Income protection insurance

How would you pay the bills if you were sick or injured and couldn’t work?

Protecting your income should be taken very seriously, given the limited government support available. How would you pay the bills if you were sick or injured and couldn’t work? Income protection insurance, formerly known as ‘permanent health insurance’, is a financial safety net designed to help protect you, your family and your lifestyle in the event that you cannot work and cope financially due to an illness or accidental injury preventing you from working. Most of us need to work to pay the bills.

Without a regular income, you may find it a struggle financially, even if you were ill for only a short period, and you could end up using your savings to pay the bills. In the event that you suffered from a serious illness, medical condition or accident, you could even find that you are never able to return to work. Few of us could cope financially if we were off work for more than six to nine months. Income protection insurance provides a tax-free monthly income for as long as required, up to retirement age, should you be unable to work due to long-term sickness or injury.

By law, your employer must pay most employees statutory sick pay for up to 28 weeks. This will almost certainly be a lot less than your full earnings. Few employers pay for longer periods. If you find yourself in a situation where you are unable to return to work, your employer could even stop paying you altogether and terminate your employment. After that, you would probably have to rely on state benefits. Some employers arrange group income protection insurance for their employees, which can pay out an income after the statutory sick period.

Income protection insurance aims to put you back to the position you were in before you were unable to work. It does not allow you to make a profit out of your misfortune. So the maximum amount of income you can replace through insurance is broadly the after-tax earnings you have lost, less an adjustment for state benefits you can claim. This is usually translated into a maximum of 50 per cent to 65 per cent of your before-tax earnings.

If you are self-employed, then no work is also likely to mean no income. However, depending on what you do, you may have income coming in from earlier work, even if you are ill for several months. The self-employed can take out individual policies rather than business ones, but you need to ascertain on what basis the insurer will pay out. A typical basis for payment is your pre-tax share of the gross profit, after deduction of trading expenses, in the 12 months immediately prior to the date of your incapacity. Some policies operate an average over the last three years, as they understand that self-employed people often have a fluctuating income.

The cost of your cover will depend on your gender, occupation, age, state of health and whether or not you smoke.

The ‘occupation class’ is used by insurers to decide whether a policyholder is able to return to work. If a policy will pay out only if a policyholder is unable to work in ‘any occupation’, it might not pay benefits for long – or indeed at all. The most comprehensive definitions are ‘Own Occupation’ or ‘Suited Occupation’. ‘Own Occupation’ means you can make a claim if you are unable to perform your own job; however, being covered under ‘Any Occupation’ means that you have to be unable to perform any job, with equivalent earnings to the job you were doing before not taken into account.

You can also usually choose for your cover to remain the same (level cover) or increase in line with inflation (inflation-linked cover):

Level cover – with this cover, if you made a claim the monthly income would be fixed at the start of your plan and does not change in the future. You should remember that this means, if inflation eventually starts to rise, that the buying power of your monthly income payments may be reduced over time.

Inflation-linked cover – with this cover, if you made a claim the monthly income would go up in line with the Retail Prices Index (RPI).

When you take out cover, you usually have the choice of:

Guaranteed premiums – the premiums remain the same all the way throughout the term of your plan. If you have chosen inflation-linked cover, your premiums and cover will automatically go up each year in line with RPI.

Reviewable premiums – this means the premiums you pay can increase or decrease in the future. The premiums will not typically increase or decrease for the first five years of your plan but they may do so at any time after that. If your premiums do go up, or down, they will not change again for the next 12 months.

How long you have to wait after making a claim will depend on the waiting period. You can usually choose from between 1, 2, 3, 6, 12 or 24 months. The longer the waiting period you choose, the lower the premium for your cover will be, but you’ll have to wait longer after you become unable to work before the payments from the policy are paid to you. Premiums must be paid for the entire term of the plan, including the waiting period.
Depending on your circumstances, it is possible that the payments from the plan may affect any state benefits due to you. This will depend on your individual situation and what state benefits you are claiming or intending to claim. If you are unsure whether any state benefits you are receiving will be affected, you should seek professional advice.

Critical illness cover

Choosing the right cover can help ease your financial pressures

You really need to find the right peace of mind when faced with the difficulty of dealing with a critical illness. Critical illness cover is a long-term insurance policy designed to pay you a tax-free lump sum on the diagnosis of certain specified life-threatening or debilitating (but not necessarily fatal) conditions, such as a heart attack, stroke, certain types/stages of cancer and multiple sclerosis. A more comprehensive policy will cover many more serious conditions, including loss of sight, permanent loss of hearing and a total and permanent disability that stops you from working. Some policies also provide cover against the loss of limbs.

It’s almost impossible to predict certain events that may occur within our lives, so taking out critical illness cover for you and your family, or if you run a business or company, offers protection when you may need it more than anything else. But not all conditions are necessarily covered, which is why you should always obtain professional advice.

If you are single with no dependants, critical illness cover can be used to pay off your mortgage, which means that you would have fewer bills or a lump sum to use if you became very unwell. And if you are part of a couple, it can provide much-needed financial support at a time of emotional stress.

The illnesses covered are specified in the policy along with any exclusions and limitations, which may differ between insurers. Critical illness policies usually only pay out once, so are not a replacement for income. Some policies offer combined life and critical illness cover. These pay out if you are diagnosed with a critical illness, or you die, whichever happens first.

If you already have an existing critical illness policy, you might find that by replacing a policy you would lose some of the benefits if you have developed any illnesses since you took out the first policy. It is important to seek professional advice before considering replacing or switching your policy, as pre-existing conditions may not be covered under a new policy.

Some policies allow you to increase your cover, particularly after lifestyle changes such as marriage, moving home or having children. If you cannot increase the cover under your existing policy, you could consider taking out a new policy just to ‘top up’ your existing cover.

A policy will provide cover only for conditions defined in the policy document. For a condition to be covered, your condition must meet the policy definition exactly. This can mean that some conditions, such as some forms of cancer, won’t be covered if deemed insufficiently severe.

Similarly, some conditions will not be covered if you suffer from them after reaching a certain age, for example, many policies will not cover Alzheimer’s disease if diagnosed after the age of 60.

Very few policies will pay out as soon as you receive diagnosis of any of the conditions listed in the policy and
most pay out only after a ‘survival period’, which is typically 28 days. This means that if you die within 28 days of meeting the definition of the critical illness given in the policy, the cover would not pay out.

How much you pay for critical illness cover will depend on a range of factors including what sort of policy you have chosen, your age, the amount you want the policy to pay out and whether or not you smoke.

Permanent, total disability is usually included in the policy. Some insurers define ‘permanent total disability’ as being unable to work as you normally would as a result of sickness, while others see it as being unable to independently perform three or more ‘Activities of Daily Living’ as a result of sickness or accident.

Activities of daily living include:

• Bathing
• Dressing and undressing
• Eating
• Transferring from bed to chair and back again

The good news is that medical advances mean more people than ever are surviving conditions that might have killed earlier generations. Critical illness cover can provide cash to allow you to pursue a less stressful lifestyle while you recover from illness, or you can use it for any other purpose. Don’t leave it to chance – make sure you’re fully covered.

Whole-of-life assurance

Providing financial protection with cover that
lasts for the rest of your life

Whole-of-life assurance policies provide financial security for people who depend on you financially. As the name suggests, whole-of-life assurance helps you protect your loved ones financially with cover that lasts for the rest of your life. This means the insurance company will have to pay out in almost every case and premiums are therefore higher than those charged on term assurance policies.

There are different types of whole-of-life assurance policy – some offer a set payout from the outset, others are linked to investments, and the payout will depend on performance. Investment-linked policies are either unit-linked policies, linked to funds, or with-profits policies, which offer bonuses.

Whole-of-life assurance policies pay a lump sum to your estate when you die. This could be used by your family in whatever way suits them best, such as providing for an inheritance, paying for funeral costs and even forming part of an inheritance tax planning strategy.

Some whole-of-life assurance policies require that premiums are paid all the way up to your death. Others become paid-up at a certain age and waive premiums from that point onwards.

Whole-of-life assurance policies can seem attractive because most (but not all) have an investment element and therefore a surrender value. If, however, you cancel the policy and cash it in, you will lose your cover. Where there is an investment element, your premiums are usually reviewed after ten years and then every five years.

Whole-of-life assurance policies are also available without an investment element and with guaranteed or investment-linked premiums from some providers.

Reviews
The level of protection selected will normally be guaranteed for the first ten years, at which point it will be reviewed to see how much protection can be provided in the future. If the review shows that the same level of protection can be carried on, it will be guaranteed to the next review date.

If the review reveals that the same level of protection can’t continue, you’ll have two choices:

• Increase your payments
• Keep your payments the same and reduce your
level of protection

Maximum cover
Maximum cover offers a high initial level of cover for a lower premium, until the first plan review, which is normally after ten years. The low premium is achieved because very little of your premium is kept back for investment, as most of it is used to pay for the life assurance.

After a review you may have to increase your premiums significantly to keep the same level of cover, as this depends on how well the cash in the investment reserve (underlying fund) has performed.

Standard cover
This cover balances the level of life assurance with adequate investment to support the policy in later years. This maintains the original premium throughout the life of the policy. However, it relies on the value of units invested in the underlying fund growing at a certain level each year. Increased charges or poor performance of the fund could mean you’ll have to increase your monthly premium to keep the same level of cover.

Term assurance

You can’t rely on always being there for
those who depend on you

It’s essential to have the right sort of life assurance in place. You can’t rely on always being there for those who depend on you. There are various ways of providing for your family in the event of your premature death, but term assurance policies are the simplest and cheapest form of cover. The plans have no cash-in value or payments on survival as their design is limited to protecting your family. However, you could also use term assurance in relation to estate planning and for the payment of mortgages or other debts.

Term assurance provides cover for a fixed term, with the sum assured payable only on death. You can choose how long you’re covered for, for example, 10, 15 or 20 years (the term). Premiums are based primarily on the age and health of the life assured, the sum assured and the policy term. The older the life assured or the longer the policy term, the higher the premium will generally be.

Term assurance policies can be written on a single life, joint life (first or second death) or on a life-of-another basis. You must have a financial interest in the person that you are insuring when taking out any life-of-another policy and the provider may require proof of this before cover is given.

There are several types of term assurance:

Level term – this offers the same payout throughout the life of the policy, so your dependants would receive the same amount whether you died on the first day after taking the policy out or the day before it expired. This tends to be used in conjunction with an interest-only mortgage, where the debt has to be paid off only on the last day of the mortgage term. With level term assurance, premiums are fixed for the duration of the term and a payment will be made only if a death occurs during the period of cover. A level term assurance policy is taken out for a fixed term. This type of term assurance policy can also be useful for providing security to dependants up to a certain age.

Decreasing term – the cash payout reduces by a fixed amount each year, ending up at zero by the end of the term. Because the level of cover falls during the term, your premiums on this type of policy are lower than on level policies. This cover is often bought to run alongside repayment mortgages, where the debt reduces during the mortgage term.This type of term assurance is less expensive than level term assurance.

Increasing term – the potential payout increases by a small amount each year. This can be a useful way of protecting your initial sum assured during periods of rising inflation.

Index-linked term – some insurers provide you with the option for the premium to be increased each year in relation to the Retail Price Index.

Convertible term – you have the option to convert in the future to another type of life assurance, such as a ‘whole-of-life’ or endowment policy, without having to submit any further medical evidence. This conversion option allows you to adapt your plan if your circumstances change. You can convert (usually within certain limits) part or all of your life assurance cover at any time during the term. And, importantly, you won’t be asked any health questions at the date of conversion.

If the level of cover you selected at the start remains the same, then the premiums will too. If you survive the policy term without any conversion of the plan, there will be no pay out. As this type of policy provides cover only in the event of death (plus the option to convert), there is no surrender value. So if you stop paying the premiums at any time, your cover would cease immediately and you would not receive any money back.

Renewable term – some term assurances are ‘renewable’ in that, on the expiry date, there is an option for you to take out a further term assurance at ordinary rates without providing evidence of your health status, as long as the expiry date is not beyond a set age, often 65. Each subsequent policy will have the same option, provided the expiry date is not beyond the limit set by the life office.

Family income benefit – instead of paying a lump sum, this offers your dependants a regular income from the date of your premature death until the end of the policy term. This is one of the least expensive forms of cover and differs from most other types in that it is designed to pay the benefit as an income rather than a lump sum. In the event of a claim, income can be paid monthly, quarterly or annually and under current rules the income is tax-free. To ensure that income payments keep pace with inflation, you can usually have them increased as inflation rises. It’s also possible to take a cash sum instead of the income option upon death.

Family income benefit can also include critical illness cover, which is designed to pay the selected income if you are diagnosed with a critical illness within the chosen term. It is a fixed term and you won’t be able to increase your cover or extend the term. If you become ill towards the end of the term (duration of your policy), you might not be able to obtain further cover.

Life assurance

Providing a financial safety net for your loved ones

Whether you’re looking to provide a financial safety net for your loved ones, moving house or a first time buyer looking to arrange your mortgage life insurance – or simply wanting to add some cover to what you’ve already got – you’ll want to make sure you choose the right type of cover. That’s why obtaining the right advice and knowing which products to choose – including the most suitable sum assured, premium, terms and payment provisions – is essential.

Life assurance helps your dependants to cope financially in the event of your premature death. When you take out life assurance, you set the amount you want the policy to pay out should you die – this is called the ‘sum assured’. Even if you consider that currently you have sufficient life assurance, you’ll probably need more later on if your circumstances change. If you don’t update your policy as key events happen throughout your life, you may risk being seriously under-insured.

As you reach different stages in your life, the need for protection will inevitably change. These are typical events when you should review your life assurance requirements:

• Buying your first home with a partner
• Having other debts and dependants
• Getting married or entering into a civil partnership
• Starting a family
• Becoming a stay-at-home parent
• Having more children
• Moving to a bigger property
• Salary increases
• Changing your job
• Reaching retirement
• Relying on someone else to support you
• Personal guarantee for business loans

Your life assurance premiums will vary according to a number of different factors, including the sum assured and the length of your policy (its ‘term’), plus individual lifestyle factors such as your age, occupation, gender, state of health and whether or not you smoke.

If you have a spouse, partner or children, you should have sufficient protection to pay off your mortgage and any other liabilities. After that, you may need life assurance to replace at least some of your income. How much money a family needs will vary from household to household so, ultimately, it’s up to you to decide how much money you would like to leave your family that would enable them to maintain their current standard of living.

There are two basic types of life assurance, ‘term’ and ‘whole-of-life’, but within those categories there are different variations.

The cheapest, simplest form of life assurance is term assurance. It is straightforward protection, there is no investment element and it pays out a lump sum if you die within a specified period. There are several types of term assurance.

The other type of protection available is a whole-of-life assurance policy designed to provide you with cover throughout your entire lifetime. The policy only pays out once the policyholder dies, providing the policyholder’s dependants with a lump sum, usually tax-free.

Depending on the individual policy, policyholders may have to continue contributing right up until they die, or they may be able to stop paying in once they reach a stated age, even though the cover continues until they die.

Tax matters
Although the proceeds from a life assurance policy are tax-free, they could form part of your estate and become liable to inheritance tax. The simple way to avoid inheritance tax on the proceeds is to place your policy into an appropriate trust, which enables any payout to be made directly to your dependants. Certain kinds of trust allow you to control what happens to your payout after death and this could speed up a payment. However, they cannot be used for life assurance policies that are assigned to (earmarked for) your mortgage lender.

Generally speaking, the amount of life assurance you may need should provide a lump sum that is sufficient to remove the burden of any debts and, ideally, leave enough over to invest in order to provide an income to support your dependants for the required period of time.

The first consideration is to clarify what you want the life assurance to protect. If you simply want to cover your mortgage, then an amount equal to the outstanding mortgage debt can achieve that.

However, if you want to prevent your family from being financially disadvantaged by your premature death and provide enough financial support to maintain their current lifestyle, there are a few more variables you should consider.

• What are your family expenses and how would they change if you died?
• How much would the family expenditure increase on requirements such as childcare if you were to die?
• How much would your family income drop if you were to die?
• How much cover do you receive from your employer or company pension scheme and for how long?
• What existing policies do you have already and how far do they go to meeting your needs?
• How long would your existing savings last?
• What state benefits are there that could provide extra support to meet your family’s needs?
• How would the return of inflation to the economy affect the amount of your cover over time?