Financial protection

In this chapter we will examine the need for income protection, the features and product design of income protection insurance (IPI) plans, underwriting and claims considerat...

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...ogram we created covering a variety of financial education areas. This presentation will be of most benefit to those learning about this area for the first time:

 

Most employed or self-employed people rely on their ongoing ability to work and earn an income to support their current standard of living and to maintain it into the future when they stop work. Some employed individuals will have access to employer provided sick pay, meaning they receive a continuation of their earnings during an initial period when they are unable to work due to illness or incapacity. This benefit will be limited to payment over a specified period, perhaps between 6 and 12 months, if incapacity lasts longer than this there will be reliance on State benefits, which are likely to be much lower than the claimant’s usual earnings.

The need ...

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...hese would be able to support the income requirements, by drawing down from the capital

The availability of State benefits: whether there is a sufficient NIC record to qualify for contributory benefits, such as Employment and Support Allowance, or whether there is access to any other benefits, such as Universal Credit, if the individual’s NIC record is incomplete

Taking all these factors into account helps to establish whether a shortfall would occur and how much cover is required.

When to an individual who is employed, why could the need for income protection be more pressing for someone who is self-employed?

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Income Protection Insurance (IPI) is a long-term insurance that is designed to pay out a weekly or monthly benefit if the insured is ill or otherwise incapacitated under the terms defined in the policy document. Once the plan has been underwritten and is in force, as long as the insured maintains premium payments, the insurance cannot be cancelled by the life office, regardless of the number and duration of claims made, this is why IPI was previously referred to as ‘permanent health insurance’. Policies are usually written over a specified term, typically to the insured’s expected retirement / State pension age, after which the plan will cease. Claims in payment will cease at the earlier of the insured’s return to work, their death or the policy’s pre-determined end date, even if the insured remains incapacitated. Policies are usually non-assignable.

Some ‘short-term’ IPI policies aim to keep premium costs down by limiting the benefit period to, for example, a maximum of b...

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...he death of the insured, whichever is earlier

Most protection policies offer WOP as an option and most income protection plans include waiver automatically so that premiums do not continue to be paid in the event of a claim

WOP contracts linked to personal pension taken out from t6th April 2001 no longer attract tax relief on the premiums paid and are now set up as separate contracts. Any plans in existence before this date will continue to receive tax relief on contributions, but care should be taken when considering any changes to a pre-6 April 2006 plan

Unemployment insurance

Some insurers offer unemployment insurance as an additional element on their income protection policies. This is usually written as a separate renewable annual contract, meaning that premiums and terms and conditions can change at each renewal date, or at any time subject to six weeks’ notice being given to the policyholder.

What benefit is payable from an income protection policy?

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Income protection plans generally contain the following features:

Deferred period

This is the initial waiting period between the onset of the illness or incapacity and commencement of benefit payment. Deferred periods can be quoted as weeks or months and are usually 1, 3, 6 or 12 months or 4, 13, 26 or 52 weeks, although some policies may provide that benefit payment commences after as short a period as 7 days and others allow a deferred period of 104 weeks. The shorter the deferred period selected, the higher the chance of a claim so the higher the premium.

The benefit

In the event of a claim the benefit may be paid up to a pre-determined maximum age (usually aligned with the insured expected retirement / State pension age so typically ranging between 55 and 70) or may be paid over a shorter term such as 2 -5 years. The longer the period of payment, the higher the premium.

Benefit limits

There are limits on the maximum amount of benefit paid from an individual income protection policy to ensure that a claimant will not be better off by claiming. This is generally 50% to 60% of the pre-claim earnings, possibly less a deduction for State benefits. This is on the basis that the benefit from an individual policy is tax-free and is not subject to National Insurance contributions (NICs), so this...

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...lp claimants return to work. Such benefits may be financial and / or practical and be automatic or discretionary. An insurer may be prepared to provide:

Treatment or rehabilitation that would help the claimant return to work, especially if this offers a net saving to the insurer; for example, private treatment if NHS waiting lists would cause an undue delay

Automatic or discretionary payments to encourage the insured to return to work or additional payments if the insured is hospitalised

Cognitive therapy, to reduce stress

Advise on appropriate adaptions to the workplace

Helplines, employee assistance programmes and digital GP services

Facilitate return to work programmes

Incentives

Insurance companies are increasingly focussed on rewarding those who take steps to improve / maintain their health. This includes discounts for gym membership and in retail outlets, if certain fitness targets are met.  

Linked periods of illness

If an insured individual makes a claim, returns to work and then has another period of illness with the same condition, it is normal practice for the deferred period to be waived on the second and subsequent claims for the same condition

In the event of a claim, an IPI policy may pay a proportionate benefit if:

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Insurers all have their own definitions of incapacity and this is usually linked to the insured’s occupation.

Own Occupation - where the insured is unable to carry out their own occupation and is not undertaking any other employment. This is the widest definition and provides the highest ...

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...once a claim has been in payment for a certain period of time, perhaps changing from an ‘own’ to ‘suited’ occupation after a period of two years (for example).

What are the three main definitions of incapacity used by IPI insurers?

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Most IPI plans have various general exclusions under which circumstances a claim would not be paid. In general, these are if incapacity is a result of:

HIV/AIDS generally only covered by a few providers but there has been a general shift to coverage. Previously claims arising from HIV/AIDS were only covered if contracted by an emergency services worker in the course of their duties or as a result of a blood transfusion

Normal pregnancy and childbirth

War, invasion, acts of a foreign enemy

Self-inflicted injury

Involvement in a criminal act

Misuse of alcohol or drugs

Failure to follow medical advic...

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... in force. However, it should be noted that when a claim is made the definition of incapacity is based on the insured’s occupation immediately before making the claim. Therefore, if someone made a claim during a period of unemployment, for example, they could find that their benefit amount is reduced to the house person’s amount or potentially, depending on the policy, receive no benefit at all. It is therefore important to read the terms and conditions of the policy carefully.

Name three general exclusions that will be included in most income protection policies.

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The underwriting of IPI is fundamentally different to that for life assurance. In assessing a proposal for IPI the underwriter is concerned with morbidity (the risk of being ill or disabled) rather than mortality (the risk of dying). Statistically, an individual is much more likely to be ill and survive than to die and women suffer more ill health than men.

Occupational Classes

Certain occupations are considered riskier than others. Some occupations will not be covered at all by insurers and other occupations are categorised by the level of risk they represent:

Class 1 (lowest ...

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...fected by factors related to the:

Insured, including their age, occupation, general state of health and their smoker status

Specification of the policy, including the deferred period, selected, the level of benefit, policy term and any escalation options

Whilst, statistically, women are more likely to suffer ill-health than men are, the provisions of the EU Gender Directive applies to all personal insurance contracts and premiums must be set on a unisex basis.

Which occupational class would you expect the manager of a retail store to fall within?

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Claims should be made in writing as soon as possible after the insured becomes incapacitated, even though it may still be several months until the deferred period ends and payment of benefit commences. This allows the insurer to start dealing with preliminary elements of the claim and they will:

Assess the claim against the applicable definitions of incapacity

Consider whether additional medical e...

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...for a certain amount of time, e.g. where own occupation definition changes to any suited occupation after a period of two years. This change is significant as the individual may not be eligible to continue to receive benefits under the stricter criteria.

Why would an insurer request a payslip or a P60 from an individual who has made a claim of their IPI policy?

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Generally, benefits from individually held IPI policies, arranged on a personal basis direct with an insurance company, are paid gross and are not subject to income tax or National Insurance contributions (NICs) However, where the premiums are tax relievable as a business expense, typically if a...

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...d through the pay as you earn (PAYE) system.

Where the benefit is taxable the insurer will often allow a higher percentage of the salary to be insured.

Where benefits are paid from an individual income protection policy the tax implications are that:

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Some employers provide income protection for their employees. This may be as an additional benefit for the employees or to provide compensation to the employer for the extra costs they may incur when an employee is off sick.

The employer is the policyholder, administers the scheme and pays premiums to the insurance company; employer paid premiums are not taxed as a benefit in kind on employees who join the scheme

Under most schemes, all employees are eligible; employers cannot be selective and must ensure that all employees within a defined cat...

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...employee is off work, the employer will not have to fund salary payments to a worker who is unable to contribute to the business

Insurers may offer ‘free cover’ – an amount of insured cover without requiring any medical underwriting – provided that all eligible employees are actively in work on the day they are eligible to join the scheme and all employees join.

In the event of a claim, how would an employer normally pay the benefits from a group IPI  scheme to their employee?

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This revision test (opens in a new...

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... test will be added to your CPD certificate.