Money: In the black, if not in the pink

The bills don't stop coming when you're ill. Virginia Wallis suggests a cure

THIS WEEKEND marked World Cancer Day, a chance to help towards reducing the physical and emotional cost of cancer. But not many of us have the foresight to follow that through and consider how we would cope financially if we had to give up work because of illness.

The insurers would like us to think about this. A lot of the marketing for critical illness insurance, which pays a lump sum if you are diagnosed with cancer or survive a heart attack or stroke, plays on our natural fear of cancer and other illnesses.

It is easy to get sidetracked by the scary "what-if" tone of much of the promotional material for this kind of insurance. The thing to focus on is not the seriousness of the illness but the financial consequences of being too ill to earn as a result of any illness, including relatively trivial things like broken bones. You should also resist the lure of the lump sum if what you want is replacement earnings. Having a large lump sum that could be used to pay off your mortgage may sound like a good idea, but only if you would still have enough money coming in to cover your other expenses.

You can get a regular income from the confusingly-named permanent health insurance (PHI) although it is increasingly called income replacement insurance. If you cannot work because of illness or injury, income protection pays out a monthly income until you are fit to work again or retire.

Before you consider taking out any private insurance, think about what you have in place already to help you if you had to stop work as a result of illness or long-term disability. If you are self-employed, the answer ought to be a private insurance scheme and you should have done something about it.

If you are an employee, your employer may run a decent sick-pay scheme. If you belong to a pension scheme (or have a personal pension) check whether it will pay you a reasonable income if ill health forces you to give up work altogether.

Without these cushions, you are looking at the possibility that a period of sickness could see your income falling to around pounds 200 a month after tax in the form either of Statutory Sick Pay (SSP) from your employer or incapacity benefit from the state.

If you don't think you could manage on SSP or state benefits and you don't want to take the risk that you'll have to, you need to arrange your own protection against loss of income by buying insurance.

So why do more people buy a lump-sum critical illness deal than arrange insurance that will replace their income? It could be that people buy critical illness insurance in the mistaken belief that it is a direct substitute for income replacement, as Roger Capham, Business Manager for Norwich Union Healthcare, points out. "Traditionally, people seeking cover against disability have chosen either an income protection or a critical illness policy, as the common perception is that they are similar products. In fact, the cover and benefits provided are very different."

Another reason could be cost. At face value critical illness insurance costs less than income replacement: at Norwich Union, a non-smoking man aged 30 would pay pounds 57.15 a month for a policy that paid a replacement monthly income of pounds 1,500, but pounds 42.52 for a critical illness policy that paid out a lump sum of pounds 90,000 (the size of lump sum you would need to pay an equivalent income for five years). The same figures for a non-smoking 30-year-old woman are pounds 95.05 for income replacement and pounds 36.57 for critical illness.

However, the figures assume that the income replacement policy would start to pay out after you had been ill for a month. If you were prepared to wait six months before it starts to pay out, the cost comes down to pounds 26.85 for the man and pounds 43.55 for the woman. Income replacement costs more for women as they are more likely to claim and claim for longer.

But it is worth bearing in mind that you may pay less for critical illness insurance because you get less in terms of what is covered, and it is less likely that the policy will have to pay out. The test for a payout under an income replacement policy is whether you are medically unfit for work, so most illnesses, including stress and back pain, are covered.

With critical illness insurance, you have to suffer one of the specific conditions listed in the policy or have become totally and permanently disabled - the test for which is usually pretty stringent. In addition, a replacement income carries on being paid as long as you need it to be paid, including part payments to top up your earnings if you go back to work on a reduced salary. There is also no limit on the number of claims you can make (provided you are still paying the premiums and provided that the claims are valid). Once you have spent the lump sum from a critical illness policy, you do not get any more.

q Virginia Wallis is the author of the 'Which? Guide to Insurance' to be published by Which? Ltd in June (price pounds 10.99). To order a copy, call the free credit card hotline on 0800 252100.

We have five free copies to give away to IoS readers. Send a card marked Which? Offer to the personal finance editor, 'Independent on Sunday', 1 Canada Square, London E14 5DL. The closing date for the draw is 1 June.

Spot the difference between sickness insurance policies

Income replacement (permanent health insurance, PHI) Critical illness insurance

Type of payout Type of payout

Tax-free monthly income. Tax-free lump sum.

Test for valid claim Test for valid claim

Medically unfit for work. The best policies define this as "incapable Diagnosis of one of specified list of "life-threatening" conditions,

of doing your own job". Less generous policies define it as "unable to typically cancer, stroke, heart attack, coronary bypass, surgery,

undertake any sort of paid employment". Some policies also cover kidney failure, major organ transplant.

total and permanent disability (TPD).

What is not covered? What is not covered?

Claims arising from self-inflicted injury, alcohol or drug abuse, As PHI plus illnesses not specifically covered by the policy, death

pregnancy and childbirth, HIV- and Aids-related illnesses, war risks. before the deferred period (see below) is over.

When does the policy pay out? When does the policy pay out?

After the "deferred period" agreed when you take out the policy, Once you have survived the deferred period, which is typically one

which can be after you have been ill for four, eight, 13, 26, 52 or 104 month from the diagnosis; six months (or longer) for TPD claim.

weeks. The longer the deferred period, the cheaper the premium.

When does the policy stop paying out? When does the policy stop paying out?

When you return to good health, reach retirement age or when the Some policies pay out for a maximum of five years but these are

policy comes to an end; whichever comes first. best avoided after the lump sum has been paid out.

Is there a limit on the number of claims I can make? Is there a limit on the number of claims I can make?

No. Yes.

How much can I insure for? How much can I insure for?

Typically 60 to 65 per cent of your before-tax salary or taxable The maximum lump sum you can insure for varies from policy

profits if you are self-employed. Housepersons can be insured for to policy, but pounds 500,000 or pounds 1m are common.

an assumed income of pounds 10,000. You don't have to insure for the

maximum.

What affects the cost? What affects the cost?

Your age, sex, occupation, income, deferred period, age to which Your age, sex, occupation, medical history, smoking habits, leisure

income will be paid, current state of health, smoking habits, pursuits, length of time you want to be covered for - either until

leisure pursuits. you die or for a fixed number of years.

Will premiums go up during the life of the policy? Will premiums go up during the life of the policy?

Yes, but the increase has to apply to all policyholders: the insurer Yes - typically when premiums are reviewed every five to 10 years,

cannot weight what you pay because you have made a claim. unless the insurer guarantees not to put your premiums up during the term of your cover.