payments start, so you generally set payments to start after your sick pay ends, or after any other insurance stops covering you. The longer you wait, the lower the monthly payments
It covers most illnesses that leave you unable to work, either in the short or long term (depending on the type of policy and its definition of incapacity)
You can claim as many times as you need to while the policy is in force
Generous sickness benefits
Some people receive generous sickness benefits through their workplace, and these can extend right up until the date upon which they had intended to retire. However, some employees with long-term health problems could find themselves having to rely on the state, which is likely to prove hard.
Tax-free monthly income
We’re already seeing, as a consequence of COVID-19, how many people are finding it a struggle financially without a regular income. Even if you were ill for only a short period, you could end up using your savings to pay the bills, but how long would they last? In the event that you suffered from a serious illness, medical condition or accident, you could even find that you are never able to return to work. Few of us could cope financially if we were off work for more than six months. Income protection insurance provides a tax-free monthly income for as long as required, up to your nominated retirement age, should you be unable to work due to long-term sickness or injury.
Profiting from misfortune
Income protection insurance aims to put you back to the position you were in before you were unable to work. It does not allow you to make a profit out of your misfortune. So the maximum amount of income you can replace through insurance is broadly the after-tax earnings you have lost, less an adjustment for state benefits you can claim. This is typically translated into a percentage of your salary before tax, but the actual amount will depend on the company that provides your cover.
If you are self-employed, then no work is also likely to mean no income. However, depending on what you do, you may have income coming in from earlier work, even if you are ill for several months. Self-employed people can take out individual policies rather than business ones, but you need to ascertain on what basis the insurer will pay out. A typical basis for payment is your pre-tax share of the gross profit, after deduction of trading expenses, in the 12 months immediately prior to the date of your incapacity. Some policies operate an average over the last three years, as they understand that self-employed people often have a fluctuating income.
Cost of cover
The cost of your cover will depend on your occupation, age, state of health and whether or not you smoke. The ‘occupation class’ is used by insurers to decide whether a policyholder is able to return to work. If a policy will pay out only if a policyholder is unable to work in ‘any occupation’, it might not pay benefits for long – or indeed at all. The most comprehensive definitions are ‘Own Occupation’ or ‘Suited Occupation’. ‘Own Occupation’ means you can make a claim if you are unable to perform your own job. However, being covered under ‘Any Occupation’ means that you have to be unable to perform any job, with equivalent earnings to the job you were doing before not taken into account.
You can also usually choose for your cover to remain the same (level cover) or increase in line with inflation (inflation-linked cover):
Level cover – with this cover, if you made a claim, the monthly income would be fixed at the start of your plan and does not change in the future. You should remember that this means if inflation eventually starts to rise, the buying power of your monthly income payments may be reduced over time
Inflation-linked cover – with this cover, if you made a claim, the monthly income would go up in line with the Retail Prices Index (RPI)
When you take out cover, you usually have the choice of:
Guaranteed premiums – the premiums remain the same all the way throughout the term of your plan. If you have chosen inflation-linked cover, your premiums and cover will automatically go up each year in line with RPI
Reviewable premiums – this means the premiums you pay can increase or decrease in the future. The premiums will not typically increase or decrease for the first five years of your plan, but they may do so at any time after that. If your premiums do go up or down, they will not change again for the next 12 months
Making a claim
How long you have to wait after making a claim will depend on the waiting period. You can typically choose from between 1, 2, 3, 6, 12 or 24 months. The longer the waiting period you choose, the lower the premium for your cover will be, but you’ll have to wait longer after you become unable to work before the payments from the policy are paid to you. Premiums must be paid for the entire term of the plan, including the waiting period.
Innovative new products
Depending on your circumstances, it is possible that the payments from the plan may affect any state benefits due to you. This will depend on your individual situation and what state benefits you are claiming or intending to claim. This market is subject to constant change in terms of the innovative new products that are being launched. If you are unsure whether any state benefits you are receiving will be affected, you should seek professional financial advice.