A guide to income protection insurance
- 13TH JULY 2007
Suffering from a disability or serious illness can be painful enough without having to contend with financial problems as well. But, unfortunately, those who fail to take out suitable insurance normally find themselves facing severe financial hardship if they become unable to work as a result of ill health.
A fortunate few will enjoy adequate protection via the workplace. They may, for example, receive full pay for the first six months and from then onwards, because they are a member of an employer-paid income protection insurance scheme, receive half their normal salary until their intended retirement date – if they never recover.
Most people, however, are not so fortunate, and it will not normally take long for any savings that have been put by for a rainy day to disappear. In the current era of sky high house prices most spare funds are likely to be gobbled up by the mortgage outgoings alone within a few months.
In the absence of a partner or family member being able to provide support, the only income available is likely to be from the state benefit system. Exactly what you will receive in state benefits will depend on your individual circumstances, but you can rest assured that you are always likely to be struggling. The spiral of debt that can result could mean that you end up losing your home or even becoming bankrupt.
It can be a tough old world, and the bills won’t stop arriving just because you’ve been unlucky.
In many cases, therefore, taking out an income protection policy to provide a regular income in the event of being unable to work as a result of ill health should form a cornerstone of financial planning.
There are three different forms of individual income protection insurance to choose between. All pay out a tax-free monthly income if you are unable to work as a result of sickness or disability, and the benefit payments can be spent on anything you choose.
Short-term income protection insurance – which can be arranged instantly but can pay claims benefit only for an absolute maximum of 12 months.
Long-term income protection insurance – which can be arranged instantly and can pay out claims benefit for up to 30 years.
Advisory income protection insurance – which can take several weeks to arrange but which can pay out claims benefit until your intended retirement date (but benefit payments don’t typically begin until after an initial exclusion period of three or six months).
Short-term income protection insurance
Benefit payments from short-term income protection insurance are payable once you have been unable to work for 30 consecutive days, and they backdate to day one. They continue either until you are well enough to return to work or until the end of the maximum pay-out period chosen at outset by the policyholder, which can be: three, six, nine or 12 months. The longer the maximum pay-out period the greater the cost.
The cover is straightforward to understand and, because there is no medical underwriting at outset, it can be arranged instantly. All policyholders pay the same flat rate, regardless of their age, occupation, gender and smoking habits.
This has obvious attractions to those poorer risks who would be charged significant premium loadings by advisory income protection insurers – which underwrite each application individually. Nevertheless the fact that claims benefit will pay out for an absolute maximum of 12 months is a very severe limitation.
Whilst many people will recover from illnesses and injuries within this time period, others will be unable to work for many years. Indeed, some will never be able to work again. Most protection experts therefore argue that longer-term cover is preferable for those who can afford it.
But there will always be some individuals whose budgets simply won’t stretch to the slightly greater costs of long-term income protection insurance or who are refused it on the basis of the answers they provide on the medical questionnaire they are required to complete. For some applicants, particularly older people, smokers and those in risky occupations, advisory income protection insurance can also prove too costly.
In such situations taking out short-term income protection insurance may seem a more sensible course of action that taking out no income protection insurance at all.
Advisory income protection insurance
An advisory income protection insurance policy can pay out benefit until you recover or, if you fail to do so, right up until the end of the policy term – which is typically your intended retirement date.
It can be exceptionally good value for those in low to medium risk occupations with reasonably clean medical histories but, because it requires applicants to undergo an initial underwriting process, it can cost poorer risks several times the headline quoted prices. A policy can also take several weeks to arrange if the insurer decides to write to the applicant’s GP or requires the applicant to undergo an independent medical examination.
Advisory income protection insurance can also be highly complex for the consumer to understand because there are numerous providers, each with their own slight variations on the same theme. The overall value offered by a policy often has just as much to do with its small print terms and conditions as it does with its premium price.
For this reason it is important that policies are bought through an expert adviser – hence the product’s title ‘advisory income protection insurance.’
Our service provides prompt objective advice from suitably qualified health insurance experts who have no vested interest in recommending one insurer over another. They can select the policy most suited to your individual needs from a broad panel of leading specialist insurers.
One issue that they will pay particular attention to is the length of the initial exclusion period (or so-called ‘deferred period’) that you should have. Unlike with long-term and short-term income protection insurance, most advisory income protection insurance policies do not start to pay out at the claims stage until after an initial deferred period of either three or six months has elapsed. Although it can be possible to have a deferred period of only one month - or even to not have one at all - the longer the deferred period the keener the premiums tend to be.
Long-term income protection insurance
This innovative new format aims to provide many of the best features of both short-term income protection insurance and advisory income protection insurance.
Like short-term income protection insurance, it can be arranged instantly, pays out benefit if you are too ill to work for 30 consecutive days and back-dates payment to day one. It is also straightforward to understand, charging all policyholders the same flat premium rate, regardless of their age, smoking habits, gender and occupation.
But it differs notably from short-term income protection insurance in that it can continue benefit payments until the policy has been in force for 30 years or until your 60th birthday, whichever is sooner. It also requires a brief medical questionnaire to be completed and turns down a small percentage of applicants on the basis of their answers.
Unlike most advisory income protection policies, there is no requirement to have a deferred period at the claims stage and there is no waiting around involved at outset. Its premiums can also be more attractive than those quoted by advisory income protection insurers in certain cases, particularly for older people, smokers and those in risky occupations. Nevertheless there are also many cases where advisory income protection insurance is clearly better value.
Exclusions for pre-existing medical conditions
It is important to realise that none of these forms of income protection insurance offers cast iron security to everyone, because - to varying degrees - they all exclude medical conditions that already exist at the time that the policy is taken out.
In the case of advisory income protection insurance, insurers tend to spell out to policyholders at outset exactly what conditions they are excluded for, based on the information that has been acquired during the medical underwriting process.
Long-term income protection insurance, on the other hand, simply excludes any conditions the policyholder has needed medical treatment or advice for within 36 months of the policy start date, but covers everything else.
Short-term income protection insurance excludes all pre-existing conditions, but waives this exclusion if you have not needed medical advice or treatment for the condition concerned for two years prior to the date on which you first become unable to work.
Security and service
The insurance companies providing all three products can be dealt with in the knowledge that they are authorised and regulated by industry watchdog the Financial Services Authority (FSA).
In the unlikely event of any of them being unable to meet your liabilities, you may be entitled to compensation from the Financial Services Compensation Scheme (FSCS).
In addition, if any of the providers are unable to satisfactorily resolve any complaints that you make to them, you may be able to refer the matters to the Financial Ombudsman Service (FOS). This is an independent body which rules on disputes between consumers and financial organisations. There is no charge made to consumers for using it and it does not affect their ability to take subsequent legal action.
