British banks are still reeling from a legal ruling forcing them to reopen thousands of claims over the mis-selling of payment protection insurance (PPI) and potentially pay up to £4.5bn in compensation.
These policies were deemed too expensive and unsuitable for most customers by the Financial Services Authority, but are there any viable alternatives?
It would be churlish to tar all PPI policies with the same brush, and, in theory, there is nothing wrong with this type of insurance. But there have been significant issues with whom it is sold to and how much it can cost. PPI is usually sold alongside loans and credit cards, designed to help you meet those repayments in the event of an accident, sickness or unemployment.
"The big problem with PPI is not with the insurance itself but with the way it was sold. For example, in most instances, the self-employed could not claim," says Simon Webster of independent financial adviser (IFA) Facts & Figures. "Also, some companies were aggregating premiums for the full loan term into the loan capital, and then if someone paid the loan off after, say, two years, they pocket eight years' unused premiums."
Even worse, some people have been signed up to buy PPI without realising it, or asking for it, and others have been unaware that it is often much cheaper to buy standalone PPI rather than buy a policy from the firm that sells you the mortgage, loan or credit card.
Rules are now in place to improve PPI; for example, borrowers must be informed that the PPI is an optional add-on, not a prerequisite for getting the loan, and all PPI providers must show how many customers have made successful claims on their policies. With such a chequered past, however, the new rules will do little to persuade many consumers that a protection product is a good idea. Fortunately, there are a few useful alternatives.
Income protection insurance or permanent health insurance (PHI) is a good option, and typically pays out 50 to 60 per cent of your income if you can't work (although it does not automatically cover redundancy).
"Health and lifestyle questions are asked up front, so pre-existing medical conditions and occupation are accounted for in the premium. For this reason, income-protection policy payout rates are high," says Darren Pickersgill, protection insurance adviser at moneysupermarket.com.
The big benefit to income protection over PPI is flexibility. You decide when the cover starts, whether it's after one month or even a year of being unable to work. This enables you to fit the policy around any cover you have from your own savings or your employer. Additionally, unlike PPI, which is short term and pays out for only one or two years, income protection is paid out until you either return to work or retire. And, even if you claim and return to work, the policy stays in place so if you fall ill again, you can make further claims.
"It looks to protect your whole income rather than just one debt – so if you have credit card PPI and lose your job, then it will only pay for that specific debt. With income protection, you can decide which debts are highest in the list of priority," says Lucy Widenka of Which?, the consumer organisation.
Although not strictly an alternative to PPI, because it pays out a lump sum rather than a regular income to cover your costs while you're off work, critical illness insurance is worth consideration too, as additional protection if you can afford it. This is designed to help financially should you suffer from a serious illness such as cancer or a heart attack, but not accidents or conditions such as stress. It's often used to pay off a mortgage or other debts.
For some, the self-insurance route is a more reliable way to cover potential unemployment, so think about setting up your own savings safety net rather than relying on insurers to protect you. Experts recommend putting aside enough money to cover all your expenses, including your mortgage, utilities, bills and food for a minimum of three months, but preferably six.
This should also correspond to any existing protection which may provide more cover than you realise; first of all, see what sort of sick-pay scheme is in place at work. Your employer may offer a top-up to statutory sick pay (SSP) so find out exactly what they would pay you and for how long. Then check state benefits to see what you would be entitled to if you were unable to work because of illness, accident or disability. SSP is paid for up to 28 weeks, covered by your employer, working out to £81.60 per week at the current rate.
As of 31 January 2011, you can no longer make new claims for incapacity benefit, but employment and support allowance (ESA) can be claimed instead if you're still unable to work. This is initially worth up to £67.50 per week for a single person aged 25 and over. Then, after 13 weeks, there is an assessment on your capability to go back to work.
If your biggest concern is your mortgage, don't automatically dismiss mortgage payment protection insurance (MPPI) which is less controversial than plain PPI. "What we've found is that the sale tends to be much more of an advised sale. You get more of an in-depth conversation about your financial needs – a more holistic approach," says Ms Widenka.
As with PPI for personal loans and credit cards, you still need to take into account any existing protection you might have and watch out for any limitations or exclusions. Crucially, you should search around for a good price, remembering that you are under no obligation to buy it from the mortgage lender and can save substantial sums by comparing the whole market and getting some independent advice.
Darren Pickersgill, Moneysupermarket.com
"Following last week's High Court ruling on PPI, it is understandable that customers may have reservations about taking out a payment-protection product. However, having adequate cover in place to protect yourself from being out of pocket as a result of an accident, sickness or unemployment is an important consideration, especially if you have a mortgage and a family to take care of."