Money: How to stay solvent in sickness

Tim Collison on policies that protect your income if ill health stops you working
ost of us are aware that we have to save for our retirement but what happens if you have to stop work because of ill health before you reach 60 or 65?

While your company may well pay your salary for up to six months, at any one time nearly 2 million of the working population are ill and off work for more than 26 weeks.

Nearly 7 per cent of the working population is claiming sickness benefits from the state, but the basic rate for an adult is just pounds 48.80 a week for the first 28 weeks. This rises again at 29 weeks and at 53 weeks but is taxable after the first six months.

The way to make up for the shortfall in benefits and lost wages is through income protection insurance. This is rather confusingly also known as permanent health insurance. This type of policy will pay out a regular monthly benefit, usually up to retirement date, although two-, three- and five-year policies are available.

As with a lot of health and protection insurance, there are several different types of policy on the market, all with their own confusing literature and complicated procedures. Last year the Office of Fair Trading told income protection and medical insurers to make things easier for the public. This is starting to happen.

Before you decide on the type of policy you want, you need to think about the level of cover you require. Penny O'Nions, of the Onion Group, an independent adviser, says: "One of the key things to remember is not to over-insure. Companies will only allow you a certain percentage of annual income. Some do 50 per cent, others do 60 per cent less state benefits. Others will do 75 per cent of the first pounds 25 000 and then scale the benefits down in layers."

Unum's Personal Protection Income Plan allows you to insure up to 50 per cent of income or pounds 125,000, whichever is lower; Lloyds TSB Life insures up to 60 per cent of your earnings up to pounds 50,000 and one quarter of your earnings above that, less state benefits. All income protection benefits are tax free.

As an example of what it costs, a man aged 35 earning pounds 25,000 in a desk job would pay Unum pounds 15.12 a month to insure half his income would be paid in ill health (payments deferred for six months). A woman would pay pounds 21.68.

If you are employed, you should be calculating the amount you want to insure from your gross salary (including bonuses and commission). If you are self employed you should take your net earnings, less any allowable business expenses.

You next need to decide when you want the policy to start paying out in the event of a claim - the deferred period. The minimum payment deferral period is four weeks and this is advisable for the self-employed policy holder who will not receive any company benefits.

You can buy policies from an independent financial adviser or from a company that sells direct to the public, such as Lloyds TSB. The standard policy on the market is a level benefit contract, which pays a set benefit formulated at the outset. All of the main insurers in this market, such as Permanent, Unum, Norwich Union, Friends Provident and Zurich Life, offer this type of cover. If you want your benefits to keep up with the rate of inflation you can take out an index-linked policy, which tracks the retail price index.

There are also unit-linked policies on the market, which are good if the fund does well, as your premium will be reduced or you can receive a lump sum when your policy matures. But as with all investment-related products, you could find that you have not accumulated enough money to get the benefits that you expected.

It is important to check the policy's definition of incapacity, as they all differ. Most of the better policies will pay out if you become unable to continue in your occupation.

Avoid "any-occupation" policies as you could find your claim turned down on the basis that you are fit to be a road sweeper, when you are trained to be a surgeon.

Premium rates in income protection have remained static for the last few years. Canada Life and Scottish Widows offer some of the most competitive. PPP Lifetime is also viewed by many IFAs as having an understanding and flexible approach to higher-risk applicants, -for example someone who is overweight.

Income protection insurers calculate premiums according to your age, sex, medical history and occupation. Women's premium are between 50 per cent and 100 per cent more than men's - insurers say women make far more claims than men. Premiums for smokers also go up by about 15 per cent.

Insurers categorise occupations according to the risk of a claim, so a metal worker would be in the highest ranking category, four, while a statistician would be in category one.

Many low-paid workers doing high-risk manual jobs have found it hard to get cover at affordable prices. In order to get round this, Unum and Zurich Life have brought out basic policies that ignore a person's occupation and enable the policy holder to buy lower level of cover that is flat- rated.

n Contacts: the Onion Group, 01494 726688; Lloyds TSB Life - contact your local branch. For other firms mentioned, call a local IFA.

n Tim Collison is editor of `Professional Broking' magazine.