Insurance: Income Protection Insurance

Income protection insurance is designed to pay out whatever the reason for your being unable to work (subject to one or two exclusions). In this respect it differs from a similar product called critical illness insurance which only pays out if you contract one of a list of specified illnesses (even if the list is pretty long). Income protection insurance also just pays out steadily over the period that you are unable to work, as opposed to critical illness insurance, which generally pays a straight lump sum.

Income protection cover is also not to be confused with life insurance, which pays a lump sum to dependants on your death.

It obviously depends on your own circumstances whether income protection insurance is necessary. If you decide an income protection policy is right for you, you'll face some big obstacles. There are all sorts of different policies with small variations that could mean the difference between being able to claim in full and getting nothing.

Just to confuse you even more, income protection comes under many different names. You might hear it called 'permanent health insurance', 'income replacement insurance', 'long-term disability insurance' or a few other things. However, they all do the same basic job, which is to pay you an income if you become unable to work due to sickness or injury.

If you are self-employed, you really ought to buy this sort of income protection insurance, although you may find it is very expensive. But if you're employed in the usual way then, before you go any further, check your employment contract to see whether your company automatically pays you if you are off sick for weeks or months.

As with all insurance, the trick to buying the right type of income protection cover is to consider exactly what it is that you need it to do for you. In other words, you need to have a very close look at the small print of any policy to make sure it will pay out when you want it to.

There are three main definitions of being unable to work:

• unable to do your own job;
• unable to do your own job or a similar one for which you are qualified; and
• unable to do any kind of paid work.

You need to decide whether you'd be prepared to do another, perhaps less pleasant, job if you became unable to do your current one. If so, you reduce the likelihood of needing to make a claim and the income protection insurance premiums should be that much lower. If you wouldn't want to have to find just any old job, the middle ground would be to go for 'unable to do your own job or a similar one for which you are qualified'.

However, if you are unable to do your current job, you're also unlikely to be able to do a similar job. So, the difference in insurance premiums might not be that great and you might think it worth going for the simple 'unable to do your own job' definition. After all, if you buy an income protection policy with an 'any occupation' clause it means that a solicitor who is confined to a wheelchair and can't move her hands would have to accept any job - for example, as a telephonist, on a much reduced salary. The policy would not pay out unless you were unable to do anything.

When you start shopping for your own income protection insurance policy, look for one with fixed premiums. A guaranteed policy will mean you pay the same price each month for the rest of your working life. An increasing number of deals want you to pay more each year (in line with your age and the company's claims record). It's tempting because the payments tend to be lower to begin with, but you should resist. Fools have to be strong!

You can save quite a bit by buying an income protection policy that makes you wait for your first payout. Delaying payments for 60 or 90 days after you first make the claim will save you money. The longer you can afford to hold out, the cheaper it will be for you. If you can squirrel away some money and actually survive a longer waiting period, your savings will build up over time. If you don't need to claim, you get the benefit of this extra cash; don't put more than the bare minimum into the insurance company's coffers.

You should check any income protection insurance policy to see what is excluded from it. A typical list of exclusions might be as follows:

• disability due to, or caused by, HIV/AIDS;
• normal pregnancy;
• war;
• self-inflicted injury;
• criminal acts; and
• misuse of alcohol and/or drugs.

So, if you consider yourself at particular risk from any of these things, then you might need to do a bit of shopping around to find a suitable income protection policy.

Published on December 7, 2006