Income Protection Insurance or Permanent Health Insurance
Income protection cover; The basics explained
Income protection is designed to pay a monthly or annual income if you are unable to work due to illness or accident.
It isn’t designed to replace your income if you are made redundant, with a few exceptions.
Some policies might be able to include redundancy cover paying a claim for one or two years, but this can be expensive.
Most insurers offer short-term cover, where a single claim can last for up to 2 years, or long-term cover (which we call full IP) where a claim could be paid until the end of the term.
It is not the same as payment protection, or accident, sickness, and unemployment cover.
Income protection cover is a term product, meaning you arrange a policy to cover you for a set term, or up to a given age, after which the policy ceases.
During that time the insurer cannot cancel the cover because you have made multiple claims or change the terms due to changes to your health.
If you have a good medical history there will usually be no medical exclusions.
Any exclusions that were applied would be agreed by the insurer at application.
It is relatively inexpensive, especially compared to Critical illness cover. The two types of policies are very different as explained below, but income protection is more comprehensive.
Typical cover options of income protection.
As it is a term product, the first option is what age to run the policy to. This could be your retirement age, the end of your mortgage, or any age you prefer.
You can then decide between short and full IP cover.
Short-term policies pay a single claim for a maximum of 2 years, after which you would need to return to work, and subsequently be signed off again, before being able to make a new claim for the same condition.
Full IP policies would pay a single claim for an unlimited period up to the end of the policy if you remained signed off work.
This is an important distinction, as full IP is a much more comprehensive policy giving cover should you develop a condition leading to being unable to work for life.
Pricing is reasonable, with full IP usually quite a bit cheaper than critical illness cover and accident sickness and unemployment cover. There is a more detailed comparison of example costs below.
Most products can be arranged on a guaranteed premium basis, which means the price will remain the same throughout the whole term.
You can also arrange a reviewable basis where the insurer can change the premium usually every 5 years to reflect claims statistics.
We would normally advise that guaranteed premiums offer greater security over long-term cost and affordability.
Some providers will offer guaranteed premiums that escalate each year by a fixed amount.
We call these “low start” plans, and they are usually more costly overall.
If customers can afford payments on a normal plan they should consider fully the long-term cost impacts of a low start plan before arranging one.
Next, you choose the amount of cover per month or year that is required.
This is generally limited to a maximum of 50-60% of your current gross monthly income but this differs with each provider.
This is so that you would always have the incentive to return to work, but the benefits are currently tax-free, so it is not as restrictive as it seems.
The lower the cover level, the lower the premium so some quotes will enable you to find out what is affordable.
And you should consider how being ill would affect your expenditure during a claim.
As you are arranging insurance for most of your life based on current earnings, inflation will reduce the value of the monthly cover over time.
Most insurers will allow you to set the plan to increase by a fixed amount each year such as 5%, or even to increase in line with inflation.
Each year your cover level would increase and your payments would increase in proportion to this.
Example cover & cost comparison
To illustrate these typical prices differences, here are some cost comparisons between full IP, critical illness cover, and accident sickness and unemployment insurance.
For a 29-year old accountant, up to age 65, with a 3-month excess and £2k per month in cover, guaranteed premiums (not an age-adjusted or low start policy) cover could be arranged currently from about £28.50 a month. The potential maximum claim on this policy would be £834,000.
As the maximum claim will reduce every month, the best way to compare it with critical illness insurance is against a policy which is also arranged to pay an annual income of £24000, so the potential cover on each policy is similar.
This type of cover could be arranged at a premium from £106 a month, nearly 4 times more expensive.
The reasons for the difference in cost between the two are complex and will largely be based on claims and medical statistics, survival rates and the odds of returning to work after a serious condition.
As the income protection would cease paying a claim if someone was fit to return to work, and the critical illness would be fully payable upon the diagnosis of a suitable condition, the potential claims have very different risks attached to the insurer and this is reflected in the price.
For the same applicant, an accident sickness and unemployment policy, with only a single year per valid claim versus the full IP cost of £28.50 – again with a 3-month excess period and a policy the insurer could re-price or cancel every year the prices would begin from £45 a month.
The reason why accident sickness and unemployment cover would be so much more expensive, despite being much less comprehensive in the medical aspect of its cover, is likely due to the very high risks of being made redundant nowadays.
But with the very limited cover period provided by such an ASU policy, it’s arguable that a customer may be much better protected by a cheaper income protection policy if they could put aside a lump sum in savings to cover the short-term risks of redundancy.
These prices were compiled 11-07-2018 and may not reflect current costs and will vary, and are provided for illustrative purposes only.
Important differences in income protection plans
Like critical illness cover income protection can be arranged on an “own occupation” basis, or other definitions such as “any occupation” or “activities of daily living”.
These define the test you must meet to be classed as incapacitated.
Own occupation means you cannot do your normal job role, so a surgeon with injured fingers might be unable to do their job but might be capable of working in a lower-paid role.
Hence own occupation cover is extremely important if it can be arranged for your profession and medical history.
People in riskier jobs or with difficult medical history might be offered cover on one of the less comprehensive bases such as "any occupation".
So, it’s very important to know what you are arranging and what it means for you.
Another key difference is that some policies offer a minimum guaranteed benefit amount.
As they are limited to paying out a maximum percentage of your salary, this can cause problems if you come to make a claim and your salary has reduced.
Let’s say you had returned from maternity leave working half your normal hours and fell ill.
As your salary would have been about half your normal rate then your benefit could be significantly reduced.
Many insurers will offer a guaranteed minimum sum insured usually the lower of your cover level or £1500 a month.
This is an important feature as it means that your cover level is still protected even if your work circumstances change.
Several insurers also include a guaranteed cover level even if you were out of work.
Imagine you were between jobs and then fell ill with a long-term deteriorating disease and were never able to work again.
Cover with no guaranteed sum assured might be worthless in this scenario, whereas a policy with it would still pay up to £1500 a month or your cover level, whichever was lower.
And this also means you would be covered if you had stopped working to care for children before becoming ill and so this feature is an important one.
There are even some providers who can arrange a policy for a homemaker from the outset, many people forget to think about the impact of a homemaker becoming ill on their families costs as the breadwinner may then have to care for children and their partner.
There are many other unique benefits offered across providers, such as daily payments for a period in a hospital helping to cover your loved ones traveling costs, or additional cover if a child is critically ill or needs long-term care.
Income protection versus critical illness cover
One aspect of income protection, often overlooked, is that it is usually a lot cheaper than critical illness cover and could be more comprehensive.
A critical illness policy only covers certain specific severe conditions like cancer, liver failure or stroke.
But there are many instances where someone could be out of work for long periods that would not be considered a critical illness.
Therefore there are lots of scenarios where critical illness cover could leave you without any protection.
To understand why critical illness cover is seemingly less comprehensive but more expensive to most people consider that most people suffer a critical illness during the latter years of their working life when the risk of cancer, stroke, liver failure or other significant conditions are greater.
This all affects the odds of the insured making a claim and how long that would payout for on income protection. Survivability and the likelihood of being able to return to work also affect the insurer's risks and how large a claim might be on income protection whereas critical illness policies will normally be paying a pre-defined amount on any claim.
These differences have a large bearing on the differences in costs. So, customers should give real consideration to the differences between the two types of cover before choosing one.
Full IP, if it can be arranged without medical exclusions, should ensure that in almost any medical scenario a customer can continue to pay their mortgage and outgoings and avoid repossession, whereas critical illness cover could leave them with significant risks unaddressed.
If you want help to understand your protection options get in touch with us and we can guide you on what is right for you, and help you get the cover you want, without the pitfalls.