8.3.2 Income protection insurance
If the ability to work and earn income is impaired or lost, there’s a major risk to the financial well-being of an individual and their household. The long-term illness or disability of someone providing care can also cause major financial loss to a household if an alternative form of care has to be found and paid for.
Private insurance policies in this area are a complement to the protection that may be offered by employers and by the state. For example, in the case of serious illness, in the UK the state will offer some support through the National Insurance and benefits system, and some employers may do so too. Yet state benefits will produce an income that is well below average, and that may be insufficient to sustain an existing standard of living. So in addition to finding out what’s available from an employer, it is also important to consider what self-insurance is available: for how long could assets produce an income, or be used up, to sustain someone in a medical crisis?
Income protection insurance (IPI) (also known as permanent health insurance or PHI): designed to pay an income (sometimes tax-free) when a person is unable to work due to serious illness or injury, if necessary through to retirement. Its take-up has been very limited, perhaps because it is a complex product and subject to adverse selection, so that the premium can be too high for the people most interested in taking it out, such as those in poor health.
Critical illness cover (CIC): this used to be a simpler product than IPI but has become increasingly complex in recent years. It pays a lump sum tax-free payment if the insured is diagnosed with a restricted range of major disabilities or life-threatening illnesses, such as heart attack, stroke, some cancers, or nervous diseases, or if permanently disabled and unable to carry out basic tasks. Assessment often revolves around whether the insured is able to undertake certain basic tasks of daily living without assistance. Once payment has been made against such a policy, the insurance ceases and the insured is free to spend the money as they wish, for example, to make adaptations to the home, or pay for private nursing care.
It’s important to appreciate that only a precise list of conditions is covered in CIC and, as treatments and survival rates improve, the list is becoming increasingly hedged around by small print. Moreover, the most common reasons for being unable to work are back problems and mental stress – neither of which would trigger a CIC pay out. Similarly, rare or undiagnosed conditions result in no pay out. Consequently, CIC could not meet an assessed need of providing protection against any loss of income from being unable to work. Many insurers offer CIC in combination with life assurance, which can be on a level or, in the case of mortgage cover, a decreasing basis. CIC can be added on to an endowment policy when arranging a mortgage. Once again, these combinations should be considered carefully according to need, particularly if taking them out together would produce a discount. In this case, it is important to think about why such a discount is being offered. CIC policies vary – some have the option of a guaranteed or a renewable premium. The former is more expensive, but means the premium will not increase even if, for example, new screening methods result in more claims being made. Some policies are now available that offer reduced premium payments for less serious, more ‘survivable’ types of disease, and others offer ‘cancer-excluded’ policies for cancer survivors.
Accident, sickness and unemployment (ASU): this insurance covers these three named eventualities. It can be a standalone policy, it can be sold as loan payment protection insurance or, as mentioned in Week 6 it can be sold when connected with a mortgage, as mortgage payment protection insurance (MPPI). The distinguishing feature of ASU insurance is that the pay-out is (normally) limited to a maximum of two years, whereas PHI pays out until recovery or retirement. MPPI needs to be considered as part of the decision on an overall ‘insurance plan’, not just in terms of state benefits and assets but also in terms of other insurance arrangements and policies. For instance, it might be duplication to have both income protection insurance and MPPI, depending on circumstances. Normally, MPPI policies are offered at a particular rate and pay up to a maximum of approximately 125% of monthly mortgage outgoings, with payment normally starting a short period after the peril happens.