Premiums can be sickeningly high

Income protection policies: the benefits vary widely, reports John Chapman
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Imagine being struck down by some long-term sickness or continuing disability, which prevented you from working. Your company, if you are not self-employed, might support you for six or even 12 months. But what then? Are you condemned to a life of poverty living off a state benefit of around pounds 70 a week?

Happily, there is a way out. More than 50 insurance companies are prepared to pay substantial proportions of your income, less state benefits, provided you have taken out permanent health insurance (PHI). Around 2.5 million people are protected by such policies, 60 per cent through group policies and 40 per cent individually. Most claims are linked to back, circulatory or mental problems.

Yet, despite their basic merits, sales actually fell from 160,000 in 1991 to 117,000 in 1995. A 10 per cent increase has been reported for 1996. But sales are still at relatively low levels. Why?

A substantial reason is the complexity of the product, and the variations available. Some products have investment elements, while others provide protection only. Premiums may be automatically renewable or subject to review. Benefits are generally set at a particular percentage of income, but may also vary with levels of income.

Conditions necessary to trigger benefits may be a total disability to follow one's occupation, though some policies introduce the concept of following "any reasonably suitable occupation". In addition, there are some 20 other conditions (deferred periods, income escalation rates, spells of unemployment and others), where terms vary between companies.

Such complexity makes it very difficult to choose between policies on offer. Indeed, in its July 1996 report on health insurance, the Office of Fair Trading called for a "benchmark product" to be drawn up by the industry, but there are few signs of this happening.

Do PHI products provide value for money? Earlier this year, a report by Tania Burchardt of the London School of Economics compared estimated actuarial premiums based on invalidity benefit data with the typical premiums in PHI policies. She concluded: "PHI might be appropriate for the better- paid self-employed, or employees who do not get long-term sick pay, for whom state benefits would not offer a good level of income replacement. However, current premiums do not appear to offer good value for money for the younger age groups." She added that it was difficult to assess the benefits for older people.

This conclusion might have been even more negative if account had been taken of the "over-insuring" revealed in the OFT report. One re-insurer revealed "perhaps 30 to 40 per cent of PHI claimants have their insured benefits reduced by some degree".

Over-insuring arises because premiums are related to expected incomes, while benefits are related to actual incomes at time of claim. Uncertainty about future income may be greatest among the self-employed. Furthermore, many policies have built in annual increases of, say, 5 per cent in premiums, and actual incomes may not rise so fast. But if actual incomes exceed expected incomes benefits are not increased.

What is the industry doing about it? As the OFT report indicated, if 35 per cent of the estimated 1 million individual holders of PHI were paying premiums of pounds 300 a year, of which pounds 75 was in over-insurance, then some pounds 25m a year may be paid in "wasted premiums".

One company at least now goes some way to what is needed. Permanent Insurance's new Flexi Protector policy allows clients to review their cover annually. If over-insurance is revealed when a client claims, Permanent will also refund excess premiums.

Overall, income replacement insurance appears like a good idea spoiled. Those holding PHI policies should check whether they have been over-insuring, and, if so, ask for refunds. That might stimulate the companies to offer a more honest product.

John Chapman, a former OFT official, helped prepare the report referred to above

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