Short-term IP kicks in when ill health keeps you off work

Redundancy, illness and accidents are all facts of life but they needn't ruin your finances. Alessia Horwich reports
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The Independent Online

Companies struggling to survive, mass redundancies and increased stress. We're all seeing the symptoms of recession, but few have the cash during tough economic times to pay out for insurance that would protect from loss of income.

In response, insurers such as Liverpool Victoria (LV), Bright Grey and Synergie have introduced short-term income protection (IP) products that are more transparent than traditional short-term payment protection insurance (PPI) and mortgage payment protection insurance (MPPI) policies, but cheaper than the full-blown IP policies. Could these be the answer for those on tight budgets?

IP insurance is designed to pay out should illness prevent you from earning. Emma Walker, the head of protection for comparison website MoneySupermarket.com, says: "The true definition of income protection is a plan that will replace up to 60 per cent of your income, tax free, if you are off work because of things covered by the policy. It will cover you until you can go back to work or you retire. These policies are the Rolls-Royce of protection." Short-term IP products are relatively new to the market and offer this same cover, simply for a shorter term; anything from 12 months to 10 years. According to figures from insurer Aviva, the average claim length for illness is only three years (unless the claim is for mental health when the average shoots up to seven years). Despite the shorter terms on these products, their cover can protect you for the average claim length and will be cheaper than a standard IP product.

Short-term IP products are often difficult to distinguish from accident, sickness and unemployment insurance (ASU), which encompasses payment protection insurance (PPI) and mortgage payment protection insurance (MPPI). These products have received bad press due to mis-selling but despite the shorter terms they shared, they have little else in common, says Matt Morris, a senior policy adviser for insurance broker Lifesearch. "A lot of people confuse short-term IP with PPI or MPPI," he says, "but these are inferior products that are restrictive and can be difficult to claim on. In terms of comprehensiveness of policy, short-term income protection is no different from the standard IP insurance."

The main difference between ASU and the short-term IP policies is that it insures only one specific debt such as a mortgage or personal loan, whereas IP is designed to ensure you have an income to meet all your financial obligations and daily living expenses. Another difference is the point at which the insurance is underwritten. Ms Walker says, "ASU is underwritten at the point of claim, so when you come to claim the insurer will then assess if the claim is genuine. But with all income protection, you disclose everything at the point of sale. Unless you've deliberately lied, you know you've got a policy that will pay out, but with ASU, terms and conditions can change and you won't know if you'll get the cash."

While IP products are geared towards covering you in case of illness, you also have the option of adding on involuntary unemployment cover for a higher premium. However, "the unemployment add-on will only be for a fixed term," says Mark Loydall, a director of Cambourne Financial Planning. "There will be a maximum length of cover – usually 12 months – as it's designed to see you over a short term period while you find another job, not so you can retire."

Before the recession, there were products available that covered you solely for unemployment, but shortly before Christmas most insurers starting pulling out of the market and now it is virtually impossible to get such a policy. You may also have difficulty getting unemployment cover as an add-on. Ms Walker says: "If you work in a high-risk sector, like construction, motoring, manufacturing or banking, it's going to be a damn sight harder to get, and if you do there might be a caveat in your policy ruling out claims in some situations."

If you can get insured, you'll have to pay a good chunk extra for it. "Like any other insurance, income protection cover is a product based on risk," says Kelly Ostler-Coyle, a spokeswoman for the Association of British Insurers. "As the risk goes up, so does the price."

The cost of short-term income protection insurance is based on your current salary, the length of the policy, the period of deferment and whether or not you want to be covered for unemployment. The longer the deferment, the cheaper the policy. Short-term IP products often offer a deferment period of 30 days.

They also back-date to the first day you are not at work, covering you for the entire period. Figures from Lifesearch show the current cheapest price of short-term IP for a 30-year-old male in good health, working in a low-redundancy-risk sector with a deferment period of 30 days, is £16.30 per month for cover up to £1,200 (also per month) and £25.84 per month for cover up to £2,000.

However, you can reduce your premiums by extending the deferment period. At three months' deferment, the cheapest prices will be £10.69 per month for cover up to £1,200 and £16.48 for cover up to £2,000. The deferment period should ideally be set to coincide with the end of your sick pay or severance package term. The term of all these policies (offered by LV) is 10 years so you could further reduce premiums by shortening this. But if you want unemployment cover you will have to add, on average, £20 to the monthly premium.

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