Do you need income protection?

Each year more than one million people in the UK find themselves unable to work due to a serious illness or injury (1). If something happened to you, could you and your family survive on sick pay or your savings, never mind maintain your current lifestyle?

Income protection insurance (also called permanent health insurance) is designed to help you if you can’t work because you’re ill or injured and could provide some much-needed financial help.

What is income protection insurance?

Income protection aims to ensure you receive a regular income until one of several situations occurs: you retire, you return to work, you die or the period of cover comes to an end. You can cover yourself for most debilitating illnesses and injuries, and you can claim as many times as you need to while the policy lasts.

There’s often a waiting period (the ‘deferred period’) before the payments start, ranging from one day to two years, and you can usually choose how long you want this to be. Choosing a longer deferred period can help reduce the cost of your premiums.

Policies come with a number of features including:

• Payouts for hospitalisation, even if this is before your deferral period is over

• Premium waiver so you don’t have to pay premiums while claiming

• Return-to-work payments if your earnings are reduced due to your illness

• No deferral period if you become ill again within 12 months.

I’m still not sure I need it

You’re likely to need it no matter whether you’re employed or self-employed. But, for employed people, the level of cover should take into account any sick pay you may receive from your employer.

So, if you’re employed, find out whether your employer provides sick pay as part of your employee benefits and, if so, how much and for how long. When this comes to an end you will be reliant on Statutory Sick Pay (SSP). This currently pays out £109.40 a week but only lasts for 28 weeks (2).

How much cover do I need?

Well, like many questions when it comes to money, it depends on several factors. But as a starting point you could follow these three steps

Step 1: Calculate your outgoings

Start with your mortgage and other debts, including credit cards and personal loans. Then add other day-to-day costs such as utilities, food and childcare. Lastly, the amount you roughly spend each year on large items like holidays and replacing your car.

Don’t underestimate this figure just to keep your premiums low.

Step 2: Check what cover you already have

For example, check your employee benefits for how long your salary will be paid before you are moved to SSP.

Step 3: Calculate the cover you need

Simply take the pre-existing cover away from the outgoings to establish the level of cover you require. And note down the period over which your employer will pay you, as this will guide your deferment period.

As an insurance payout, any money you receive will be tax-free. So a higher rate taxpayer generally only needs to target around 50 percent of their gross salary to receive the same level of net income. Typically, the insurer won’t let you target more than 50-60 percent of your gross salary.

How much does income protection cost?

How much you pay will depend on the options you select and on your circumstances, including:

• your age

• your gender

• your current health, weight and family medical history

• your job

• your hobbies

• whether you have ever smoked, used drugs or drank heavily

• the percentage of income you’d like to cover

• the waiting period before the policy pays out

• the range of illnesses and injuries you’d like to be covered against

• the age at which you’d like the policy to stop covering you (i.e. retirement)

Be honest about your medical history

Give your insurer the full facts to the best of your knowledge. It could mean the difference between getting a payout and having your claim refused.

Do you want to inflation-proof your payments?

When you are working, you hope for an increase in your salary every year to ensure your pay keeps up with the rising cost of living. But income protection policies don’t automatically adjust payments for changes to the prices of goods and services. Instead, you have to select an increasing policy. This will push your premiums up but can provide an additional level of comfort.

Different levels of cover

The type of payout you get from an income protection policy depends on the severity of the illness or injury you sustain and, again, you need to think carefully before deciding what type of cover you need.

• An ‘own occupation’ policy pays out if you are prevented from doing any aspect of your specific job because of an accident or illness and are not working in another job.

• A ‘suited occupation’ policy pays out if you are unable to pursue an alternative but suitable occupation given your education and training etc.

• An ‘any occupation’ policy pays out if you are unable to perform any occupation at all.

• And an ‘activities of daily living’ policy pays out if you are unable to perform a number of everyday tasks defined within the policy, such as washing or dressing yourself, or cooking and cleaning.

These represent a sliding scale in premium payments (high to low) as the likelihood of a payout decreases.

Changing your mind

You can usually cancel your policy any time in the first 30 days and get a refund of any premiums you’ve paid.

If you decide to change providers outside of this period – say in a couple of years’ time – or you decide to change the policy with your existing provider, you might find your premiums increase. This is because their assessment of your potential claims on the grounds of ill health is likely to change, if only because you are now older. If you have had a serious illness in the meantime (whether you claimed on a policy or not), this could also affect the premium.

Keep your cover up to date

You should frequently review your protection to make sure you still have the right amount of cover.

You might want to consider increasing your level of cover if:

• you become a parent

• your partner stops working

• you’ve taken out a new mortgage

Are there any other options?

There are other insurance products you could use to protect your loved ones financially in the event that you’re ill, injured, or die. These could potentially be used to complement an income protection insurance policy. They include:

• Life insurance, which could provide financial support to your dependants or cover outstanding loans such as your mortgage if you die.

• Critical illness insurance, which provides a tax-free lump sum or regular income if you’re diagnosed with a serious illness covered by your policy.

• Payment protection* will cover specific payments, such as your mortgage, if you can’t work because you’re ill, had an accident or get made redundant.

• Short-term income protection* (also called ‘accident, sickness and unemployment’ insurance) covers your essential outgoings if you can’t work for a short period of time (typically from two to five years).

Conclusion

The incidence of illness or injury is higher than many think, it can come out of nowhere, and is an unexpected shock. Imagine you were unable to work due to an illness or an injury, you’d still need to pay your mortgage or rent, and your day-to-day bills. The lifestyle you’ve worked so hard to achieve could be at risk. It doesn’t matter whether you have children or other dependants or not: if illness would mean you couldn’t pay the bills, you should consider income protection insurance.

Having the right type of insurance in place could help you make your loan payments or repay credit card bills in your time of need.

However, income protection can seem complex. You have to choose when it starts to pay out, how long it lasts for, what constitutes an inability to work, what eventualities you want covered, how much income you need to receive and whether you link compensation to rising prices.

Some jobs and occupations are difficult to find cover for using comparison sites, but the list varies from insurer to insurer so you need to pick your provider carefully.

Talking to a financial adviser could provide valuable insights into how different policies work, and how much funding you are likely to need as some potential medical costs might be difficult to predict in advance. At SPW one of our principles is to have regular reviews with an adviser, who can consider your holistic financial planning needs, including protection.

*Insurance product not currently available at Schroders Personal Wealth (SPW).

Sources:

(1) Health and Safety Executive (www.hse.gov.uk), ‘Costs to Great Britain of workplace injuries and new cases of work-related ill health 2019/20’, 12 June 2023.

(2) Gov.uk, ‘Statutory Sick Pay (SSP): employer guide’, 12 June 2023.