Look After Your Greatest Asset!

Last week, I came across a report which claimed that the average Briton has more than £40,000 in disposable assets.

This may sound like a lot, but it includes housing equity (the difference between the value of your home and your mortgage), as well as savings and stock-market investments. Multiply this figure by fifty million adults and you get £2 trillion of assets, but, alas, this pot is very unevenly distributed, so the above "average" doesn't really tell us very much!

Anyway, £40,000 of wealth may sound like a lot, but it is peanuts compared to the value of your individual earning ability, sometimes referred to as your "human capital". For example, to earn a pre-tax £30,000 a year in a top-notch savings account paying annual interest of 5%, you'd need a lump sum of £600,000. So, one way to find the value of your human capital is to multiply your annual income by twenty; for most full-time workers, this will be £400,000+.

Of course, if you find yourself unable to work for an extended period because of a serious illness or medical condition, then the value of your human capital can fall to zero. However, you can take steps to lessen this misfortune by buying income protection insurance, which is a form of long-term sickness cover.

Sadly, many people who buy income protection (IP) don't take specialist, independent advice, with the result that they make several basic mistakes. Here are ten tips to help you to find the perfect policy to help you sleep easily at night:

1. Don't buy protection from your bank

There are two problems with buying IP from your bank. First, banks are tied to a single provider, so they cannot search the entire market to find your ideal policy. Second, they love to sell over-priced protection products, so you'll pay well over the odds for any cover bought via your bank!

2. Don't buy payment protection insurance (PPI)

I never tire of telling my readers to steer clear of payment protection insurance, which is perhaps Britain's biggest financial rip-off. PPI is optional insurance which covers the repayments on a mortgage, loan or credit card if you are unable to work due to accident, sickness or unemployment. However, it's massively over-priced, policies are packed with exclusions and get-out clauses, plus it only pays out for up to a year. Income protection is a much better bet for most workers.

3. Buy the best-value policy, not the cheapest

When looking for an income protection policy, your goal is to find the best value-for-money cover, not the cheapest. A cheap policy may offer "budget" or "cut-down" cover: for example, it might not cover you for your own occupation, which would effectively prevent you from making a claim. So, be sure to understand what you're getting for your money.

4. Consider income protection before critical illness insurance

Critical illness (CI) insurance pays out a lump sum if you suffer one of a number of specific medical problems, such as a heart attack, cancer or stroke. However, it doesn't pay out for any medical condition, whereas income protection does. Sadly, banks are far more likely to sell CI cover than IP to their customers, which, once again, highlights why it's a mistake to buy protection from your bank!

5. Tell the whole truth

If you have an existing medical condition, you may be tempted not to mention this to an insurer, in order to avoid paying higher premiums. However, this "non-disclosure" could lead to all claims being denied, just when you need your cover most. So, be sure to mention any and all aspects of your medical history, and leave the insurer to decide which are trivial and which are important. If you don't, you risk buying a policy against which you can never claim. Oops!

6. Check the occupation class

When an insurer decides whether or not to pay your claim, it needs to decide whether you are unable to work. However, some policies require you to be unfit to pursue your own occupation, whereas inferior policies insist that you can only receive benefits if you are unfit to pursue any occupation.

"Own occupation" or "suited occupation" clauses are far less onerous than "any occupation" clauses, because you may be unfit to do your job, but could, for instance, sit at home stuffing envelopes. It's vital that you get this right; personally, I'd steer clear of any policy with an "any occupation" clause.

7. How much cover do you really need?

Typically, you can insure up to 65% of your gross (pre-tax) salary via income protection. As these benefits are tax free, you won't need any more cover than this, as, in effect, you can replace your entire take-home pay.

However, could you get by on less than this? To keep the cost down, you could choose only to cover your basic monthly living expenses, such as your rent/mortgage, utility bills, shopping and so on. After all, you don't actually want to make a claim on your income protection policy -- all you're looking for is something to fall back on in an emergency, so there's no need to spoil yourself by over-insuring!

8. When should monthly benefits kick in?

No income protection policy will begin to pay out until you've been off work for at least, say, four weeks. Naturally, a policy which pays out after four weeks will be far more expensive than one which pays out after, say, 104 weeks (two years). Hence, choosing a longer "deferred period" can dramatically cut your monthly premiums.

So, check how long your employer will pay you sick pay (one/three/six months?) and then calculate how long you can survive without your income by relying on State benefits, savings and other assets. Note that income protection benefits will not be paid for any period during which you're receiving sickness benefits from your employer.

Also, as earnings and prices tend to rise over time (what's known as inflation), it's wise to "index link" your IP benefits so that they increase in line with inflation.

9. Are your premiums guaranteed or reviewable?

Beware of reviewable premiums, which may start off low, but have a nasty habit of increasing every, say, year or five years. As low-cost reviewable premiums may eventually cost you more than guaranteed rates (which are fixed for the life of your policy), it makes sense to plump for guaranteed rates if you can afford them. After all, you don't want to see the cost of your policy shoot up after making a claim and returning to work, do you? The extra peace of mind offered by a guaranteed rate is well worth having.

10. Don't forget your spouse or partner

Even if your other half isn't a breadwinner (s/he doesn't work), the work that s/he does around the home is of major financial benefit. Indeed, as I warned in How Much Is A Mum Worth?, the financial cost of replacing the work that a mum does (bringing up children, cooking, cleaning, shopping and other household chores) comes to over £2,000 a month for a typical family. So, be sure to cover your better half if you couldn't afford to employ someone else to take on their workload!

Many thanks to Kevin Carr of LifeSearch.co.uk for his help with this article.

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