Income Protection do I need it?
The simple answer is a resounding “YES! We all do.” Everything we do in our lives requires us to maintain an income, from feeding & clothing the family, paying the rent or mortgage, or even just enjoying life. As soon as our income stops, our lifestyle has to change. So it makes sense to protect that income if we can.
What is Income Protection insurance?
Quite simply, it is an insurance policy that pays you a replacement monthly (or weekly) income in the event that you are off work through Sickness or Injury. Policies are available from most popular providers (Aviva, Legal & General, Liverpool Victoria etc.)
The maximum income you can protect is typically 60/65% of your gross earnings before tax, with any benefits paid tax free. For someone earning say £20,000 per annum this means they can protect around £12,000 per annum, to provide an income of £1,000 per month tax free. This is a little less than their usual take home pay but should keep the wolves from the door.
How does income protection work?
Just like a Life assurance or Critical Illness policy the provider takes into account your medical history, and whether you smoke, but more importantly they usually take into account what you actually do for a living. The more dangerous the occupation, the higher the premium becomes as you have a higher risk of Injury claims.
In addition the policy is set up so that you can claim after any sick pay from your employer ceases. The longer the initial waiting period (or “deferment period”) the lower the cost, as the risk of a claim is reduced. You can usually choose 1mth, 2mth, 3mth, 6mth or 12 months deferment.
A) For example, Tim works for a Bank and receives 6 months full pay from the bank if he is off sick. He is a relatively “safe” job, and would not claim unless off work for over 6 months. His premium would be quite low.
B) Now consider Tom, his Twin, who is of course the same age and is working as a self employed Scaffolder on building sites. He obviously has a much higher risk of sustaining an injury, and also receives no sick pay. He can manage on his savings if he can't work for a month, or two, but needs to be able to claim after two months. Obviously this is higher risk, and generates a higher premium. Sometimes this premium would be sufficient to deter an applicant, but I'll come back to that later.
What does “OWN” occupation mean on an income protection plan?
Depending upon your job, the actual cover available has different definitions.
- The first of these is OWN Occupation, which means you are covered as long as you can't do your own job.
- The next best is ANY or SUITED occupation. This means it won't pay out if you could still do something different that you had suitable skills for.
e.g. Tom the Scaffolder, hurts his leg so can't climb ladders for 12 months. He can perhaps still unload the van, and work as a labourer for the team. If that was so then he might not be able to claim if he had “ANY” cover, but he could claim if he had “OWN” cover
The weakest cover is known as Activities of Daily Living (or Working). These are usually 6 specified tests of which you must be unable to complete 2/3 before you can claim. These might include climbing stairs, washing yourself etc. so suggest you are very ill at the time.
So does Income protection actually pay out?
A good question, and a very common reason people give for not taking out Income protection is their belief that it won't pay out. So let's take a look at some statistics.
One provider Cirencester Friendly www.cirencester-friendly.co.uk have provided the following info relating to 2012.
Their figures show that 1.3% of all claims were ineligible to claim. The reasons included illnesses that had been excluded in the original terms (e.g. someone with a history of heart disease being told this would not be covered). Other claims were ineligible because the illness was only covered within the deferred period and the client had recovered before they had exceeded it.
Of the remaining claims 94% were paid, not a bad percentage!
Before we condemn the insurer for declining the remaining 6% we need to understand exactly why they were declined, because in the main they were the clients own fault!
- Some claims were denied because the client could not provide evidence that they had been earning the covered income. Most of us receive payslips, or other proof of payment so this seems unlikely. Possible reasons could be the client was no longer working and hoped the insurer wouldn't know. Or perhaps they had insured a £30,000 income, but only earned £15,000. Of course the payout would be limited to 60% of the lower figure!
- Other claims were denied as the client could not provide medical evidence that they had actually been off sick, presumably because they hadn't seen a Doctor. Given that you have to be off sick for a while this would suggest you'd want to see the Doctor, so seems a little odd.
- There was no loss of earnings. Presumably the client was still being paid sick pay. This suggests the deferment period was incorrect. The insurer is bound under legislation to not make you actually better off when you are “on the sick” than if you were at work, so in this instance couldn't pay out.
- Non-Disclosure on the original application. This means the client, whether intentional or not, had failed to disclose important info regarding their medical history, smoker status, or the duties of their occupation. These issues if disclosed could have affected the original premium, or resulted in restrictions on the policy which meant a claim wasn't possible. e.g. the client “forgot” to mention a previous heart disease, and goes off sick with heart disease. If the insurer had known originally they may not have offered cover to the client
- and finally the most obvious. The clients had not been paying the premiums and were in arrears. I'm sure none of us would expect the cover to be valid if we hadn't paid!
(Aviva have published similar figures showing 93.5% of claims being paid in 2012, with the average claim on their books lasting 5 years!)
So you know what it covers, and that it pays out on most of the claims made but
How much does an Income Protection Insurance cost?
The premium cost depends on the individuals situation, so let's look at our previous cases Tim & Tom the twins.
- A1) Tim is a 30 year old Bank clerk, earning £20,000 per year and he gets paid his full pay for the first 6 months if he is off sick
- He needs £1,000 per month, after 6 months deferment, to age 65
- His premium is £18.20 per month
- B1) Tom, also 30, is a Self Employed Scaffolder working on building sites. He earns £20,000 but obviously has no sick pay. He can survive for a month, maybe two, on his savings.
- Unfortunately his occupation means he is subject to a minimum of 3 months deferment as he is at risk of injury. This means he has to eke his savings out for another month
- He needs £1,000 per month, after 3 months deferment, to age 65.
- His premium is £42.44 per month.
So Tom pays over twice the premium that his twin pays. He may see this as unacceptable.
Fortunately there are other options, provided by companies such as the previously mentioned Cirencester friendly, Exeter friendly, Holloway friendly and others.
These companies offer Income protection policies that are structured differently. Instead of the premium staying the same throughout the policy, the premiums increase automatically every year in line with a fixed schedule. So the premium usually starts out lower than “normal” Income protection policies and rises over the years until eventually it is more expensive. The total paid throughout the term is similar.
More importantly the premiums are not usually based upon Occupation or Smoker status, making the policies particularly cost effective for riskier jobs.
So let's check out Tom the Scaffolder again, using Cirencester Friendly as an example
- B2) 30 year old Scaffolder needs £1,000 per month
- firstly cover is restricted to only £954 per month (close enough)
- Cover is OWN Occupation (that's better)
- Deferment of 2 months is available (Brilliant)
- Premium is only £14.91 (RESULT!)
Something to note is that these providers usually offer deferment periods as low as ONE Week, or even ONE DAY! (I'm not sure how practical that is)
YES the policy is worth having
YES the policies do pay out on most claims
BUT you must seek the advice of your financial adviser, as policies vary and they will ensure you get the one most suited to your situation.
The above article 'Income Protection do I need it?' has been written by Darren Amos, an independent financial adviser, with expertise in providing bespoke insurance solutions for consumers. If you would like Darren to review your protection needs click here.
(image by pakorn - freedigitalphotos.net)