How Does Contractor Sick Pay Insurance Work?
Income Protection works by covering up to 80% of your income if you can’t work for any medical reason.
You can protect both your salary and dividend drawdown, as well as your potentially your partner’s dividend drawdown providing they’re in a non-revenue-generating role within the business.
Setting up Income Protection requires a lot of careful thought as there are many factors which will impact the cost and scope of your cover.
The four biggest factors to consider that will have the most impact on how much Income Protection costs are:
- Level of cover you need
With Contractor Income Protection, due to the tax situation (see below) you can cover a little more of your income than for a personal policy. This means Contractor Income Protection can cover between 50% and 80% of your pre-tax (gross) income depending on the insurer and the type of cover you pick (i.e. Director Income Protection vs personal cover).
- Length of deferral period
A deferral period is how long you’ll need to be off work for before the policy starts to pay out. The longer your deferral period, the cheaper your cover will be. Note that longer deferral periods are typically more cost-effective with Contractor Income Protection paid for by your limited company; for a shorter deferral period, a personal policy may prove better from a cost perspective.
- Your policy cease age
How old you’ll be at the end of the policy. Most people set this to a date where there’ll no longer be working in their limited company, so their retirement date. Many providers will allow you to take out cover that lasts all the way up to age 70, but this will significantly increase premiums compared to a policy that ends at age 65 or even age 60, so consider this carefully.
- Your payout length
Short-term plans pay out for a maximum of 1, 2 or 5 years per condition per claim, whereas long-term policies can continue paying out either until you are well enough to return to work or you reach the end of the policy term (typically your expected retirement date).
Bear in mind the average claims length for insurer Liverpool Victoria is 7 years and 7 months, far longer than the length of time a short term policy would pay out for.
Choose Your Premiums
With Income Protection, there are three main types of premiums you can choose from:
- Reviewable premiums
The insurer is able to ‘review’ these premiums as they see fit. They might therefore increase premiums in a year where there has been lots of claims or due to poor underlying economic factors, for instance. This can make it hard to know what you’ll pay for cover year-on-year.
- Age-banded premiums
These premiums will also increase over time. However, unlike reviewable premiums, they can only increase by a percentage laid out in your policy documents and only to reflect the greater risk of you claiming as you age. This means you’ll know exactly what you’ll pay each year. These tend to start out slightly cheaper.
- Guaranteed premiums
These premiums cannot change over time – they’re fixed from the outset of the policy. Although they usually start out a little more expensive than age-banded premiums, they tend to work out cheaper over a long-term policy because they can’t rise with time.
Your Definition of Incapacity
How ill you need to be to make a claim is determined by the definition of incapacity your policy uses.
Opting to index your policy will result in the insurer writing to you each year to inform you of the increase in the cost of goods and services (known as the Retail Prices Index) and offer you the option to increase your benefit by the same amount to ensure it maintains pace with inflation.
The best is the ‘own occupation’ definition of incapacity, while the one most difficult to claim on is the ‘any occupation / work tasks’ definition.
There are three definitions of incapacity an insurer may use:
Own Occupation Cover
Own occupation cover means that you will be entitled to your benefits as long as your injury or illness prevents you from working in your specific job role.
For example, a contractor who runs their own architecture business and injures their hand wouldn’t be able to complete technical drawings and so could make a claim.
Policies that use a suited occupation definition of incapacity mean that in order to claim benefits, you have to be unable to undertake your current job role or any other job where you may have experience or education to perform.
So where an architect with a hand injury may not be able to do their own job, they may not necessarily be able to claim under a ‘suited occupation’ definition because have the skills and experience to do another job role suited to them.
Any Occupation / Work Tasks
This is a definition of incapacity that means you can only claim if you’re so totally unfit to work that you can’t work in any occupation / perform a set number of tasks required at most basic jobs.
This is the most difficult to claim on and in general we’d recommend it’s best avoided.
Should I Link My Policy to Inflation?
When you take out a long-term policy, i.e. one that will pay out in the event of a claim right up until retirement, you run the risk of that payout being eaten away by inflation.
If you agree, your benefit will rise and so will your premiums to take into account the fact that you now have a higher benefit.
Covering Dividend Payments
Many contractors pay themselves a small salary and top the rest up with dividends to maximise the tax-efficiency of working for themselves.
If you are a director of your own business many insurers will allow you to cover this type of remuneration, although by no means all will permit you to do so.
This means you need to know which insurers will work best for you as a contractor buying Income Protection.
In order to cover dividends, however, you must be a director who is actively contributing to the success of the company – either as part of a team or as the sole employee of the company.
In other words, the dividend must be paid to you in lieu of salary for work undertaken.
Be cautious if your income rises and falls as you win and complete contracts. Some insurers will base the maximum amount of cover allowable on an average of the last 3 years of earnings, whereas others will base it on earnings over the previous 12 months. This can make a big difference when it comes to a claim.
Making an Income Protection Claim…
The process of claiming your benefits begins by contacting your Income Protection provider’s claims team. Instructions on how to do so are usually included in your policy documents.
In order to claim on your policy, you will need to supply your insurer with a completed claims form and evidence of your condition, which will usually come in the the form of a note from your GP.
Online or post is the typical method of submitting a claim, but it’s become increasingly possible to make claims over the phone.
Receiving a Payout
Once your claim has been approved by your policy provider, you will need to wait out your set deferred period.
If you still can’t work after this period of time has elapsed, then you’ll begin receiving a monthly income from the policy to replace your lost wages.
You’ll receive this until either your payout period has expired (short-term policies), until you’re well enough to return to work, or until you retire if you can never work again (long-term policies).
Neil’s Cancer Claim With British Friendly
Neil is a client of Drewberry and took out an Income Protection policy with British Friendly. He was a member for 4 years before he needed to claim.
He became unwell and had pains in his stomach. After consulting his GP and having some further tests Neil was diagnosed with stage 2 Bowel Cancer and needed to make a claim.
🤕 Read More About Neil’s Claim