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WHAT IS INCOME PROTECTION INSURANCE?

Income Protection insurance is designed to replace most of your income if you become injured or ill and cannot work. While all personal insurance is important, Income Protection is a particularly significant part of your financial well-being as your ability to earn an income is perhaps the most valuable asset you have.

Consider the possibility that you were to become injured and were unable to work for several months. Could you continue to meet your monthly commitments like mortgage repayments, telephone bills, and rent?

There are several common options that you should understand when deciding on which income protection policy to choose and some of these are listed below:

HOW DOES INCOME PROTECTION INSURANCE WORK?

Being too ill to work is likely to affect your earnings. What this effect may be, and how soon it will happen, will depend on your personal circumstances. Income protection insurance is designed to reduce the impact of this loss of earnings.

Under an income protection policy, you pay regular premiums to an insurance company and, in return, they agree that - subject to certain conditions - they will pay you a benefit if you are too ill to work.

Which definition applies to you will be decided when you take out your policy. A number of different definitions of incapacity are used by insurance companies. You should check with the insurer what definitions they use, but the most common ones are:

'own occupation' - you will be able to claim if your incapacity is sufficient to prevent you from following your own occupation

'any suited occupation' - you cannot claim unless you are too ill to carry out your own occupation, and any other occupation to which you are suited, as defined in your policy;

'any occupation' - you cannot claim unless you are too ill to carry out any job whatsoever;

'activities of daily living' - you can only claim if you are unable to carry out a selection of everyday tasks, such as washing and dressing yourself; and

'activities of daily working' - you can only claim if you are unable to carry out a selection of work-related tasks, such as walking, communicating and exercising manual dexterity.

Some of these definitions of incapacity may not be available for certain occupations. The definition that applies to you will have a significant effect on the amount you will have to pay.

There will usually be a period after the start of incapacity before your benefit is paid. This is called the 'deferred period'.

There is no limit to the number of claims that you can make.

Insurance companies offering income protection will always limit your benefit to an amount less than your normal earnings. This is because income protection benefits are free of personal income tax, and insurers are keen to encourage you to return to work.

HOW CAN I DECIDE WHETHER I NEED INCOME PROTECTION INSURANCE?

You will need to consider what might happen to your income and your expenses if you were too ill to work.

First - calculate your income

Potential income sources will depend on your personal circumstances and a number of factors:

If you are employed:

Your employer may continue to pay you for a limited time. Some employers will only pay Statutory Sick Pay. Others may be more generous. You should check what arrangements your employer has made.

If you are self-employed or a member of a partnership:

Your income will almost certainly cease, although your business may continue to generate income for a short time if, for instance, payment is outstanding for work already completed.

State benefits:

In the longer term you may receive Long Term Incapacity Benefit and other State benefits. Some of these benefits are means-tested, and in most cases there are conditions that have to be met, such as your having paid sufficient National Insurance contributions.

You should note that the amounts of, and eligibility conditions for, State benefits may change in the future.

Savings and investments:

If you have savings, these may produce income that will not be affected by your incapacity. Cashing in some investments earlier than planned may, however, result in a financial loss. Such savings may also affect your eligibility for some State benefits.

Pension payments:

If you are receiving a pension from a previous job this is likely to continue despite your incapacity.

Early retirement:

You may be able to start receiving an early retirement pension. This will depend on the rules of the pension scheme(s) to which you belong, and may also be at your employer's discretion. Remember, any pension which starts early is likely to be significantly lower than if you had worked until normal retirement age.

Alternative employment:

Second - calculate your expenses

If you are too ill to work for a long period of time, the way you spend your money may well alter. You need to consider how your expenses might change.

Ongoing costs:

Some types of expenses will continue. These include mortgage, rent and other housing costs, council tax, gas and electricity bills, etc. Some expenses may be covered by specific insurances (although it is common for such cover to be limited, say, to a year from when you become too ill to work). You should check whether your mortgage, hire purchase, credit card or loan repayments or pension contributions are covered by this kind of insurance.

WHEN MIGHT I NEED INCOME PROTECTION INSURANCE?

Having considered the effect on your income and your expenses, do you think that you could cope with your changed circumstances if you were too ill to work? If so, for how long could you cope? If your calculations reveal a probable shortfall, you should seriously consider taking out income protection insurance.

WHEN MIGHT I NOT NEED INCOME PROTECTION INSURANCE?

When:

You have sufficient income from other sources:

Your employer has comprehensive arrangements in place:

You could live on State benefits:

If you compare your income with State benefits, and feel that these will meet your needs, then you will not need income protection insurance.

You should note that the Benefits Agency will use their own definition of incapacity when deciding whether you can receive State benefits. This definition may not be the same one your insurer would use.

IF I DECIDE TO BUY INCOME PROTECTION INSURANCE, WHAT DECISIONS DO I NEED TO MAKE?

Most insurance companies will offer a range of different policies. The overall cost of a policy is likely to be an important consideration. You should remember that, in general terms, the broader the scope of the cover, the greater the cost. For example, 'own occupation' cover is likely to be more expensive than 'any occupation' cover. The exact cost will depend on a number of factors, including your age, sex, occupation and medical history.

You also need to:

Choose how long to wait before your benefit becomes payable:

You can usually choose from a range of possible deferred periods. You will probably wish to match this to your personal circumstances so that, for instance, if your employer will pay you for six months, the benefit from your income protection insurance policy starts after that time. You may consider that an interval, between when your employer stops paying you and when income from your income protection policy starts, would also be acceptable. The longer the deferred period, the cheaper your policy will be.

Choose how long you wish your cover to last:

This will usually also be the maximum period for which benefit will be paid if you are too ill to work. It may be sensible to link this with your normal retirement age, but remember that the longer the term of your policy, the more expensive it is likely to be.

Choose whether the premium you pay should be fixed or could change. You may be able to choose between:

Guaranteed rates - the amount you pay is fixed in advance. The amount you pay cannot be changed by your insurer, except in agreed circumstances (e.g. to rise in line with inflation).

Reviewable rates - your insurer can change the amount it charges you in the light of its costs, overall claims experience etc. This rate does not depend on any claims that you have made. Usually, no change can be made by your insurer during the early period of your policy.

Renewable rates - premiums are set for a fixed period. At the end of that time, you have the right to continue your plan, and your insurance company will set the premium level for a further fixed period, based on your age at that time.

The type of rate you choose will affect the amount you pay. Initially, guaranteed rates are likely to be the most expensive. But over a period of years, renewable rates may become more expensive, since they will increase as you grow older.

WHAT OTHER KINDS OF HEALTH PROTECTION PRODUCTS ARE THERE?

Insurance can give you the resources to cope when you encounter unexpected misfortune. Most people see good health as being very important, as it makes other aspects of life possible.

Accident, sickness and unemployment cover

Accident, sickness and unemployment insurance typically provides benefit for a limited period. A common form of this type of insurance is Mortgage Payment Protection Insurance which usually covers your mortgage payments for a maximum of 12 or 24 months in the case of accident, sickness or redundancy. There is usually a waiting period before payments are made of either 30 or 60 days.

You will need to decide which of these risks concern you, and then select the product(s) which meet your needs.