Guide to Income Protection [Video]

Video Transcript

Hi, I’m Tom Conner, one of the directors here at Drewberry.

In this short video we’re going to talk through the basics of Income Protection. In particular, we’re going to cover off these three questions:

• What is Income Protection?
• What are my options when taking out a policy?
• Who should consider this type of cover?

What is Income Protection?

Well, in a nutshell, Income Protection is designed to replace lost earnings if you were to be unable to work due to illness or injury. With some policies you’re also allowed to add cover for the risk of redundancy as well.

But focusing on the illness and injury side, the policy doesn’t list particular conditions that you can and you can’t claim for. Rather, with all leading policies, you’re able to cover any medical condition that prevents you from undertaking the duties of your normal occupation.

So, for example, suppose you’re a manual worker and you slip a disc in your back and the doctor sends you off to see the consultant and the consultant says that you need to have surgery. Naturally, you can’t work during this time and there’s going to be a period of recovery afterwards, so you’ll be signed off from work. Here, the purpose of an Income Protection policy would be to replace lost earnings whilst you’re out of work so you can keep up to date with all your bills.

Income Protection Options

Monthly Benefit

First of all you need to choose the monthly benefit. The monthly benefit is the amount that the policy would pay out to you each month if you were to have to take time off work due to illness or injury (or in some cases redundancy if you have that cover included on the policy).

When setting the amount that you want to cover each month, it’s important to ensure that you consider and tally up your core essential outgoings. So these are things such as your mortgage/your rent, your grocery bills, your utilities, council tax – anything that really has to be paid at the end of the month.

It’s important to remember that the higher the level of cover, the higher the monthly premiums will be. So if you’re on a budget, a good place to start is with those core expenses and then add additional cover on from there if it’s affordable.

Deferral Period

Right, the next option to think about is the deferred period. It sounds like a technical term, but really all it’s saying is that it’s the amount of time that you would need to wait after becoming ill before your policy kicks in.

So often people have sick pay – for example, if you have a month’s worth of sick pay from your employer, you may set the deferred period at 30 days. This means that after 30 days the policy would kick in. So before that you have your employer’s sick pay and after that you have the policy for that continuation of income.

It’s important to remember that the longer the deferred period, the less chance there is that the insurer is going to have to pay short-term claims. Therefore, the longer the deferred period generally the lower the premiums. This could make a significant difference: With some insurers, if you go from a deferred period of say 4 weeks to 13 weeks it can reduce the premiums by as much as 50 percent.

So often if people have savings as well – perhaps they have a month’s worth of sick pay and have say 2 months worth of savings in the bank – they could afford to stretch out that deferred period to 3 months and lower their monthly premium.

Policy Length

The next option that you’ll need to choose is the policy length, i.e. how long the policy will run for. With Income Protection, it’s usually to a specific age. Often it might cover you until retirement age, i.e. so it’s covering your entire working life. So often you might set that to state pension age, which could be between 65 and 67 at the moment.

Or alternatively it may run for a period of time that covers a specific liability. So for example if you have a mortgage and then the mortgage has a 20-year term it might run for 20 years.

Now as you get older the chances of suffering an illness or injury increase. So the longer the policy term the higher the premiums.

Premium Type

The next option that you choose is the premium type. Now unlike car insurance, which tends to come with reviewable premiums (i.e. each year the insurer can make a decision about whether they increase the premiums or not), with protection policies such as Income Protection you can have guaranteed premiums as an option or you can choose reviewable premiums

With guaranteed premiums, the premiums are fixed over the life of the policy so they can’t change over that life. So if you have a policy for say 20 years they’ll be fixed for 20 years. Naturally, with the reviewable premiums they can increase over time.

The third premium option you have with income protection is what’s called age-banded premiums. With age-banded premiums, they’re age rated. So as you get older the premiums increase with time.

• Guaranteed premiums – these tend to be the highest at the start because they’re fixed over time
• Reviewable premiums – these tend to be a little bit lower because the insurer does have the right to increase them over time, say for example if their claims experience is higher than what they expected
• Age-banded premiums – at the lowest cost you have the age-banded premiums, which do tend to shoot up quite a lot, especially in the latter stages of life.

Payout Length

The next option that you need to choose is the payout length. This is the maximum period of time that the policy will pay out for should you need to make a claim. Traditionally there was only one option with this: It would pay out either until you were well enough to return to work or you reach the end of the policy length.

So for example if you had a policy that ran for 20 years and you were to suffer something that was particularly nasty, maybe paralysis say as the result of a car accident, or Parkinson’s, for example, and you could never return to work the policy could pay out all the way until the end of the 20 year term.

Since then, however, other options have entered the market with lower premiums but they would limit how long they would pay out for. Typically policy options with regards to payout length are 12 months, 24 months and 5 years.

Now with this it’s important to be very, very careful. Although the premiums for a policy that could pay for say a maximum of 12 months might look attractive, research from a lot of insurers in terms of their average payout lengths for Income Protection range from say 5 years to 7 years. It’s a surprising length of time, but when you look at all the serious medical conditions that you could suffer from it’s quite easy to see how that time could add up.

Now if you were to have a policy which could only pay for 12 months and you were to suffer something that was particularly serious, then you could easily find yourself in a situation where you reached the end of the 12 month period, you’re still unable to go back to work, but the policy payments stop. Now that’s not a position that you want to be in.

So generally if you have the budget and you can afford a policy that wouldn’t limit how long it could pay for, i.e. it would run to the end of the policy life, then that would generally be the best option.

Occupation Definition

The next thing we have on the list is occupation definition. It’s not really an option: I put it on here mainly as a warning. Most policies these days will cover you under what’s called the own occupation definition of incapacity.

This means if you’re unable to undertake the main duties of your particular occupation due to medical reasons then the policy will pay out. It’s very straightforward and clear-cut, as you would expect it to be taking out an Income Protection policy.

Now the warning is that there are policies on the market with lesser definitions of incapacity. For example, there’s one on the market known as the ‘suited occupation’ definition. With this, at the claims stage the insurer would assess your skills and experience and determine whether they think that you’re capable of undertaking another job for which you’re suited.

For example, if you’re a pilot and you lose sight in one of your eyes it’s common for you to lose your pilot’s license. In this example the insurer could say, ‘well given your skills and experience you could teach student pilots navigation’ – even if it meant that you had to take a significant drop in income – and therefore not pay out.

Even worse than this is the ‘any occupation’ definition of incapacity. With this, the insurer could say ‘well are you capable of undertaking any other job?’ So given these lesser definitions, we strongly recommend that you steer yourself toward ‘own occupation’ cover, so you’re covered comprehensively and you know where you stand.

Who Should Consider Income Protection?

So now we’ve covered what policy options you have when taking out the policy, the last question is do you consider Income Protection?

We arrange Income Protection for a very wide range people, from self-employed people who have no sick pay at all to doctors and surgeons who have as much as 6 months of NHS sick pay.

Really, if you would suffer financially and struggle to pay your bills if you lost your income, then Income Protection could be suitable for you. It’s really as simple as that.