Income Protection Insurance

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Income Protection Insurance

Income protection insurance is an important insurance product for most people as it is designed to provide cover in the event of a significant loss of income caused by a long-term illness or injury. This type of insurance is also commonly referred to as Income Replacement Insurance and Permanent Health Insurance (PHI).

How does the policy work?

If you are unable to work due to health issues, your income protection insurance policy will pay out a tax-free monthly income to compensate for any loss of earnings. The maximum amount of benefit you receive each month is based on a percentage of your gross earnings (usually around 50% of your pre-tax income). These monthly payments will continue until you are fit enough to return to work or, if you fail to make a recovery, until the end of the policy term which is typically your selected retirement date.

Types of income protection policies

There are long-term and short-term income protection policies available. Long-term plans are designed to kick in between when you stop receiving sick pay from your employer and when you collect your pension, while shorter-term policies are designed to protect a mortgage, bank loan or other payment, and often include unemployment and redundancy.

Types of income protection premium

There are three types of income protection premiums available – ‘reviewable’, ‘renewable’ and ‘guaranteed’.

• Reviewable premiums - A reviewable premium means that premiums may start off relatively low, but will be reviewed in the future and may increase every few years or so. In some cases, the premium may be reviewable every year, or every five years, to take into account your changing circumstances.
• Renewable premiums - Renewable premiums are a variant of reviewable premiums, and are reviewable whenever the policy is due for renewal.
• Guaranteed premiums - Guaranteed premiums tend to be more expensive than the other two options, but are fixed for the life of the policy, which may be as long as 25 years.

Your insurance provider or broker should explain how the review process works and help determine which option is best for you, both now and in the long-run.

Cost issues

Income protection insurance premiums are affected by a number of different factors including:

• Amount of benefit required
• Length of cover - (see Types of income protection insurance)
• Length of ‘deferred period’ (the number of weeks/months before payment starts) - the shorter the deferred period the greater the cost
• Occupation
• Your age
• Estimated retirement age
• Smoker status
• Medical History
• Sex - women purchasing income protection insurance in the UK can find that they pay up to twice the price as a man with exactly the same age, occupation, medical history etc.

When searching for a suitable income protection policy it is important to remember that cheap cover is likely to have many limitations and restrictions on the policy, meaning that cover may not be available when you need it.

Typical exclusions of income protection plans

As with all types of insurance, most income protection policies will have a list of exclusions. These commonly include:

• Disability due to, or caused by, HIV/AIDS
• Normal pregnancy and childbirth
• Self-inflicted injury
• Criminal acts
• Misuse of alcohol and/or drugs
• Failure to follow medical advice

In addition, you may not be able to make a claim for some pre-excising medical conditions such as back pain or stress-related disorders, even if you are unable to work because of them.

Remember, different providers can have significant differences in their policy conditions, so it’s important you read the small print and fully understand what you’re covered for before buying an income protection plan.

Income protection confusion

The whole area of income protection can be very confusing, particularly as there are many insurance products that go by a similar name but offer significantly different cover. For example, income protection insurance is also commonly confused with a significantly different product called payment protection insurance, which can be very misleading.

Payment protection insurance differs from income protection as it covers unemployment as well as poor health. However, its main drawback is that it only pays out for a maximum of 12 months, or in some cases 24 months, meaning that if you suffer from a long-term illness or injury you could still find yourself without a source of income for many years.

To complicate matters further, payment protection insurance is also commonly known as:

• Accident sickness and unemployment insurance or ASU
• Loan protection insurance (when it is used specifically to protect a loan)
• Mortgage payment protection insurance or MPPI (when it is used specifically to protect a mortgage)
• Income payment protection insurance (when it is used to protect a person’s general lifestyle)

Income protection insurance is also often mistaken for critical illness insurance. However, critical illness policies do not pay out for every illness like income protection cover. For example, medical conditions such as depression or stress-related illnesses would not be covered by critical illness, but would be covered by an income protection policy. Critical illness policies also tend to pay out a lump sum, compared to monthly payments under an income protection plan.

Applying for income protection insurance

Although income protection insurance offers better value for money than any form of payment protection insurance, it can take longer to arrange as applicants have to be underwritten individually at outset.

Applicants must answer a detailed health questionnaire and may also have to undergo an independent medical examination with a doctor in their area if further information is required from the underwriter. As a result, the application process can take several weeks to complete.

Professional advice

Because this field can be extremely complex, it is often a good idea to seek professional advice from an independent Financial Adviser (IFA) to ensure you get the most suitable cover at the right price.