18 Jan Income protection
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Several years ago, a friend of mine was doing well at work and moving forward in his career when he was diagnosed with an illness that meant he couldn’t carry on working. At first this was fine as his employer had a good sickness policy, but after 6 months this stopped and he found himself with no earnings and still with the usual bills to pay. However, he had had the foresight, or good advice, to take out an insurance policy to provide a continuing income should he be unable to work. This provided him and his partner with enough income to avoid going into debt and retain their home. In the end he recovered and returned to work, but without the insurance policy his time spent not working would have had a much greater impact on his and his partner’s plans.
Your human capital is one of your greatest assets. Your earning capacity enables you to fund your current lifestyle and hopefully put money aside for your future expenditure. It’s extremely important to consider all the risks to your future financial security, but one of the most important risks is what would happen if you were unable to carry on working? Your earnings would stop and it’s highly likely that you wouldn’t be able to fund your current, or future, objectives.
So, what can you do if this happens? Or more importantly what can you do in advance to protect yourself in case this happens?
Thankfully, like my friend did, it’s relatively easy to protect at least some of your income stream using an insurance product known as permanent health insurance (PHI) or more accurately income replacement insurance. However, it appears that c.19m of UK employees do not have any form of income protection.
PHI provides a regular, tax-free (in the case of an individual policy) income if you are unable to work due to illness or incapacity. Benefits continue until recovery, death or the cessation age selected at the outset.
The benefit is paid after a deferred period, generally between one and 12 months, which is chosen when the policy is established. The longer the deferred period and the earlier the cessation age, the cheaper the cover will be. So if, for example, you know that your employer provides good sickness benefits and/or you have enough cash savings to tide you over for a period of time (and ideally you want to ensure that you have cash savings to cover a minimum of six months’ expenditure), you could opt for a longer deferral period.
The cessation age should usually be chosen to coincide with when you are likely to receive pension benefits or are planning on accessing other savings to fund your lifestyle having ceased paid work.
Premiums can be either guaranteed throughout the policy term or subject to review periodically, with guaranteed premiums being more expensive at the outset. It is also possible to elect for the benefit to increase before and/or during a claim to provide some inflation protection. My view is that this is essential when considering this type of insurance, otherwise the purchasing power of the cover is gradually eroded by price inflation.
The basis on which benefits are paid following a claim will also depend on the insurance company’s definition of incapacity. Incapacity can be defined as an inability to perform ‘any occupation’; ‘any occupation for which you are reasonably suited or trained’; ‘your own occupation’ or a number of ‘activities of daily living’.
In order to insure your future earnings based on your current role then ‘own occupation’ is the option to choose, although this is usually the most expensive.
PHI is one of the most under-used forms of insurance for reasons which have been variously attributed to the perceived time taken to underwrite benefits, their complexity and (perhaps more likely) a lack of awareness by individuals of the likelihood of needing to make a claim.
However, if you are dependent on your earnings for your current and future lifestyle, PHI is the only form of insurance which can provide prolonged protection against their loss.
 Source Canada Life June 2018